Retailers and landlords alike struggled financially during the last year because of the COVID-19 pandemic. Their prospects are beginning to improve now however because stores are reopening and customers are starting to shop again, meaning in theory, retailers can afford to pay rent now. But now there’s a new problem—retailers and landlords can’t agree on what counts as a sale, The Wall Street Journal reports.
The sale debate comes from percentage rent deals that landlords have offered their tenants. Retailers pay a percentage of their monthly sales as rent instead of a fixed amount. This arrangement gives tenants relief during slow sales months. It also benefits landlords who could receive a surplus when sales pick back up again.
On paper, the deal sounds like a win-win, but e-commerce has made things more complicated. Some landlords want part of retailers’ online sales to be included in new leases. Their argument is that the brick and mortar locations are key for online sales. Retailers don’t agree, landlords, real estate brokers and retail executives, told The Wall Street Journal. Everything depends on how the documents were written.
“We’re just looking not to get hurt when they do sales (if the store is involved in that sale),” Simon Property Group Chief Executive David Simon told analysts in February. “If the store interaction is important to (retailers) we don’t want our sales to be reduced because the store is providing a service.”
Online sales creating a ‘gray area’ for retailers, landlords
The increase in online shopping has forced some retailers to use their stores as fulfillment centers, which is another reason landlords have argued that e-commerce sales should be included in tenants’ rent. It’s becoming harder to distinguish between online and in-store sales in some cases. For example, if a customer orders an item online, but goes to the store to pick it up, is that an online or in-person sale? A formula for this situation was never created so sales percentage leases have become more difficult to negotiate.
“It’s become a very gray area,” Alyssa Gates, director of North American property for cosmetics retailer Lush, told The Wall Street Journal. “Especially this past year, when there was so little in-store shopping.”
“Landlords don’t want stores used as warehouses,” added CBRE Executive Vice President Annette Healey. “They want all of the space in the store to be dedicated to sales for that store. But most retailers feel that if the transaction originated online, it’s not a store sale.”
Lenders aren’t as keen on the percentage rent lease
Landlords offering percentage rents isn’t new. It’s just become more commonplace during the pandemic. Tenants and landlords have also struck hybrid deals, where the retailer will pay fixed amount that’s capped and then a percentage of sales beyond the agreed upon threshold.
Unfortunately, landlords’ lenders aren’t as big of fans of percentage rent, which makes it harder to finance their properties. Investors want a guaranteed, consistent income stream and a lot of times landlords are required to keep rents at a certain level.
“The more percentage-rent deals that landlords do, the greater the push to include e-commerce sales in rent calculation,” Amish Tolia, the co-CEO of Leap Inc., which operates physical stores for online brands, told The Wall Street Journal.
Tolia noted his leases are all based on in-store sales only—even if an online order fulfilled at a physical location. He did say there have been more conversations recently with landlords about this topic, however. They want to know if online sales go up within a certain area after a store opens, as well as what percentage of e-commerce shoppers visit that location.
Meanwhile, there are landlords who have created their own online platforms for the their tenants. The platforms are designed to help tenants succeed but also show them how the brick and mortar locations are impacting online sales.
Until an agreement can be made on what constitutes as a sale, lease negotiations will likely remain complex, real estate brokers say.
“Ten years ago, you’d say this is the rent and hand over the keys,” David Abrams, chief executive of Masonre, a commercial real-estate brokerage and advisory firm. “Today, I have to be part psychologist and part accountant.”
Joe Dyton can be reached at firstname.lastname@example.org.