This year has been off to a promising start for the retail sector, with empty storefronts gradually filling up as people have ventured out of their homes and into the new normal, giving businesses the confidence to reopen or expand. As of Q1 2022, the percentage of retail vacancies across the country was 4.5%, decreasing 200 basis points from Q4 2021.

The sooner developers and landlords can fill the remaining vacancies, the better, as holding onto empty spaces can get costly, said Clay Smith, associate vice president at Matthews, a commercial real estate investment services and technology firm.

“There are costs associated with vacancies, whether it has to do with leasing commissions or tenant improvement costs,” Smith said. “Also, landlords have to start paying their share of the vacancy’s taxes, the insurance and maintenance. All of these costs can add up.”

To avoid vacancies during the pandemic, he said, many landlords chose to work with existing tenants who lost customers and made accommodations for them if they needed extra time to pay their rent or bring their stores and restaurants back to capacity.

Smith said that in some cases, however, landlords and developers have taken advantage of vacancies. Many leases, especially ones executed in the 1990s or prior, are paying rents below the market rate. If those leases expired or the tenant defaulted due to complications during the pandemic, landlords were able to make plans for redeveloping properties or re-leasing the space at a higher rental rate. By increasing their net operating income and getting a longer lease and oftentimes a stronger lease, they are able to add significant value to the asset.

“Some tenants could be paying substantially below-market rent because the rates that they locked in decades ago are lower than where rental rates are today,” Smith said. “If landlords and developers have a lease from the ’80s or ’90s that has expired, however, they can take a new lease to a much higher value.”

He said that another aspect of filling a vacancy that landlords must consider is the credit profile of the tenant occupying the space.

“The more creditworthy the tenant is, the less likely they will default on their lease or not make their rent payment on time,” Smith said. “Landlords are just looking for guaranteed income and not dealing with constant follow-ups about rent payments or suing a tenant over unpaid rent.”

Smith said that high-credit net leases are worth the investment because they would give landlords the comfort of knowing that they have tenants who can honor their lease.

He said that in addition to finding tenants to fill unoccupied spaces, some landlords have partnered with tenants to build new sites from the ground up. In this case, landlords and developers can use build-to-suit leases, or an arrangement between the two parties that involves building a space according to a new tenant’s needs. With this type of lease, the tenant can request a property that fits its target market. He added that having the tenants involved throughout the development process helps build relationships.

Finding the right tenant is important, Smith said, but what is more difficult and more important is finding the right real estate to develop.

“If you’re in a great market, there’s probably a great tenant who wants to be in a long lease,” Smith said. “However, finding that undeveloped piece of land, or finding a piece of land that needs to be redeveloped because previous tenants are leaving or the operator is retiring, is very difficult. There’s no lack of tenants looking for spaces, but there’s a lack of unencumbered properties that can be developed.”

Smith said that it takes a combination of savviness, hard work and effort to beat out other landlords and developers competing for the same opportunity. However, once you find an attractive site or redevelopment opportunity, tenants will flock to compete for a lease within the building or land.

“To be successful as a developer or landlord, it all starts with building tenant relationships and owning real estate with strong fundamentals,” Smith said.

This article was produced in collaboration between Studio B and Matthews. Bisnow news staff was not involved in the production of this content.

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