Developers of new retail product in the e-commerce era face an array of roadblocks, from rising land and construction costs to heightened scrutiny from lenders on cash flows.
Besides a larger economic downturn, in today’s Darwinian retail environment, nothing makes a new project fizzle or a stabilized center depreciate faster than lost income and occupancy brought on by an un-engaging, uninspiring tenant mix.
Consequently, developers are devoting more of their budgets than they have in years past to researching, meeting and analyzing users to ensure they nail their tenant rosters on their first try. This is particularly true for developers whose business models center on long-term holds of their properties.
“If we put a problem tenant in a center on day one, we inherit that problem for the term of the lease,” says Anderson Smith, co-founder of Capital Retail Properties, a Houston-based retail firm that holds its developments for the long term. “So it’s very important that we do it right the first time.”
Smith says that his firm’s first move when researching a potential tenant is to check out that company’s Instagram account, which provides insight on the retailer’s approach to store build-outs and quality of product or service. Instagram pages also provide landlords with real-time customer feedback on the retailer.
Tenants that have leased space at retail centers owned or developed by Capital Retail Properties include boutique gyms such as Crew Fitness and Iron Tribe Fitness, as well as restaurants like Dickey’s Barbeque Pit and Mod Pizza.
When evaluating the performance of restaurants, Capital Retail Properties looks at alcohol sales as indicators of larger traffic patterns. Steadily improving or declining sales of alcohol — taken both at face value and as a percentage of overall sales — can reveal a lot about the health of a restaurant, according to Smith.
Approaches like these illustrate how the tools, technology and metrics for evaluating performance are evolving to help developers and landlords better understand tenants’ financial outlooks, operating strategies and benchmarks for their industries. Social media in particular can be an excellent indicator of a retailer’s relevance and brand awareness within the community.
“There’s a lot more effort that goes into sourcing tenants in today’s market,” says Steve Graham, principal at Kansas City-based Stellar Development LLC. “It takes a lot of time and energy, as well as creativity to get them to say ‘yes.’ The good ones are out there, but you have to go see them, experience them and learn about them.”
Graham notes that his firm, a development partner at Grandscape, a 433-acre mixed-use project in metro Dallas (see sidebar on page 7), invests more in tenant research today than in years past. That includes traveling the country — and occasionally internationally — to meet owners, perform in-depth financial analysis and conduct other types of research to determine if a retailer or restaurant is a good fit for a certain project.
Performance Evaluation
Landlords have always been preoccupied with the credit and sales per square foot of their tenants. But the newfound importance of getting the tenant mix right early in the game has precipitated the rise of new performance evaluation metrics. Like any emerging statistical framework, the sophistication of these metrics is very much evolving.
Although newer retail developments tend to feature more sales reporting clauses and requirements, developers are finding that traditional financial metrics are insufficient for accurately gauging a user’s performance in today’s market.
“Reporting sales provides less and less clarity for some concepts, particularly soft goods and brands that have healthy online platforms,” says Ben Bufkin, principal at Austin-based Endeavor Real Estate Group. “Performance evaluation in general is becoming more holistic. It goes beyond balance sheets and sales per square foot and requires a thorough investigation to determine if a retailer will be successful.”
“Ten years ago, you might look at sales versus cost of occupancy or overhead costs, or perhaps sales per square foot, and you’d have a pretty good idea of a retailer’s performance,” adds Jason Thumlert, Bufkin’s partner at Endeavor. “The conversation is much more nuanced today because the combination of brick-and-mortar and online sales makes it harder to gauge the health of a single store.”
To these ends, it’s more critical than ever for retail developers to truly understand the demographic and financial profiles of their patrons. A retail concept that does well at the regional level may flame out at the local level, and a concept that worked for a given target market in one area may not carry over from state to state. Analyzing the market correctly prior to sourcing tenants goes a long way in ensuring that the first recruits are the right ones.
Endeavor’s upcoming Saltillo project, which is transforming an abandoned train depot in downtown Austin into a mixed-use development, will be anchored by a Whole Foods 365 store. Several restaurants, including Tarka Indian Kitchen, Barcelona Wine Bar and breakfast eatery Snooze, have been announced at Saltillo, which is expected to open in 2019.
A Whole Foods 365 store will anchor Saltillo, Endeavor Real Estate Group’s project in Austin that will convert an abandoned train depot into a mixed-use destination.
The increased emphasis on developing online sales platforms to complement the brick-and-mortar component — or vice versa depending on the concept — means that retailers themselves are learning new methods of self-valuation. But some businesses consider these metrics, which are still being honed, to be trade secrets and are reluctant to share them with landlords.
“The new data points for performance evaluation aren’t entirely in place yet, but they’re coming,” says Brenna Wadleigh, president and CEO of Southlake, Texas-based development firm N3 Real Estate. “Without tons of data we can point to or that retailers will share with us, we look at the overall health of the retailer.”
According to Wadleigh, determining a retailer’s big-picture health also entails examining the revenue relative to the competition, the size of the debt load and the extent to which the product or service aligns with consumer expectations. The track record of the operator is examined closely as well.
“Whenever we’re trying to backfill a vacated space or make concessions to renew a lease, before we even look at the rent or credit or synergy with the center, we ask ourselves if this retailer is going to survive the next downturn,” says Wadleigh. “We look at how they’ve evolved in response to e-commerce, and if they haven’t, we’re reluctant to rent to them, even if we really need to fill the space.”
Joined At The Hip
With different methods and perspectives for evaluating retailers’ performances comes a shift in the relationship between retailer and developer. The overall shakiness of retail real estate in the age of e-commerce poses threats to both groups, which now function as partners more than anything else.
“As landlords, it’s critical to be in constant contact and conversation with retailers,” says Bufkin of Endeavor. “Retailers are the ones creating the magic, and the landlord’s assistance can help their businesses evolve. Landlords who really understand retail get that the effort to cultivate a good retail experience never really stops — you don’t just lease space and forget about it.”
Jeff Harrison, senior vice president of retail at The Signorelli Co., an owner-operator based in The Woodlands, says that utilizing onsite management services is another way to strengthen the partnership between landlord and tenant.
“To operate at the highest level, you have to be in stores every day, sourcing information from the tenant, the shoppers and the community,” says Harrison, whose firm owns and operates Valley Ranch Town Center in metro Houston. “When you have your own people on the ground you get the best information more quickly, and with that kind of communication, there are really no surprises.”
Anchors at Valley Ranch Town Center include discount retailers that have weathered the assault on big boxes, like Ross Dress for Less, T.J. Maxx, Burlington and Rack Room Shoes. Other anchors include Kroger and Academy Sports + Outdoors.
Several restaurant concepts, including Freddy’s Frozen Custard & Steakburgers, Sub Zero Ice Cream and Airi Poké and Ramen, recently opened at Valley Ranch Town Center. In addition, Signorelli recently announced that Olive Garden will join the tenant roster in May 2019.
As the contract between the two parties, leases have come to reflect the more collaborative relationship. For developers, that means offering more flexibility: shorter lease terms, greater allowances for tenant improvements. For users, it means easing back on co-tenancy requirements and providing more advanced and detailed sales reports.
Flexibility in retail real estate presents itself in a variety of ways. Developers are beginning to see value in opening new centers or destinations before they’ve reached full occupancy so as to allow themselves some basic wiggle room and time to collect feedback. Staggered openings increase the odds that the next tenants developers sign are truly the right ones.
Retail landlords are also encouraging flexibility in their leases via pop-up spaces. This concept, also known as flash retail, allows retailers to promote their brands outside their stores and grow their exposure to the market. Pop-up retail, which centers on small footprints and low operating costs, is particularly effective for retailers making their initial entry into new markets.
Lastly, with lenders putting retail projects even deeper under the microscope, developers are upping the ante on preleasing. Preleasing a certain amount of space within a certain amount of time can yield more favorable loan terms. Just as important, preleasing enables landlords and retailers to begin collaborating and strategizing well in advance of the store opening.
“We’re highly invested in the success of our tenants,” says Thumlert of Endeavor. “Having a partnership-type relationship instead of just sitting back and collecting a rent check is a big part of delivering a successful retail experience to customers. It’s more like being in the hospitality business than anything else.”
Activation Is Critical
Today’s retail climate demands that once a developer has curated the ideal tenant mix for a property, the developer must then engage in activation. Typically this entails organizing events and activities around retailers’ brands and promoting them on social media.
The growth of online shopping has only elevated the role of activation, which in today’s market is really a buzzword for “get people to your site by any means necessary.” Concerts, movies, holiday-themed parties, food and drink tastings — any activity that delivers an experience that can’t be had without traveling to the site — is fair game in the world of retail activation.
Combined with the right architecture and design, a good programming plan transforms a retail development from a place to shop into a shopping destination.
A strong activation plan allows retailers to function not just as purveyors of goods and services, but as gatekeepers to an engaging experience at the site. In this sense, activation is a critical element of marketing to millennials, as well as in enabling a mixed-use property’s retail components to drive traffic to other uses.
“We place a big emphasis on programming and activation,” says Rip Reynolds, vice president of leasing and commercial land for The Howard Hughes Corp., which develops master-planned communities with retail uses. “We believe these activities go a long way in distinguishing us from other developers outside of master-planned developments and in driving traffic to the community.”
— By Taylor Williams. This article first appeared in the December 2018 issue of Texas Real Estate Business magazine.