New Plan Excel Realty Trust Inc. faced an expensive challenge a few years back when an anchor, Builders Square, went dark at its Washtenaw Fountain Plaza neighborhood center in Ypsilanti, Mich. Soon, smaller inline tenants fled the 136,000-square foot project as well. So, New Plan Excel puzzled over how it could make money on a retail-light property.

“We had a struggling center,” recalls Michael Carroll, executive vice president of New Plan Excel. “With the peaks and valleys of the economy, sometimes there's a lot of demand from retailers and sometimes there's not. At the time, we couldn't attract any retailers so we started looking at alternative uses, non-retail tenants.”

The New York-based REIT experimented; leasing, for example, 5,000 square feet to Michigan's Department of Motor Vehicles. The DMV office, with 900 to 1,000 visits daily, single-handedly revitalized the center, Carroll says. And they paid just as much rent as any other inline tenant.

In fact, within just a few months of bringing the DMV to the center, New Plan Excel was able to rent the bulk of the small shop space to a mix of retail users such as RadioShack and Heavenly Ham and non-retail users such as Ypsilanti Dialysis, H&R Block and Nation's Insurance. The REIT also found two large retailers to backfill the empty anchor space, and today the center has only two small vacancies.

As proof of success, Carroll notes that New Plan Excel has since rolled out DMV locations in four other centers. “Their ability to generate traffic is attractive for all properties,” he says. And it doesn't necessarily cut into rental revenue.

Lesson learned: As the middle-class shrinks — and their disposable income with it — developers must get creative to offset retail slack.

Filling the holes

“Leasing retail space to non-retail tenants can help ensure a steady cash flow even in the face of an economic downturn and declining consumer spending,” says Ken Balin, CEO of AMC Delancey, a Philadelphia-based real estate owner and operator. “When retail sales slump [and stores go vacant] you have to figure out how to fill the space” he says.

NewPlan Excel is just one of many shopping center owners that are increasingly faced with empty spaces and underperforming centers, as retail tenants vacate once profitable spaces. Even though retail sales have been robust for many years, changing demographics and trade areas are raising concerns about future vacancies.

While not as sexy as, say a Gap, some service-oriented businesses can help hedge against a downturn in consumer spending. “They add a degree of diversity of rental income because when retail drops the school and medical offices are doing just fine,” notes John Mokas, director of leasing at Columbus, Ohio-based Casto.

Rating rents

And contrary to common owner concerns, they usually don't have to take a big hit on rental rates, says Rich Hollander, president of the Buxton Co., a Fort Worth, Texas-based retail research and consulting firm. “A lot of companies that have traditionally located in office buildings are realizing that they are more successful when they're closer to the customer,” he says. “The smart ones believe that they're better off paying higher rent for greater visibility.”

As for getting rents that are based on retail sales, a lot of owners are concluding that percentage rent doesn't add much value to a lease. “A lot of owners would rather forgive the percentage rent to get overall higher [fixed] rents,” says Wyatt Russo, senior vice president of The Retail Connection, a Dallas-based retail real estate brokerage firm. Even when the rent is the same as a previous retail tenant, cash flow is guaranteed.

Statistics bear that out. In fact, percentage, or overage, rent has come to make up an ever-shrinking portion of the rental income taken in by retail property owners. As the industry has matured, the majority of rental revenues has increasingly come in the form of fixed rents. On most leases today, percentage rents only kick in when retailers reach extremely ambitious sales goals. According to ICSC data, percentage rent accounts for less than 5 percent of REIT rental revenue, down from more than 15 percent 20 years ago. The trend has been spurred on by REITs, who have aggressively negotiated for higher fixed rents in order to be able to lock in their annual revenues and not have their fortunes tied to the fickle whims of consumers.

In addition to sustaining market rate rents with non-retail tenants, owners also can benefit from the credit and financial backing offered by many non-retail tenants with national brand names and multiple locations, Russo says. With credit-worthy tenants, an owner could increase the value of his property based on the leasehold value of the credit.

Russo contends that these non-retail tenants may be even better than local retailers. “If you have a start-up franchisee or a mom-and-pop, you might not have the protection provided by some of the better known non-retail users,” he notes.

Not the big easy

All great ideas…but that's not to say this is a miracle fix. “It's a slippery slope to have non-retail uses because if you have one that's not so great, you might not be able to attract other retailers and you might lose the ones you have left,” says Mokas.

Moreover, the doctors, lawyers and financial advisers are often one-offs, so there's no economies of scale to be gained from many of these transactions, says Jeff Green, president and CEO of Jeff Green Partners, a retail-consulting firm based in San Francisco.

The fact is, some non-retail tenants are more equal than others. While busy spaces, such as the DMV, medical centers and financial advisory offices increase foot traffic at retail centers and are backed by financially sound entities, others, say churches and back-office operations such as call centers, don't enhance a center's overall performance. They do provide for cash flow, but don't necessarily make the center attractive to other tenants looking for foot traffic

“We're approached by churches all the time, but they're just not a good use for a retail environment because they're only open one day a week and occasionally one night a week,” says Numa Jerome, a vice president with Columbia, S.C.-based Edens & Avant. “They don't generate enough traffic.”

Edens & Avant doesn't have a formal program to bring non-retail tenants to its centers and prefers to limit the number of non-retail tenants in each property. That's not to say that the owner doesn't value this category, particularly libraries or weight-loss clinics, for example. Jerome says that these uses generate traffic throughout the day, seven days a week and typically attract the same demographic group that retailers desire. “You want non-retail uses that bring in people who are most likely to cross-shop,” Jerome contends.

Other non-retail uses such as tutoring services like Sylvan Learning or medical uses may not be as attractive because their hours of operation are limited, but they still generate more traffic than churches and call centers. Even community colleges and beauty schools have their own peculiar benefits, Mokas notes.

“Throughout the day, the students and the teachers are going in and out and they'll stop for coffee, run errands or eat lunch at the center,” Mokas explains, adding that Casto, which owns and operates 19 million square feet in 81 shopping centers, has several centers with non-retail tenants, including schools. For example, the 138,000-square-foot Century City Plaza in Reynoldsburg, Ohio, claims the Ohio State Cosmetology school as one of its largest tenants.

In addition to generating foot traffic, non-retail uses can balance out the number of people who visit the center throughout the day and evening, notes Jeff Dash, vice president of retail leasing for The Lightstone Group, which owns several retail centers tenanted with non-retail users. For example, Larchmont Commons, a 130,000-square-foot center in Mt. Laurel, N.J., has a hefty mix of non-retail tenants including H&R Block, Novacare Rehabilitation Clinic, Great Life Wellness Center and Tot Time Child Development.

Dash points to H&R Block as an example of a non-retail tenant that is good for many centers. Even though the tax-accounting business doesn't operate year-round, its hours of operations is what counts. “Retailers do their business during the day, and most traffic falls off at 6 p.m. — about the same time that tax preparers' business starts to kick,” he says. So it could be an ideal complementary tenant, generating traffic at what would otherwise be a slow time for a center.

People need professionals

People need accountants — and doctors and financial advisers, too. As a result, the fastest growing non-retail uses today are medical and financial, Green says. “Neighborhood and strip centers are great locations for non-retail services like medical and dental offices, as well as insurance and financial locations,” he notes. “What's interesting is that they're used to paying pretty good rents, so they're not a bad reuse.”

And as Russo points out: “If a doctor or lawyer or another professional leases space, the owner would likely have the guarantee of a rental stream because of the personal net worth.”

With that in mind, Russo pursued several non-retail tenants as part of the revitalization of Lincoln Square, a shopping center in Arlington, Texas, a suburb of Dallas-Fort Worth. He signed leases with CitiFinancial and Children's Dentistry of Arlington, and then rounded out this selection of non-retail tenants with Coldwell Banker and a local staffing firm.

Russo notes that these tenants, although not retailers, bring in a fair amount of regular foot traffic. For example, when parents drop off their kids at the pediatric dentist to have a cavity filled or teeth cleaned, they don't waste time in the waiting room. Instead, they stroll around the center, creating traffic for retailers such as Bed Bath & Beyond and Ann Taylor Loft.

Mokas agrees, pointing to Casto's Circleville Plaza in Circleville, Ohio, as a prime example of mixing traditional retail with non-retail uses. The 300,000-square-foot center is anchored by Wal-Mart, but also counts Jackson Hewitt, CitiFinancial and Berger Health Systems as tenants.

In the end, the diversified centers of tomorrow may have a hedge over the all-retail centers of today if consumer spending does end up falling and cuts into retail, says Kristin Mueller, an executive vice president and director of business development for Jones Lang LaSalle Retail in Atlanta. “The time and effort is usually well invested,” she says. “In most cases, a property that isn't 100 percent retail is more successful.”