REBusinessOnline

Reduce High Retail Occupancy Costs by Ensuring Property Valuation Isn’t Excessive

Small businesses face enormous challenges in competing online with major brands such as Amazon and Walmart, which command a far greater web presence than small mom-and-pop retailers. Pictured is a recently completed distribution center for Amazon at Pullman Crossings in Chicago.

By Morris Ellison, Womble Bond Dickinson

E-commerce was here to stay even before the pandemic devastated small businesses and placed an even greater premium on technology. In the changed landscape, lowering occupancy costs by reducing property taxes is one of the most important steps businesses can take to remain competitive.

Stay-at-home orders still prevent many shoppers from visiting their favorite brick-and-mortar stores, while fear of contagion exacerbates consumers’ reluctance to shop in person. Regardless of customer traffic, however, retailers still incur fixed costs including insurance, enterprise software, property taxes and, arguably, rent.

Morris Ellison, Womble Bond Dickinson

Online-only retailers’ occupancy costs are much lower, making it difficult for small brick-and-mortar businesses to compete. Put differently, sales taxes decline with reduced sales but property taxes do not. Landlords and tenants in triple net leases often fail to examine property taxes, but the survival of both may depend on reducing this cost.

Other costs such as insurance and the enterprise software needed to run the business generally lie beyond a small business’ control and do not diminish with reduced business volume. The active 2020 hurricane season certainly has not reduced insurance costs. During the pandemic, some landlords have deferred or forgiven rent, but this forbearance provides no long-term solution to the challenges e-commerce poses.

Mounting pressures

The threat that high ad valorem taxes pose to pandemic-battered small businesses is compounded by, and interrelated with, the e-commerce threat. Small businesses face enormous challenges in competing online with major brands such as Amazon and Walmart, which command a far greater web presence than small mom-and-pop retailers.

E-commerce’s challenge to traditional retail will not end with the pandemic. The bulk of retail sales still occur in stores, with online purchases peaking in the second quarter of 2019 at just 16 percent of total U.S. retail sales, according to the Commerce Department. That percentage slowed to 14 percent in the third quarter.

COVID-19 has accelerated the trend to “Buy Online, Pick Up In Store” (BOPIS). Pre-pandemic, BOPIS offerings were already growing as shoppers used it to avoid in-store browsing time and shipping charges. A 2018 study reported 90 percent of surveyed online shoppers stated high shipping fees and home delivery longer than two days would likely deter them from completing an online purchase. Even before the pandemic, Amazon’s rapid delivery model was pressuring conventional retailers to compete by accelerating shipping times.

BOPIS allows retailers to blend online and in-store customer engagement while offering a more convenient way to shop. COVID-19 accelerated this trend as shoppers sought to minimize interpersonal contact during store visits. Retailers, however, need to be certain that applicable restrictive covenants permit BOPIS, since shopping centers often limit tenants’ right to use common space. Further, traditional methods of valuing properties for tax purposes struggle to recognize and separate the intangible and untaxable value of web presence from the value of a physical location that serves as a pick-up point.

Black Friday and Cyber Monday 2020 illustrate the evolving relationship between brick-and-mortar stores and e-commerce. RetailNext reported foot traffic to physical stores on Thanksgiving through the following Sunday decreased by 48 percent from 2019, while spending per customer increased more than 36 percent.

Mall traffic tracker Sensormatic Solutions concluded that online ordering and social-distancing restrictions made shoppers more “purposeful” on their Black Friday trips. Adobe Analytics reported that Black Friday saw $9 billion in U.S. online sales, a nearly 22 percent increase year-over-year that made it the second-largest online spending day. Cyber Monday brought the largest shopping day in American history with $10.8 billion in volume, a 15.2 percent increase over 2019, Adobe reported.  Adobe also noted that Black Friday curbside pickup increased 52 percent year-over-year.

Shared interests

Landlords and tenants must recognize the mutual harm of high occupancy costs and guard against unwarranted property taxes as local governments seek to shore up their finances. Every nickel counts when retailers are under economic pressure just to keep their doors open. Years of remaining lease term is of cold comfort to a landlord whose tenant is forced to close by reduced revenue and high occupancy costs.

Some short-sighted landlords ignore the property tax burden placed on their triple-net tenants until a renewal is imminent since the landlord’s costs are not directly impacted.  Where possible, a good lease on multi-tenant properties will address tax challenges and discourage taxes from being viewed as a mere pass-through expense. Further, prudent landlords should help reduce tax costs and avoid being forced to negotiate reduced rent to keep small businesses operating. Most leases do not include a provision permitting tenants to challenge ad valorem property taxes.  Similarly, many state statutes only permit property owners, not tenants, to challenge taxes.

Most assessors have not yet recognized COVID-19’s impact on retail stores, primarily because the valuation date for most properties preceded the pandemic’s full impact on retail. That will change in 2021 in many jurisdictions. Similarly, the trend toward BOPIS will increase the intangible value of online presence, generally not subject to ad valorem taxation, and decrease the importance of physical locations.

COVID-19 is pressuring local governments to increase the property tax burden on small businesses. A recent survey found that municipal revenues are down 21 percent while expenses have increased 17 percent amid the pandemic. The survey reported 45 percent of mayors expect to see dramatic budget cuts for education, while at least one-third expect to see drastic cuts in parks and recreation, mass transit and roads. Only 36 percent of mayors expect to see a replacement of the businesses shuttered due to COVID-19.

High property taxes will only exacerbate the municipal revenue problem. A short-term remedy to municipal finances, higher property taxes, risks the permanent closure of many small businesses. Failing to address the problem will only accelerate the decline of physical stores and eliminate their local jobs and taxes.

Morris Ellison is a partner in the Charleston, S.C., office of the law firm Womble Bond Dickinson (US) LLP. The firm is the South Carolina member of American Property Tax Counsel, the national affiliation of property tax attorneys.

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