Want proof that the retail real estate market is in a slump? The tenants are rebelling.

A year ago, everyone was clamoring to open new stores. Both large national chains and smaller regional players were happy to take any deal they could find and didn't insist on perks such as free rent or tenant improvement allowances.

Now things have changed. Recently, a big-box tenant looking at a 30,000-square-foot lease at a class-A property managed by Jones Lang LaSalle in the southeastern U.S. sought $6 per square foot off the asking rent and a build-to-suit allowance, among other concessions.

If this deal were taking place last year, the tenant would probably still ask for those things, says Chris Rehmet, senior vice president and regional leasing manager for the open-air division of Jones Lang LaSalle. The difference is that now the retailer is refusing to sign the lease unless it gets the concessions.

“The big change is the pace of the conversation — the tenants are more obstinate,” Rehmet says.

In some cases, tenants have so much leverage, they are actually walking away from deals. Gene Spiegelman, executive director of retail services with New York City-based global brokerage firm Cushman & Wakefield, represents a specialty apparel chain that has been looking at new locations in the southwestern United States. Recently, the chain has been thinking about taking some space at a class-A regional mall. But due to concerns about light foot traffic — the Southwest being one of the regions hardest hit by the housing downturn — the prospective tenant wanted 15 percent off the asking rent in 2008 and a switch to a percentage rent model in 2009.

“They want the landlord to partner with them on the risk in 2009; they are taking less of a gamble,” Spiegelman says.

So far, the landlord has not agreed to the terms and Spiegelman doubts it will. Instead, his client will likely move on to either a strategic Main Street location or a mall willing to accept more favorable lease terms. “We don't need them in this situation and they might not need us,” he says, referring to the landlord.

In many cases, the tenants' new attitude has led to longer negotiating periods — a deal that would have taken two or three months in 2007 now takes from four months up to a year, according to Brian M. Smith, chief investment officer with Regency Centers Corp., a Jacksonville, Fla.-based shopping center REIT with a 51-million-square-foot portfolio. So far, landlords are not overly concerned — after all, leasing activity has not come to a complete halt. But as the year progresses, those in smaller markets might be forced to accept discounts on rents — of 5 percent to 10 percent — and much larger concession packages.

“The leasing environment is definitely tougher than it was a year ago,” Smith says. “The anchor tenants are planning fewer store openings in 2008, and as a result, secondary markets are completely out of favor. And those retailers that do go to smaller markets will try to get very tough deals.”

Brazen new world

The change comes in the wake of numerous national chains announcing store closings and downward revisions in their expansion plans. In March, Charming Shoppes Inc. said it would open fewer than 56 new stores this year, a 50 percent decrease from 2007. The Bensalem, Pa.-based firm operates women's apparel chains, including Lane Bryant and Fashion Bug. Earlier this year, Charming had already said it planned to close 150 underperforming stores. Office Depot also announced plans to reduce the number of store openings in 2008 by half, to just 75. And, the Home Depot's expansion plans call for 55 new stores this year, compared to 87 stores in 2007.

In addition, troubled bookseller Borders and electronics retailer Circuit City are said to be up for sale. That's not good news since sales are often preludes to store closings.

These days, when national retailers do open stores, they are careful to take only high-traffic locations in top-tier markets, Smith notes. Meanwhile, the smaller operators who traditionally seek in-line space have virtually stopped expanding.

“The small shops are tougher all the way around — the restaurants are not doing so well, the credit crunch severely hurt the local mom-and-pops, making it difficult for them to get the financing to open new stores,” Smith says.

What's making the situation particularly difficult for landlords is that tenants are aware that if they fail to sign a lease now, they can get space at the same location a year from now, says Mitchel S. Friedman, senior vice president with RCS Real Estate Advisors, a New York City-based real estate services firm.

The national vacancy rate for retail properties is expected to rise 1.5 percent in 2008, forecasts Property & Portfolio Research, a Boston-based independent real estate research and portfolio strategy firm. Last year, the national vacancy rate in the retail sector averaged 9.7 percent, says research from national brokerage firm Marcus & Millichap Real Estate Investment Services.

The sense of urgency, which characterized leasing negotiations over the past few years, has gone out the window.

Lowballing

To date, the concessions retailers have sought tended to be modest, says Steve Ewing, vice president with Staubach Retail, an Addison, Texas-based real estate services firm. Larger tenants — taking spaces from 25,000 square feet to 35,000 square feet — want discounts on base rents ranging from $1 per square foot to $2 per square foot and one or two months of free rent.

They have also become bolder about negotiating on rent increases. Over the past few years, if the landlord sought a 15 percent increase and the tenant countered with a 10 percent offer, the owner would generally come out on top with the resulting increases ranging between 12 percent and 15 percent, says Patrick J. Paladino, Jr., senior vice president of retail brokerage with Colliers, Meredith & Grew, a Boston-based commercial real estate firm. However, recently Paladino was involved in a deal where the tenant, a restaurant looking at a storefront in downtown Boston, opened with an 8 percent increase — a lowball figure by 2007 standards — and managed to get the landlord to come down from 15 percent to 10 percent. “That's something I haven't heard in a couple of years,” Paladino notes.

Anticipating that the economy will start to improve next year, tenants have been pushing back opening plans to 2009 and 2010 and they are also seeking greater tenant improvement allowances, a marked change from 2007.

Jeff Fuqua, president of the Sembler Company, a St. Petersburg, Fla.-based developer with a 5.5-million-square-foot retail portfolio, says his firm is in negotiations with an undisclosed apparel chain that wants $60 per square foot as its tenant improvement allowance, whereas last year it was willing to accept $47 per square foot. And, the chain is seeking a rent reduction to $24 per square foot, from the $27 per square foot it agreed to in 2007.

So far Sembler has not agreed to the demands. With rising construction costs and the challenges securing financing, Fuqua says the company can't afford steep discounts on rents. But, he adds, “because of this there are a lot of projects just not being built. I've never seen anything like it.”

How low can it go?

As this year progresses, the situation could get worse, says Robert Bach, chief economist with Grubb & Ellis, a Santa Ana, Calif.-based commercial real estate services firm. If we are in a recession — which seems to be the case, with Federal Reserve Chairman Benjamin Bernanke acknowledging the possibility — we are only in the second or third month, whereas recessions typically last an average of nine to 10 months, according to Bach. That means vacancy rates at retail properties will continue to climb throughout 2008.

The market conditions are also likely to negatively impact rental rates. After growth of 4.5 percent in 2006 and 1.5 percent in 2007, rent increases in the retail sector are likely to remain flat in 2008, according to Property & Portfolio Research. And in smaller markets, rents might actually decline as much as 5 percent, Bach notes.

“The tenants are certainly enjoying more leverage now than they did 12 months ago and I wouldn't be surprised if the pendulum swings a little more in their direction in the next few months,” he says. “I do think we will see larger concessions, mostly in the form of free rent and higher buildup allowances. In the best-located centers, these concessions will be token. But in lesser properties, they will be significant.”