While the nature of the relationship between landlords and tenants remains purely transactional and in many ways adversarial, the crisis might push both to reassess their positions. The retail and hospitality industries do have some frameworks, designed to align parties’ interests. For instance, leases paid in the form of revenue sharing; or contractual terms, which prevent a shopping mall owner from accommodating its tenants’ competitors. However, it might be a good time to bring those relations onto the next level of collaboration. Talking broadly, there are four reasons, why such an experiment is worth trying.

Financial Rescue

Sadly, many retail businesses are not going to open again once the lockdown restrictions are lifted. Their business models were simply not designed to sustain such forced interruption. Private emergency loans and state support funds happened to be out of reach for many of them.

By no means do mall owners want to let troubled tenants shut down now, as “black holes” in their shopping infrastructure would immediately bring the place vibrancy down, reducing foot traffic and  triggering closure of even more SMEs. Unfortunately, overleveraged retail landlords do not have another choice, than to unleash this cascading process. However, well capitalized owners might be in a position to give their tenants a hand.

Strategic Partnership

As a result, both parties should enjoy the advantage of a more coherent space development strategy, which creates business synergies and excludes clashes of interests.

What starts as a rescue operation might eventually evolve into a new strategic opportunity. Not always, though, but under certain circumstances, such as:

*Financial and operational health of tenants’ business;

*Growing demand for tenants’ products and services;  

*Considerations, whether a landlord’s portfolio presents more locations for growing the physical footprint of its tenant;

* Tenant’s contribution into increasing foot traffic, generating spatial synergies for other tenants, creating brand equity and boosting place’s recognition.

In case of success, a landlord would end up enjoying multiple benefits from such partnership – increased occupancy, dividends from a tenant’s growing business and own brand recognition.

From a tenant’s standpoint, having a landlord as a strategic partner means ability to restrict competitors from entering the same physical space, and to foster arrival of tenants, whose business is complementary. As a result, both parties should enjoy the advantage of a more coherent space development strategy, which creates business synergies and excludes clashes of interests.

Source of Business Intelligence

n order to predict tenants’ business sustainability and foresee potential troubles in collecting rents, landlords need to dig much deeper into consumer sentiments

Many would find it difficult to describe what real estate businesses actually do, other than generate return on their assets and report to shareholders. The reason for such judgment is that real estate has been consistently treated as an asset class for passive investment, but not as a business, not as a sphere of serving customers.

As a result, real estate companies have, in general, a poor grasp of consumer market trends. In order to predict tenants’ business sustainability and foresee potential troubles in collecting rents, landlords need to dig much deeper into consumer sentiments, especially today. Being alert and agile in these turbulent times is essential for everyone’s survival.

Repurposing seems to be the most effective way of revitalizing retail real estate. Such a capital intensive “surgery” cannot be performed until a landlord has a clear vision of what exactly should be done. There is no room for error. There is no reliable source of expertise on obsolete assets repurposing, either.

The most obvious source of first-hand information on consumer market shifts are the tenants, operating in B2C spheres. Historically, they have been much more preoccupied with knowing their customers inside and out. Retail stores, in fact, have lost much of their distribution channel functions, and became tools for collecting data on consumer behavior. B2C tenants are much farther ahead of their landlords when it comes to tracking market sentiments. Therefore, equity partnership with key tenants might become a landlords’ compass in their repurposing journey.  

Technology adoption

Through equity partnership, the landlords’ system of incentives gets shifted in a very favorable way for the tenants

A big chunk of proposed technological innovations in real estate are built around occupiers’ needs. However, the capital and implementation power has normally been on the landlords’ side. Such deep misalignment has been one of the major hurdles on the way to mass adoption of real estate tech. This situation is especially common in the office segment, but in some cases it holds true for retail as well.  

Through equity partnership, the landlords’ system of incentives gets shifted in a very favorable way for the tenants. At last, parties’ interests become aligned. More than that, tech adoption is going to be a lasting project, which should be led by a designated mixed team of people from both landlord’s and tenant’s sides. Creating such a team, ensuring its continuous and productive work and, finally, arriving to a viable solution – all of that does not seem feasible, unless both sides truly have skin in the game.

Underwriting such investment deals certainly poses a big challenge, as there is no one to learn from.

There are actors in the real estate space who are already making steps into this direction. Most notable, perhaps, is the Fifth Wall VC firm, which has recently closed a USD 100 million retail fund. The investments are to be made in well performing online retail businesses, now seeking to expand into the offline space. Such businesses, in fact, constitute a surprisingly big category within the retail industry. Their rapid growth is driven by something that might be defined as “Amazon outcrowding phenomenon.” Not only has Amazon made the cost of digital advertising unsustainably high, but it has also gained its notorious reputation of retaining full control over its sellers’ data and using it for their own brand’s development. As a result, digitally native brands choose to follow an Amazon-resistant strategy, which includes brick and mortar stores as customer acquisition and data collection channels, as well as renting their own storage space and building own distribution chain. Forward thinking real estate players should definitely take a close look at this promising and clearly underserved customer segment.

Brookfield launched a USD 5 billion retail rescue fund, and some other institutional asset managers did the same. There is a different set of incentives for them, however – avoid the mass exodus of retail tenants from their properties. Those investments can be structured in different ways, including buying out tenants’ storage assets.

Underwriting such investment deals certainly poses a big challenge, as there is no one to learn from. Landlords seem to be taking more risk in this situation, and in order to balance it, they would probably expect higher risk premium, as well as more flexible option execution terms, convertibles, etc. This is going to be a steep learning curve for everybody.

Photo by Austin Kehmeier on Unsplash