Shopping Centers Today International

JAN 2016

Shopping Centers Today is the news magazine of the International Council of Shopping Centers (ICSC)

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Rent escalations have for some time been a part of retail leases lon- ger than three years. Those escala- tions can vary based on the size of the deal, the credit of the tenant and the quality of the shopping center. In most long-term leases, rent steps are either paid on an annual basis or they increase after a given time frame, say, every three to five years. The most common annual increases usually are about 2 or 3 percent, with five-year bumps of 10 to 15 percent. In some cases, landlords negoti- ated sweetheart deals during the recession, with minimal or no rent steps, and now they are in a position to push harder for those midterm increases in new lease negotiations. "It really boils down to simple supply and demand," said Jennifer Watson, a senior managing director at New- mark Grubb Knight Frank, in Chi- cago. Nationally, retail vacancy rates have improved steadily, on strong demand for space from retailers and restaurants. "Rental rates are driven u p by this d e m a n d , which give s landlords more leverage in dictating higher rent steps," she said. As the retail sector has contin- ued in recovery, and with retailers and retail property owners alike on a more solid footing, landlords are again turning their attention to rent steps as a means to boost cash flow. In fact, landlords in some markets are hoping to leverage strong occu- pancies to negotiate for bump-ups that are even higher than the histori- cal norm. In New York City, for ex- ample, rent steps have typically been about 3 percent per year. But some landlords are pushing for 4 percent annual increases, notes Ezra. In some cases landlords are successful in getting those higher rent steps, in other cases they are not. But that ef- fort goes to show that landlords are trying to be more aggressive at their best shopping centers to create bet- ter long-term value, he says. Rent steps are a useful tool for landlords seeking to increase profits. Regency Centers Corp. reported in its third-quarter earnings call that it is now getting rent steps from about 90 percent of its tenants, with increases that have risen by nearly 70 basis points, to an average of 2.3 percent. At DDR Corp. 81 percent of new leases and 42 percent of renewals in- clude rent bumps within the initial terms, the firm said on its third-quar- ter earnings call. "This focus on rent steps is one of the most significant recent changes we have made as we negotiate and analyze deals, and one that we continued to leverage dur- ing the quarter," said Paul Freddo, DDR's senior executive vice president of leasing and development. "It seems to me that landlords are more focused on rent increases than ever before," said Ezra. "I would just caution that while things are generally good right now, retail has softened a little bit, and I want to make sure that my retail cli- ents are not overpaying with significant increases." The 4 percent rent steps in New York City now are not palatable for tenants, especially in the retail sector, which tends to be cyclical, he says. Most developers and shopping center investors are underwriting rental increases at 10 to 12 percent every five years on larger spaces, 12 to 15 percent every five years on mid- size spaces and 3 percent annually on smaller spaces, notes Terrison Quinn, a senior vice president and co-market leader at SRS Real Estate Partners, in Newport Beach, Calif. "That said, many developers and shorter-term in- vestors are not focused in on bumps nearly as much as many of the long- term institutional groups that will likely hold for a longer period of time," he said. Those long-term own- ers are particularly concerned about higher inflation ahead. Landlords are trying to get op- tions set at uncapped fair-market value, or adjusted in accordance w i t h t h e c o n s u m e r p r i c e i n d e x . "This has created complications with a lot of deals, because most credit tenants are not getting [real estate committee] approval without fixed, known rent increases over the ini- tial term and options," said Quinn. "This is especially true when a tenant is spending considerable tenant-im- provement dollars on their turnkey build-out and need to amortize those costs over longer periods of time with a fixed, known rent structure." Many landlords unable to get con- sumer-price-index or fair-market-value adjustments in the options are trying to get tenants to increase rent more frequently — 6 to 7.5 percent every 30 months, say, versus 12 to 15 percent every five years, says Quinn. "We see this working in more cases now than a couple years ago, but it is not yet the norm," he said. "At times tenants can get pushback at [real estate com- mittee], and it can threaten the lease from getting to the finish line." In addition to the push for higher rent steps, there also is a notable shift among owners looking to secure J a n u a r y 2 0 1 6 / S C T 49 With retailers and retail property owners alike on a more solid footing, landlords are again turning their attention to rent steps as a means to boost cash flow.

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