Reprinted With The Permission From The Real Estate Finance Journal
By Richard J. Brunelli
Local retailers often represent the difference between a profitable strip center and one suffering from a negative cash flow. Strip centers of all sizes are much more dependent on leasing to local retailers than regional malls are. By definition, a local retailer is one with three or fewer stores, generally a family owned-and-operated business trading in a relatively small geographical area and not doing business as a franchisee or under a licensed trade name.
Positive Attributes Of Local Retailers: Local retailers are essential to the success of a strip center for a number of reasons:
Flexibility and openness to leasing opportunities. Often, a local retailer will commit to space that a chain will reject. In many cases, the space may not meet the strict specifications of the chain retailers in the terms, tenant mix, market demographics, anchor tenant (or lack of one), and or, the space configuration just does not match the chain’s prototype store.
Local retailers tend to be more flexible and, by some measures, better merchants. They are able to recognize a market’s demand for their products or services better than the real estate directors of large chains. Those directors generally are bombarded with leasing brochures and calls from brokers and owners. To cut through the clutter, they have to eliminate many locations based on strict site-selection criteria.
Personalized service. As markets become more overbuilt, the strip centers in those markets grow increasingly similar to each other in terms of tenant mix. Competition to attract the finite number of customers residing in a given locality is very tough. Owners, leasing agents, and retailers all agree: In such a market environment, service is often the aspect that sets the successful merchant apart from the crowd.
Offering the best service can take many forms, such as having short checkout lines, knowing customers by name, establishing liberal refund and return policies, and employing knowledgeable salespeople. A center with a good mix of service-oriented local retailers usually will outperform a similar center tenanted by chain stores unless those chain stores have highly motivated sales managers and staff.
The plain truth is, that the person likely to be most interested in a store’s success is that store’s owner, and one of the best ways to ensure success is by providing top-notch service. Chain-store managers often work for an impersonal owner hundreds or thousands of miles away, frequently are underpaid, and rarely have their compensation tied directly to their stores’ profitability performance.
Public relations value. Local merchants—especially restaurants—often have a loyal following of regular customers. The pace of their expansion is often dictated by the number of trustworthy relatives they have available to manage new units. Their success rests more on the level of service they provide than on the price or selection they offer. Many customers are willing to pay a little more for a better level of service.
The reputation of the local merchant often has deep roots. He or she has the store that local people “grew up around the corner from.” With careful expansion into adjacent trade areas, local merchants frequently are able to capitalize on that reputation through word-of-mouth publicity. Large chains, on the other hand, have to finance expensive advertising campaigns to cultivate the desired image to a new market.
Economic advantages. Local retailers are sometimes willing and able to pay higher rents than chain stores. Part of the reason may be that their sales per square foot are better because of the higher prices their service levels allow them to charge. Perhaps because they are so attuned to the market, they are able to project sales volume more accurately than chain real estate directors and thus can see the inherent value in a particular location that a chain might miss. Almost certainly, local retailers have more freedom to make on-the-spot decisions regarding a lease than does a real estate director, who normally is bound to conduct market studies and “sell” the site to a selection committee.
In many cases, local merchants will demand fewer leasehold improvements than chain tenants. Often, they command less free rent prior to opening, and they are far less likely than large chains to argue for changes in the standard lease. Owners should be wary, however, of standard lease forms signed and returned by local merchants with very few comments. Such lack of attention to so important an element of business may indicate other deficiencies in “business sense.”
Do not Lose Focus. Of course, there can be disadvantages in renting to local merchants, and they are easily identified. Unfortunately, owners anxious to lease empty space too often overlook these disadvantages. In many cases, a shopping center developer has to fight an overwhelming “urge to lease,” especially during the final months or weeks prior to the center’s grand opening. Control is required in order to achieve the best results.
The key to successful strip center leasing is to have a positive identification of the center’s reason for being and to have an appropriate tenant mix—one that matches the center’s reason for being—targeted well in advance of construction. In fact, the specific tenant mix should be formulated even before the project has gone through the approval process.
No doubt many developers have been hurt by local tenants whose businesses failed. Probably more often than we’d care to admit, however, local merchants, often family-run businesses, have had their lives ruined by having been granted a lease by an owner suffering from the “urge to lease.” Sometimes, a site plan has been developed without input from a leasing professional; other cases are the result of simple incompetence. Whatever the reason, however, the sad result is generally the same; failed businesses for local merchants followed by broken leases and empty storefronts for the developer.
Such unfortunate situations can be avoided, and the following guidelines can help:
Determine if prospective tenants currently own and operate any stores. If they do, a firsthand inspection is recommended; photographs do not tell the whole story. If a prospect does not own an existing store, find out specifically what experience he or she does have, and who will actually manage the operation and their experiences.
Under absolutely no circumstances should prospective tenants be considered until they have presented a viable business plan.
Require from prospective tenants a financial statement, paying special attention to the area of working capital available to carry the store through the typically unprofitable first year of operation. A reasonable security deposit should also be required.
Determine the level of advertising support tenants with existing stores are providing their other locations. Make sure they are willing to commit an acceptable level of advertising support to the new location.
Ascertain that the prospective tenant has access to reliable sources of supply and that the breath and depth of his or her merchandise mix will be sufficient for the level of competition in the market where the tenant will be operating.
Have a handle on the macroview of the market’s competitive environment, and limit tenant selection to those types of business for which there is a clear and demonstrated market need.
Failure to pay close attention to these guidelines from the onset of a new project’s development can lead to disaster for everyone involved. Developers pressured to fill empty space as a project nears completion are prone to violate basic rules. They begin mixing convenience tenants with specialty stores, perhaps throwing in a few office tenants as well.
As the center’s business/failure rate climbs, its reputation plummets, and the remaining tenants begin to suffer its effects. The entire center can end up in foreclosure with numerous businesses and families facing bankruptcy and ruin.
Following the six guidelines just outlined is important in avoiding such a scenario; but, even before that, careful attention must be paid to securing a good location and to informed site planning.
Finding the Best Tenants. A developer who starts out with a good location and site plan and an appropriate tenant mix target is already one step ahead of the game, but he or she still has to find tenants for the sores. When it comes to local merchants, probably the best way to do that is by door-to-door canvassing. Granted, it is hard work, and it might require fifty individual calls to fill each storefront, but no other method is as likely to ensure a project’s chances for success.
The obvious place to begin the search is in the town in which the center is located. From there, the search can be expanded into adjacent trading areas. The search boundaries should, however, be limited to an area served by a single dominant newspaper.
If, for example, a center is convenience oriented, the large chains have been contacted, and pre-leasing is focusing on local merchants, then the leasing agent should be out looking for the best pizza parlor, the busiest beauty salon, the area’s most popular drugstore. Tenant the center with the best local merchant available in each classification, and the synergy of the tenant mix will pull the center through difficult times and protect it from existing and future competition.
Local telephone directories and newspapers are obvious sources for leads. Owners who do not have in-house, full-time professional leasing specialists on staff are probably best served by employing, on an exclusive basis, the leading broker specializing in retail leasing in the subject trade area.
Depending on circumstances, local merchants may represent the best, the only, or the last group of retailers solicited in obtaining lease commitments for a strip center under development. The developer who wants to get the best local merchants should contact them as soon as the property is under contract. Their input will be important in defining their site-planning and space requirements, and it will help ensure the right tenant mix.
Targeted local merchants should be visited, inspected, subjected to a financial review, and, if they do not meet the developer’s carefully structured high standards, rejected. Except for financing considerations, there is no optimum ratio of local-to-chain tenant mix for any given center. Generally speaking, the larger the center, the more chains are attracted and required. The market will dictate how much choice the developer has.
In any event, developers should not wait until they get the “urge to lease” before investing the time and resources required to locate and interview the best local merchants. In the case of shopping center development, leaving the best until last can be a big mistake.