Is There a Pandemic-Proof Tenant Mix in Retail?

After a tumultuous year-plus, we can now glean useful lessons and insight for more successful strategies in retail leasing during a pandemic. The primary data driving these conclusions are actual gross sales from different categories of retailers. But there are other observations about tenant psychology and preferences that are noteworthy, including term duration. We looked at how retailers actually performed, survived and, in some cases, thrived amidst restrictive governmental health-related mandates and guidance, and found some interesting trends and patterns.

Impact on Retail Uses

The pandemic not only altered consumer habits, it also led to a shift in the mix of retail uses in shopping centers. As we fell into the pandemic, it was obvious that certain core “survival” retail uses were special and hardy and would better withstand customer avoidance. Perhaps the most notable of these survival retail uses has been grocery stores. Interestingly, we now believe other food concepts, particularly dessert shops, fast food and quick-serve food stores (such as sandwich shops) – what these authors refer to as “happy food” sellers – have a similarly strong resiliency. We have also seen the greater emergence of so-called ghost kitchen concepts – meaning, cooking facilities that only prepare food for delivery and/or takeout. Among other things, these new concept stores for restaurants who traditionally always included an indoor dining component allow for the leasing of fewer square feet in less desirable locations in a retail property (thus helping to reduce rental rates) and allow for a reduction of operational costs by avoiding additional costs that come with offering an indoor dining experience.

As customers looked for boredom relief, ice cream, desserts, fast food and quick-serve food stores (meaning prepared, ready-to-eat food stores) experienced a steady flow of consumer traffic. This is no longer a mere anecdotal finding. Ownership groups who have looked at trends in their reports of gross sales from tenants have seen a clear pattern emerge: These dessert shops and other prepared food sellers are less in need of, and can less justify asking for, rent relief – and are performing better than soft goods and other nonfood retailers.

The success of these food concepts may be attributed to several factors:

- Takeout orders constitute a large portion or even majority of their typical business;

- There is comforting convenience in drive-thru and pickup windows when coupled with the psychology of looking for reduced physical contact while still fulfilling a want;

- Although grocery store customers are drawn to the center, the traditional hope that customer traffic spills over to benefit adjacent small shops may be dashed when fear for health and safety are paramount. Yet, these same customers nonetheless may well be inclined still to visit a neighboring dessert or quick-food seller; and

- Even aggressive governmental mandates and restrictions recognize the need to find ways to serve customers needing and wanting food, including drive-thru and takeout operations and outdoor seating opportunities, even if in-store operations are prohibited.

 Impact on Retail Lease Duration: Smaller Retailers Lag

As in prior challenging economies, there have been plenty of retailers electing shorter duration terms or extensions. We believe this is a predictable and temporary change in overall tenant leasing strategies only. It seems obvious that it is due to the current climate and psychology of concern and worry about pandemic impacts on customer traffic.

In the case of financially healthy regionals, nationals and strong-credit retailers, we are already seeing a reduction in the number of shorter duration tenancies as these folks are returning to their traditional lease terms of five or 10 years. Thus, these higher credit retailers are clearly trending back to the retail norms on term duration. But we are seeing the hedge as well: an uptick in the negotiation of “kick-out” rights for a termination at an earlier juncture in the initial term, if sales were unimpressive in a specific measuring period. The use of kick-out clauses was more common in prior years and had largely been ignored by the stronger retailers for the last six or seven years. Arguably, failing to lock in option term rents at a depressed rate is a missed opportunity for retailers who opt for shorter duration tenancies without options, and the stronger tenants realize this. Yet, predictably, landlords are responding by pressing for market-rate clauses for option terms.

However, we are seeing a continued impact on duration of tenancies for smaller retailers. So, while regionals and nationals are already returning to their usual perspective of looking ahead many years in their leasing duration choices, we find that the “mom and pops” and local or small-chain operators are still by and large skittish and lag behind the larger tenants. Thus, we are still seeing the smaller retailers opting for shorter duration renewals and extensions and shorter duration initial terms, such as three years rather than five at lease inception. It appears the less confident tenants see a shorter duration term as a way to reduce risk and maintain flexibility. Arguably, it is a short-sighted perspective as it also allows landlords a sooner opportunity to increase rents.

While landlords have historically preferred the security of long-term leases, the result of the current climate, with landlords’ worries about filling vacancies and maintaining adequate cash flow, means that, for now, landlords prefer the “bird in the hand.” Our view, though, is that focus on the temporary trends concerning lease duration miss the mark. This topic is self-correcting over time and may even end up allowing landlords to recover higher rents in the near future due to lack of locked-in lower rates.

Strategies for the Future

We believe the focus now should be on use mix as the single most significant and helpful day-to-day strategy focus to improve leasing success in retail. One might conclude these retail-food-use leasing trends suggest new strategy guidance not only for retail leasing but also for ownership and acquisition choices going forward. In the short run, that may well be wise.

David S. Drobner, P.A., a partner at Duane Morris’ Real Estate Practice Group, concentrates his practice in commercial leasing, including negotiating and drafting complex commercial leases, subleases and assignments or other transfers of retail and office space. Cristina T. Sanchez, an associate, focuses her practice in the area of commercial real estate finance and commercial leasing.