Retail enters the age of flexibility

In May, the hit Netflix show ­Stranger Things opened a four-month pop-up shop at Brookfield Properties’ Oakbrook Center in suburban Chicago. The pop-up provided an interactive experience for the show’s fans and coincided with the Stranger Things season four premiere. The tenant originally signed a two-month deal, but the pop-up proved to be so popular that the lease was extended for an additional two months.

Welcome to the age of flexibility in retail, as landlords continue to grapple with challenges relating to the rise of e-commerce and changing consumer expectations. With more space available to lease, some landlords have embraced flexible lease options in order to attract – or retain – occupiers for whom the traditional leasing model no longer works.

Although flexibility in retail leases depends on the type of asset and the landlord’s leeway, it is evident in certain segments. “Certainly, in the high street and shopping centers, we are seeing a shift in lease structures, not only in lease terms, but also the way leases are settled,” says Larry Brennan, Savills’ head of European retail agency in Dublin. “Before, we would be looking at leases in shopping centers of 15-years plus. Those days are gone. Now, you are going to see a blend of lease lengths.”

Indeed, for the first time, UK retail landlords anticipated leases of less than a year for 2022, with three to five year leases dominant, according to Savills’ retail landlord survey from June 2020. The survey data was the most recent available.

JLL’s EMEA head of retail research, Tjard Martinus, notes that there has been a quicker adoption of flexible leases in weaker or secondary retail assets, where landlords are at greater risk of having tenants move out or close stores. “In this case, we’re talking about leases of perhaps six or 12 months or even an introduction of break clauses.”

In such assets, retail owners are more likely to adopt turnover-based leases, which include a fixed-base rent and, on top of that, a flexible or “turnover” component depending on the revenue generated. In some cases, retailers pay turnover-only rent. “Fashion retailers and food and beverage operations in particular have been looking for more flexibility,” he adds.

Industry participants insist not all occupiers are looking for short-term leases. Martinus notes that he is now seeing some retailers in the UK wanting a more traditional lease structure, to have security of tenure and control the rising costs of fitting out a store.  However, headwinds impacting retail in the UK – such as its high density of stock and Brexit – are putting the country “at the forefront” of flexible leasing, says Brennan. “What you see in the UK market is not typical of everywhere in Europe, but it’s certainly an insight into where the market could be going.”

Pop-up revival

Before covid, flexibility was on the rise through temporary retail spaces or pop-ups, which are typically used to test a new market or generate awareness for a product. The pandemic, however, put a halt to these short-term lets. Since summer 2021, though, activity in this space has recovered strongly, says Mohamed Haouache, chief executive of Storefront, a digital marketplace for renting physical spaces to host pop-ups around the world.

“This surprised us,” he says. “There was a lot of talk about the fact that retail was dying, everything would move online and so on. But now that the covid crisis is technically over, we have seen more transactions and requests taking place at Storefront today than we had in the pre-covid world. This is a strong market signal for us that retail is not dying – it has changed. In the new world of 2022, short-term retail is extremely welcome.”

Haouache argues that, in today’s market, the long-term lease model is broken. Some new retailers, he explains, would not commit to a three-year lease, as they do not know if their brand will last during that period, or what future market conditions will look like.

Meanwhile, the omnichannel strategy is being fully addressed by major retailers, Haouache notes. “The fact e-commerce is growing is actually contributing to more physical retail opportunities for traditional retailers. By moving into a flexible retail strategy, they can capture more market opportunities, as they can test locations, products or market segments,” he says.

Landlords, for their part, are using short-term lets and pop-up stores to fill vacant units. “We have seen a lot of traditional institutional investors coming to our platform with vacant inventory. They know that some of their long-term lease opportunities are gone and might not come back in the future. So, they are changing their model,” Haouache notes.

The challenge to match long-term liabilities with multiple short-term rents means these investors are moving away from a predictable revenue model into an opportunistic model, where instead of having one long-term tenant, they have several short-term occupiers renting the space over the long-term lease period. 

“This is challenging but it’s either that or you sit in a vacant space for a while,” Haouache says.

According to Don Edrington, executive vice-president at Dallas-based SRS Real Estate Partners, the largest real estate firm in North America dedicated solely to servicing retail clients, most landlords have been willing to accommodate shorter lease terms in ­order to fill vacant spaces. “They prefer to have spaces filled to maintain cashflow,” he says. 

The ‘Airbnbfication’ of retail

Accepting a more dynamic occupier turnover means a more operationally intensive model. But multiple short-term rentals could encourage landlords to charge more per square foot than they would with a single long-term tenant, which is essentially what ­Airbnb does.

This is precisely what Haouache is observing through his platform, which The New York Times called the ­‘Airbnb of retail.’ The premium charge per square foot for a short-term lease – 14 days is the average at Storefront – can range from 25 to 75 percent higher than a standard lease, he says.

According to several industry participants, a premium for flexibility is not the norm at the moment, though. 

“When I’ve negotiated flexible leases, it is typically a lower rent or a turnover-only based rent. And part of the idea has been giving the retailer an opportunity to test the location and see the profitability from the store. And then there can be a discussion about what a fair rate would look like if the occupier wishes to take on a longer lease afterwards,” says Astrid Cheyne, director, tenant representation, EMEA retail at JLL in London.

“Some brands, however, are willing to pay higher rates because rather than being a retail store, it’s more of a marketing experience to create the buzz for a product or to launch a new product. For those very short-term leases, you will in some cases see occupiers willing to pay a premium to secure the right sites,” Cheyne adds.

Some commercial real estate landlords have built their own flexible leasing strategies to adjust to new retail demands and optimize rents. Legal & General Investment Management is one of them. In 2020, the UK asset manager developed flexible partnership models to deliver optionality to existing and future occupiers.

“Last year, we did around 100-plus deals through flexible partnership models, ranging from independent market stores all the way up to brands that wanted to do something a bit different,” says Denz Ibrahim, head of retail and futuring at LGIM. “It’s definitely going in the right direction, because off the back of this, we have a much deeper and closer relationship with our occupiers.”

Ibrahim explains that, as rents have dropped dramatically in the last 10 years, the aim at the moment is to achieve reasonable rents given current market conditions. “We are in a really strong position where these new deals are getting closer and closer to ERV [estimated rental value], within a more favorable partnership structure, which is fantastic,” he adds.

The asset manager is currently looking into flexible pricing based on seasonality. 

“That is pretty rare in real estate, to have some agility in pricing which responds to the rhythm of our assets. It has never happened before, and we are doing it at a small scale initially, but we will end up seeing it within the bigger shops,” Ibrahim notes.

According to Haouache, the flexible leasing trend in retail has just started but, by 2040, he predicts big institutional investors like LGIM will generate around 20 to 50 percent of their rental revenue through this model.

Ibrahim, for his part, believes the future of retail property is about finding the right balance of occupiers as well as having a balance between short- and long-term leasing.

Flexibility, though, is here to stay: “This is not a short-term solution ‘until the market comes back’ – it’s a cultural shift in how occupiers partner with landlords and how audiences engage with brands and places.”

Come for the pop-up, stay for the perm

Retailers have embraced the pop-up concept to create buzz for a product or to temporarily test a particular market. 

But this brief occupation of a retail space sometimes becomes permanent. “We see that all the time,” says Katie Kurtz, senior vice-president of business development at Brookfield Properties.

“Our success is seeing retailers do well enough in our shopping centers to want to flip to perm and stay long-term. That’s the biggest win for us,” Kurtz says.

One of the “winning partnerships” she highlights involves Carrousel, a Venezuelan-based kids clothing boutique that opened as a pop-up at Brookfield’s Merrick Park, in Florida, in October 2020. “During this time, they expanded their merchandise to carry other South American and Spanish brands. Their sales grew 50 percent, and they became a permanent tenant in July 2021,” Kurtz says. “They continue to do very well, and our shopping center is their only brick-and-mortar location in the United States.”

According to Brandon Isner, CBRE’s Americas head of retail research in Miami Beach, it usually takes one to two years for small retailers to build up enough revenue to be confident enough to take a long-term lease. “We estimate that around 5 to 10 percent of the temporary tenants [in the US] end up converting into long-term leases,” he says.