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Higher Rents

Power to the landlords? Some see shift as retail market recovers


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The window for flat and even discounted rental rates is starting to close, experts say. That means franchisees looking for new locations should move sooner rather than later, to beat the increase.

Tenants have remained firmly in the driver’s seat in recent years as shopping center owners worked to retain tenants and fill empty space. Yet as the retail market climbs out of the recession, some of that power may soon start shifting back to landlords.

“We haven’t seen much upward pressure on retail rents since the market started to recover, and it’s mostly because there has been a lack of demand,” says Ryan Severino, senior economist and associate director of research for Reis Inc., a New York-based real estate research firm.

The national vacancy rate for neighborhood and community shopping centers has changed very little in the past five years. Although vacancies declined slightly to 10.4 percent at the end of 2013, they remain elevated compared to 2008 levels, 8.9 percent, according to Reis.

It has been a weak economic recovery both in jobs and income growth. “That has taken a little bit of the wind out of the sails of consumers,” says Severino. Another challenge for the retail sector has been increasing competition from online sales. “Those two things have conspired together to hold back demand,” he adds.

Starting to close? 

Given that backdrop, it is no surprise that rental rates have moved very little in the past few years. In fact, effective rates for neighborhood and community centers averaged $16.83 at the end of 2013, just 8 cents above 2009 levels, according to Reis. But the window of opportunity for flat and even discounted rents may soon start closing.

Penn Station East Coast Subs is one company already starting to see landlords pushing asking rents higher. In 2008 and 2009 when the economy was really struggling, it wasn’t surprising for landlords to come off their asking price of $20 per square foot and go as low as $15 or $16. Now landlords are asking $24 and they might only go down to $23 or $22, says Craig Dunaway, president of Cincinnati-based Penn Station. “So, it is kind of a double-edged sword. They are going down less and they are asking for a little bit more,” he says. 

There are cases where landlords are once again in a power position to start pushing rents higher. “By and large those are more the exceptions than the rule. In the majority of cases, it is still very much a tenant’s market and not a landlord’s market,” says Severino. Most notably, concessions are disappearing and rents are creeping higher among high-end malls, top neighborhood and community shopping centers and well-located lifestyle centers.

Rents do vary widely from market to market. In the Midwest in particular, rents have remained fairly consistent over the past five years. Rents may have inched slightly higher, but not by much, notes Dunaway. When you get into markets in the south such as a Charlotte or Raleigh or into the east coast near D.C., rents are very expensive, he says.

Penn State ups estimate

For example, Penn Station recently updated information for its franchise disclosure document related to real estate costs. In 2013, the company estimated its real estate rental costs for franchisees between $18 and $26 per square foot. The company since has raised that estimate to between $20 and $28 per square foot for 2014. That increase is based on quoted rents the company has seen in the 13 states where they have locations, including Ohio, Indiana, Kentucky, Georgia and Texas, among others. 

“I think what really matters more so than broad generalizations about property sub-types or wide geographical areas is the underlying economic and demographic characteristics of these trade areas,” says Severino. Those centers located in very affluent areas with high income earners have pricing power, as do those properties located in good inner-ring suburban locations with good population density.

Buffalo Wings & Rings expects to open six or seven new stores in 2014, but the firm does not anticipate big jumps in rents for those new locations. Quality sites always have been expensive. “So, when the economy collapsed in 2009, we did not see the price of the rent going down,” says Philip Schram, vice president of development at Buffalo Wings & Rings.

Buffalo Wings & Rings is typically looking for B+ or A- locations, whereas the discounts were mainly in the lower quality B- and C centers that suffered significant store closings. For the most part, the company has seen rents remain stable in recent years. “I think the price of the rent is following the general Consumer Price Index,” says Schram. The cost increases in labor and construction will likely cause rents to rise slightly in the near term at about 2 to 3 percent, he adds. 

What could accelerate rent increases further is a bigger demand for space. Franchise groups are already seeing competition increase, especially for premium real estate locations. Restaurant and retailers were planning to open an estimated 38,000 new stores in the U.S. over the next 12 months, according to a ChainLinks Retail Advisors report published last fall. Restaurants accounted for 44 percent of those new units.

The best advice for tenants thinking about signing a new lease or opening new stores is to move sooner rather than later. Reis expects asking rents to rise about 2 percent this year, 2.5 percent in 2015 and likely nearly 3 percent in 2016. “From a pricing point of view, it is only going to get more expensive as we go forward,” says Severino. 

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