Retail Operators Unfazed by Inflating Rents, Occupancy Costs

Demand is not slowing in the retail sector despite inflating rents and occupancy costs, according to Margaret Caldwell, managing director and senior vice president at Northmarq.

“It has been amazing to see occupancy rates continue to increase,” she tells GlobeSt.com.

“This trend began during the pandemic. Many shopping centers had vacancies for years prior to COVID-19 during a time when we experienced significant retailer bankruptcies and store closures due to retailers’ downsizing.

“During the early stages of COVID-19, we thought brick-and-mortar retail demand was going to be significantly reduced but thankfully that was not the case. Americans want to experience retail shopping in person, and they love the entertainment aspect of dining in a restaurant.

“Consumer demand during the pandemic resulted in existing retailers expanding and new concepts evolving.

A Lack of New Retail Development

Corey Bialow, CEO, Bialow Real Estate, tells GlobeSt.com that in Florida, Texas, and Arizona, retail rents are starting to cap out as retail occupancy costs are becoming too high as a percentage of sales.

Bialow said the reason for this dramatic decrease in vacancy rates was primarily due to the lack of any new retail development for 3 to 4 years as nobody really knew how long COVID-19 would last.

“Within the next 12 to 18 months, we’ll start to see rents decline and vacancy rates rise as a lot of new product comes onto the market.”

He said that additionally, heading into a recessionary period, many large national retailers will be announcing mass store closures – brands such as Bed, Bath & Beyond and Party City already have.

Rising Sales, Decreasing Occupancy Costs

Mark Sigal, CEO of Datex Property Solutions, tells GlobeSt.com he is not surprised to see retail vacancy numbers decreasing and rents increasing.

Based on Datex Tenant Track data, which analyzes validated rent collections, retail sales, and occupancy costs across thousands of shopping centers and tens of thousands of retailers nationwide, 12 of the 21 categories tracked show rising sales and decreasing occupancy costs, which are the strongest, clearest indicators of retailers’ capacity to pay their rent, and thus, stay in business.

In fact, disproportionately low occupancy costs are indicative of retailers’ capacity to pay higher rents, since occupancy costs track the portion of sales eaten up by rent and triple net costs.

Looking at tenant occupancy trends, they continue to improve month by month, and January numbers bumped up another 0.42% versus December 2022. Notably, tenant occupancy numbers from January, December, and November, respectively, outpace their prior year comparisons, with January 2023 showing a 2.62% bump versus January 2022.

Collection Trends Raise Some Concerns

That noted, the collection trends for national tenants in December 2022 raise some concerns, with December 2022 rent collection numbers dipping to 92.72%, representing a drop of 2.52% versus November 2022, and the single lowest collections percentage for national tenants since February 2021, when the recovery from the pandemic was in its early stages.

“One month does not a trend make,” Sigal said. “Having limited new shopping centers being developed in the past three years, we are optimistic that vacancy absorption shall continue unabated and retail tenant metrics will remain strong in the new year.”

Occupancy Costs: Explained

Occupancy cost is a standardized metric used in brick-and-mortar retail in the same way that sales per foot and rent collection percentages are standardized metrics.

To calculate occupancy costs¸ take the recurring charges that a given retailer pays and divide that number by their reported sales.

So, if a sandwich shop that pays $3,600 in monthly rent plus triple net generates $100,000 in sales in that same month, it has an occupancy cost of 3.6%.

Then, say a better newer shopping center opens down the block and attracts many of those patrons, and the sandwich shop sees its sales drop to $40,000. Now the same $3,600 rent divided by $40,000 = 9% so occupancy costs have increased by 2.5X in this case, effectively meaning a higher marginal cost for the physical location.

Fast food has averaged 6.77% occupancy costs across all Datex clients over 48 different reporting periods since 2019, so fast-food operators with materially higher occupancy costs are potentially struggling.

Fast Food operators paying materially lower occupancy costs are probably not paying enough rent and when the lease comes up for renewal the landlord has a strong basis to negotiate higher rent.

Movie theaters’ occupancy cost average was 16.04% pre-pandemic. Post-pandemic, those costs have averaged 50.36%, which means over 50 cents for every dollar generated of sales is going to rent.

“That’s not really a sustainable business model,” Sigal said.