Who's Holding the Cards in Retail? Tenants or Landlords?

Over the past year, we've watched retail vacancy rates slowly rise nationally at the same time record amounts of new retail space delivered or broke ground. Couple this with retailers pulling back on expansion plans, closing unprofitable locations or even going bankrupt, and the question many are starting to wonder is, just how strong is the retail market? Is it still a landlord's market? Or do retailers now hold all the cards?

For the answer, CoStar interviewed several 2006 CoStar Retail Power Brokers from across the nation. Not surprisingly, their mixed results vary somewhat regionally. However, the consensus is that it's not yet a retail tenant's market, but the tide is turning in that direction.

Pat McHenry, senior vice president of retail brokerage for CB Richard Ellis' Denver office and a 2006 CoStar Retail Leasing Power Broker, said she's seen a clear uptick in concessions to retail tenants over the past year.

"Development is still active enough that tenants have choices and as retailers in general pull back, the one's that are still expanding have more leverage. So it may not be a tenant's market, but it’s a lot less of a landlord's market than it was two years ago," said McHenry.

In Denver as in most areas, McHenry said retail conditions tend to be submarket specific. "Strong submarkets with good density and higher incomes that are supply constrained -- those submarkets are still landlord markets where there's a lot less wheeling and dealing going on. In the less desirable submarkets and those in outlying areas where developers are trying to go out in front of the market it’s a more competitive situation and is really starting to become a tenant's market -- that's where I'm seeing the most negotiating being done and concessions being given."

Another area McHenry is seeing tenants have more power is in trade areas hurt by store closures. "In certain trade areas you've got boxes that have opened up very close to each other, and they're competing. I have a situation like that now where I'm representing the tenant and they're getting a better deal because there are multiple options in the submarket."

Don't expect to see lower rent, however, McHenry cautions. "Landlords are working very hard to keep their face rates up and they're willing to give more tenant improvement allowances and free rent to try to maintain rental rates." Three years ago, free rent had "almost disappeared," McHenry said. Now she's seeing three to six months of free rent being given. And although the change hasn't been as dramatic with TI allowance, she estimates, she's seen a 20% to 25% increase in the amount of TI.

McHenry also said she is starting to see broker commission incentives, such as a higher percentage or dollar amount per-square-foot offered by some developers, particularly existing landlords, to get more exposure for their retail centers. McHenry points out, however, that broker incentives aren't seen as much in the retail industry because they're not very effective. "I think the broker incentives aren't as effective in the retail space because retailers' analysis of sites is a lot more complex than an office tenant, for example. So when brokers are looking at sites for their clients, they are more focused on fulfilling all the various needs than they are on an increased commission."

McHenry acknowledges that with national and regional credit tenants pulling back, landlords are opening up to local, less-credit worthy tenants. "I think landlords are more willing to do deals with lesser credit tenants. I'm not seeing them have a lot of leverage in negotiating terms, its just that some landlords are willing to take the risk of brushing off a not-so-great financial statement to take on a local tenant with a good concept."

"Landlords' responses to the current market are a mixed bag. I have some landlords that understand the marketplace and have increased responsiveness accordingly, grabbing deals when they show up. But then I have some institutional clients that continue to move slowly to get deals done and they're losing out on more deals as a result. I think the sales cycle is shortening up and those that don't respond quickly are being left out," McHenry stated.

With the caveat that there are certain retailers that won't benefit from more inventory because of prototype constraints, McHenry said she anticipates more vacancy in existing shopping centers, which will result in conditions that favor tenants over the next year. "It's going to be most prevalent for junior anchor tenants, but in general tenants that are willing to look at second generation space are going to have an easier time finding good deals and locations."

Also in Colorado, we talked to Chris Boston CCIM, an associate at Gibbons White and a specialist in the Boulder retail market. Boston said he's not witnessing landlords increasing concessions to retail tenants; in fact, he's seen a "firming up" of retail rents and competition for space in certain markets. Boston doesn't think it’s a "tenant's market" in his area and also doesn't think the market will turn to favor retail tenants in 2008.

source: costar.com