Nothing like recession to change the balance of power between landlords and tenants. “Over the last few years, clearly the landlord had the advantage,” says Andrew Goldberg, a senior managing director of Insignia/ESG's Retail Group in New York. “It is now going back toward the tenant having a better hand in negotiations.”

The result: landlords are sometimes bending on lease rates and dropping percentage rent clauses.

This shift in leverage has everything to do with vacancy. “A few years ago a lot of the better malls had a whole list of people waiting to get in,” Goldberg says. “Today, they have more space coming available than they expected. Mall owners were not counting on leases ending earlier than their expiration dates.”

The numbers appear to support Goldberg's observations. A recent report by REIS Inc., the real estate information and consulting firm, measured vacancy rates for more than 15,000 neighborhood and community centers in 48 metropolitan markets — properties that represent about 90% of all shopping centers and 70% of total retail GLA.

That report noted that during the prosperous first three quarters of 2000, the market not only ate up new retail space coming online, it also ate up lots of existing space, causing vacancy rates to drop. But from fourth quarter 2000 to third quarter 2001, net absorption of vacant retail space began to slow. Then, in fourth quarter 2001, vacancy rates shot up dramatically.

“The market not only failed to absorb any fraction of the amount of space delivered, it also gave up more space that had been previously occupied,” explains Tom Dwyer, REIS Inc.'s manager of retail solutions. “There was this massive shift in fourth quarter 2001 where we saw unprecedented numbers. Net absorption just plummeted. Retail vacancy went up about 50 basis points compared with the third quarter.”

Dwyer says the most eye-popping statistic is the net absorption of space in 2001 overall: at 9.6 million sq. ft., it is less than half the previous lowest figure (22.7 million sq. ft.) measured during the past 22 years. “While vacancy has begun to edge up, it is still historically low, and is still just below the level in 1980,” Dwyer observes.

According to preliminary data from REIS, the national vacancy rate in neighborhood and community centers continued to inch slightly upward through first quarter 2002.

Feeling the pinch

Markets such as New York, where the recession hit retail particularly hard, are feeling the reality behind those numbers. “There were about 1,400 vacant storefronts in New York two years ago,” says Charlie Aug, chairman of Garrick-Aug Associates, a top New York leasing firm. “Now there are about 2,300 vacant stores — about 40% more vacant space.

“If you look historically back 10 years ago — which is when most of the leases in the city were signed — you'll see that they were signed at a fraction of the cost of what the rates are today,” Aug continues. “With the leases that are coming up now in the greater New York area, the merchants are faced with much higher rent increases. A lot of them can't sustain their businesses based on these rents.”

Has Aug seen a shift of power away from New York landlords into the hands of retail tenants? “Absolutely,” he says. “There are a lot fewer tenants around looking for space today, and there's a lot more space.”

Supply and demand

In the past 12 to 18 months, some of the biggest names in retailing have disappeared or had to cut back, leaving hundreds of unrented stores in their wake. The list includes Kmart, The Museum Co., Toys “R” Us, McCrory's, Ames, Lechters, CVS, A&P, Service Merchandise, FAO Schwarz, Eddie Bauer, Gap, Albertson's and more.

Landlords who own dominant malls can still set the terms in lease negotiations, but for just about everybody else in retail real estate, it's time to think more about concessions than demands. “Leasing is pretty tough,” observes Anthony Buono, a managing director for retail sales with CB Richard Ellis in San Diego. “Rates are soft and in general are declining. In regional malls, tenants have a lot more flexibility in negotiating with landlords.”

“The economy has affected everybody, retailers as well as shopping center owners,” says Howard Grody, VP of mall leasing at Chattanooga-based CBL & Associates Inc. CBL has 52 malls in 25 states.

Grody says many retailers have scaled back their expansion plans. This slower expansion, combined with the bankruptcies of Kmart and others, has created a situation in which mall owners are working hard to fill vacant spaces from a shrinking pool of retailers. CBL can point to one recent coup. The first Target store in Charleston, S.C., will be in a CBL mall. How did those negotiations go? “They were tough,” Grody concedes. “But at this point everyone is tough.”

Cutting the best deals

In this environment, the strongest retailers can make the greatest demands. Target, Wal-Mart and Kohl's are the hot stores at the moment — and they know it. “They look at market comparables and will not pay anything above,” says Mike Neal, a senior VP and managing partner with The Staubach Co. in Atlanta.

Target always seeks a “win-win” situation for itself, knowing that many developers will shell out whatever it takes to do a deal, if only to prevent a competitor from beating them to it. “If a developer wants to be in business developing shopping centers, he better have a win-win situation with a Target or he won't be developing shopping centers for long,” Neal says.

Bill Winn, COO and senior VP of asset management for Passco Real Estate Enterprises in Santa Ana, Calif., says he has seen developers basically giving land away to Wal-Mart. Passco, which owns 18 mostly grocery-anchored shopping centers in its home state, doesn't have to deal with Wal-Mart much. But Winn says chains such as Starbucks, Michaels and various fast-food restaurants that are staples of community centers have quite a bit of leverage.

Usually, the owner is willing to deal because a traffic-generating store such as Starbucks attracts other tenants that want to be nearby. Winn adds that Starbucks, Michaels and other chains have adjusted their prototypes to fit in smaller centers because most primary locations are already filled.

Losing their leverage

At the same time, retailers who fail to generate traffic no longer wield much clout. “Some of the stores such as Gap, Old Navy, Banana Republic and the ultra high-end retailers have seen a significant fall-off in their customer base,” says Ted Slaught, a senior managing director at Charles Dunn Co., the Los Angeles-based developer. “Their negotiating power has significantly diminished.”

Donahue Schriber of Costa Mesa, Calif., which owns 62 shopping centers west of the Rockies, many incorporating Gap brands, finds itself in a similar position. “We are presently negotiating probably a dozen leases and we are getting fair-market rents,” says Candace Rice, Donahue Schriber's senior VP of leasing and merchandising. “There are strong sales at the centers to support the rents we are requesting.”

Retreating on percentage rents

In a thriving economy where strong sales seem almost a given, landlords see no problem with pushing for percentage rent clauses in new leases. But when the economy goes soft, many landlords take a pragmatic approach, focusing instead on negotiating the highest possible base rents.

Although experts say percentage rents are still being hotly negotiated in some markets, the issue appears to be fading from the scene for now. “Percentage rates exist in a variety of leases for a variety of tenants,” says Slaught of Charles Dunn Co. “But when you get into the large-anchor, high-volume, big-box locations it is somewhat of an anomaly these days. These kinds of tenants have been able to negotiate long-term, fixed-rate leases without any prospect of a percentage participation by the landlord.”

Neal of The Staubach Co. agrees. He says many mall landlords in Atlanta, for example, aren't pushing hard for percentage rent because they're having a real problem with occupancy.

For real estate veterans such as Charlie Aug, the ever-changing balance of power between tenants and landlords is a familiar part of an almost predictable economic cycle. For landlords, losing leverage might seem negative, but in fact it's part of a process that keeps retail markets active and strong. “Retail is in a healthy spot today,” Aug says. “Maybe it's not healthy by landlords' standards, but what's happening is we're laying the foundation for a recovery. Recessions are necessary and healthy. They clean things out, they prevent inflation, and you just start all over again.”

Steve Bergsman is a Mesa, Ariz.-based writer. Associate Editor Joel Groover contributed to this article.

SIDEBAR: Mall retailers move to hybrid and power centers

As regional mall development has slowed and consumer mall traffic has decreased, typical mall-type retailers have begun looking for other viable real estate solutions that will enable them to expand and locate stores in high-growth areas. Increasingly, a new breed of “blended” retail offerings — most notably “super regional” power centers and “hybrid” regional malls — are meeting these retailers' needs.

Super regional power centers aggregate popular value retailers, such as Target and Kohl's, and mall-type retailers, such as Sears, Bath & Body Works and Lane Bryant, into open-air shopping centers, 750,000 sq. ft. or more, located in markets lacking a regional offering. Likewise, hybrid regional malls place traditional power center tenants, such as Barnes & Noble, Bed Bath & Beyond and Old Navy, in open-air retail centers along side traditional mall anchors and in-line retailers.

There are many factors driving mall-type retailers to locate stores in these new centers, including:

  • Few Enclosed Regional Malls Under Development — With few new regional malls on the horizon, mall-type retailers are now forced to identify alternative real estate solutions in order to support expansion activities.

  • High Cost of Mall Occupancy — With profit margins decreasing, mid-size retailers are looking for more cost-effective lease rates in order to maximize revenues. Power centers and open-air regional centers offer attractive options with average occupancy costs less than half of those of traditional regional malls.

  • Consumer Shopping Habits — Today's economy has consumers looking for bargains and shopping at value retailers, such as Target and Kohl's. Typically found in community centers, but increasingly represented at super-regional power centers and “hybrid” regional malls, these value retailers have become the anchors for mid-size, mall-type retailers due to their ability to attract the right kind of shopper and a significant portion of the region's market share.

  • Speed of Deployment — Super-regional power centers and hybrid regional centers have minimal gestation periods as compared to 5-10 years for traditional malls. This enables retailers to enter new sub-markets and more quickly capitalize on market opportunities.

A prime example of a super regional power center is North American Properties' Camp Creek MarketPlace, a 750,000-sq.-ft. project located in East Point, Ga., a suburb of Atlanta. Though this high-growth community, devoid of a viable regional center, now demonstrates adequate density and income levels to support a traditional mall, the appetite of retailers calls for a more immediate solution.

In less than a year, retailers have flocked to this center, resulting in a line-up of powerhouse players, including Target, BJ's Wholesale Club, Lowe's Home Improvement Warehouse, Barnes & Noble, PetsMart and Staples. The rapid pace of this center's lease-up outpaced all industry projections — proving the viability of this pre-dominantly African-American, upper-middle-class Atlanta community.

The retail horizon is also marked with the swift movement of hybrid regional centers into new sub-markets. One such example is Bowie Town Center, developed by Simon Property Group, in Bowie, Md. Anchors include Hecht's, Sears, Barnes & Noble, Petco and Safeway in an open-air mall environment.

The deployment of these centers, and others across the country, are indicative of a definite trend in retail development. These new “blended” centers tailor a unique mix of traditional regional mall, power center, community and lifestyle center tenants that address the needs of the surrounding community, as well as expansion plans for retailers.

Mark Toro is a partner with North American Properties, a real estate development company specializing in power centers, mixed-use and neighborhood grocery-anchored centers. The Atlanta regional office has developed 2.7 million sq. ft. since 1996.