LOIS WEISS: Retail Is Being Manipulated To Live Another Day
For years, business practices by a select few retail owners have been driving asking rents sky-high on key New York City retail corridors. These machinations, while completely legal, have masked the actual net effective rents in some of the most coveted retail locations, and have changed the makeup of the merchants along the city's busiest shopping districts.
But now, the changing market is leaving buildings unsold and vacancies increasing.
As the market rose, some NYC retail players purchased buildings and retail condos for soaring prices, brought in equity partners and short-term debt, obtained high mortgages, and later sold them, rented or not, for a big profit.
Other owners were more creative. They thought long and hard about properties they wanted and about ways to make the retail space in them more attractive. Sometimes, after acquisition, they played musical retail chairs and moved ceilings and walls, along with tenants.
Luxury retail tenants leased the reconfigured stores for thousands of dollars per square foot, and with the new deal, the developers could refinance the property for a cash infusion. Without selling holdings, they could make roughly the same amount of money as landlords who flip properties in the world’s most expensive shopping districts.
As the market rose, the landlords pushed for rents far higher than what the current occupants were paying. Asking rents nearly doubled in New York between 2012 and 2014. The discrepancy was even greater along Broadway in SoHo and along stretches of Fifth and Madison avenues.
“In the High Street areas, we have been in a frothy market,” Adelaide Polsinelli of Eastern Consolidated said. “You had to read the tea leaves, because there is no place to really vet out [what] the actual rent [is].”
The real estate industry's metric for price is asking rent. But there are too many factors in play to accurately determine what a tenant actually pays every month, Polsinelli said.
To capture rising values, a building or retail condo owner may jump ahead of the market and provide incentives. Even if tenants have several years left on their leases, the owners could try to convince them rents are rising. They can renegotiate and extend the lease or shops could lose their prime space.
In other cases, in exchange for a new or longer lease, owners may give free rent, swap locations within their portfolios or even provide additional locations in secondary corridors. All these machinations bridge the gap between the asking rent and what tenants can really afford to pay.
“When a retailer needs money to run their business they can sell their receivables at a discount," Polsinelli said. "Some owners have applied this to enable their tenants to get to the point where they can afford the market rent.”
To seal the Nike deal at 650 Fifth Ave., for instance, the retail operators, Jeff Sutton and SL Green Realty Corp., bought out three other tenants completely and enlarged the space they had previously staked out in the base of the office tower.
Once Nike moves in, these retail condo operators will also take over the balance of the Nike lease in the Trump Tower annex at 6 East 57th St., which runs to 2022 and has two five-year renewal options. It has an old lease and very low rent, giving Sutton and SL Green wiggle room to cut sublease deals.
Nike was also given millions of dollars toward a work letter at its new location, sources said, essentially a check from the landlords for the construction. Nike will do all the work itself and receive six months of free rent, whether or not it opens as planned in August. Over time, its lease is worth some $700M. So what if the actual net income is a bit less?
Once a retailer is given a work letter or bought out of its lease, it has the money to move, fix up the space and pay higher rent in the new location. It can walk away from the old location when its new store is built out and not worry about buying out its old lease itself. Bloomberg reported that Joseph Sitt's Thor Equities provided Tom Ford $12M for a work letter at its recent 12K SF lease at 680 Madison Ave.
All of these factors are inflating asking rents beyond reality, as the effective price these tenants pay is rarely made public.
“You can’t value something on asking rents,” Polsinelli said. “It’s not just the taking rent but what went with it. It’s not for the faint of heart.”
And yet, based on the asking rent of one property, owners ask for more in the space next door, down the block or across the street. They may even obtain something akin to this higher rent from similar tenants but with even deeper pockets or better credit.
Vacancies shot up in 2017's first quarter. Some owners keep many of their retail spaces empty by insisting on high asking rents, but with the ultimate exit strategy of selling the property if they do not find a tenant.
These owners can point prospective buyers to the high rent reportedly paid by the relocated tenant as a comparison. As the prospective buyer drools over the prospect, the seller explains it can buy this property and get that same rent, sealing that sales deal.
Once the property is sold, the new owner’s bankers and equity partners expect the rent they were sold on, and will not approve deals that do not bring in that cash. But now, in the current retail climate, there are not a lot of stores looking for spaces at high rents. Retailers do need to make money, too; not every dollar of a high-profile store's rent can be chalked up to the marketing budget.
Brokers that represent retail tenants have been advising them to wait it out, because rents have to drop at some point. Unless a store absolutely must be in a certain location, or one of the best locations comes available, tenants are advised to wait or lease on a side street or down the block at substantially lower rents, but with similar foot traffic.
As the music has stopped, along with rising retail rents, the market is going to face adjustments. The real question is: How many keys will get handed over to lenders because they will not allow a lease to be signed with a lower net effective rent?
Retail is not dead, some of it has just been manipulated and reconfigured into something worth less in many locations and something much more in others. Along with losers, there will be winners.
Lois Weiss is a Bisnow featured columnist as well as a real estate reporter for the New York Post. She has covered New York City real estate for more than two decades and is a past president of the National Association of Real Estate Editors.