It pays to be a tenacious tenant in Las Vegas retail market

Tuesday, June 30, 2009 | 2:13 p.m.

Commercial real estate markets across all property types have changed from a landlord’s market to a tenant’s market, but the retail market has recorded the greatest change.

For the past 25 years, high demand for retail space has allowed landlords to set lease terms and rates. However, as a result of today’s economic conditions, demand for retail space has dropped, as retailers have been forced to downsize and consolidate in the wake of shrinking consumer spending. As a consequence, tenants rather than landlords are taking the lead in lease negotiations, demanding lower rents and greater concessions.

All commercial real estate markets follow the residential real estate market, but the retail market is the most influenced by residential trends. The location and size of new retail developments are planned on the projected residential development for an area, because retailers are directly dependent on a local consumer population. As a result of this close alignment, the declining residential market has directly impacted retail centers located within Las Vegas’ external submarkets. As residential vacancy rates have risen, so too have retail vacancy rates, as the local communities that were intended to serve the retailers have shrunk.

After such a prolonged period of sustained economic growth, some retailers became complacent and overstretched themselves, committing to one or multiple additional ventures at properties located within these outer submarkets. As the economy contracted, these additional stores folded, as their consumer base dissolved. In some cases, the collapse of these additional stores in outer submarkets across the country may have been enough to bankrupt the whole company. These bankrupted companies have been forced to vacate all of their properties, including those located within the central core markets, pushing up vacancy rates across the country.

Coupled with the decline of the housing market, the drop in consumer spending also has heavily affected retail vacancy rates. Not only are retailers now serving a smaller population of consumers, because homes have either foreclosed or were never filled, but the consumers that remain have dramatically reduced their spending. People, today, are no longer spending money on what they want; they are only buying what they need. Rising unemployment and a growing fear to invest, created by the continued economic decline, has caused people to curtail their spending. Retailers are, therefore, serving a customer base that is not only smaller but also thrifty. Most have seen their sales figures sharply decline, forcing some of them out of business.

As a result of the across-the-board rise in vacancy rates, tenants are negotiating low rents on new leases. What’s more, tenants are even negotiating lower rents on existing leases, a trend that the market rarely has seen before.

In the past, landlords would have ignored any attempt by tenants to renegotiate an existing lease, because high demand allowed them to quickly fill space at market rates. However, the scarcity of alternative retailers in the current market has forced landlords to listen to negotiations and set leases that tenants can afford to pay. Landlords that refuse to do so risk being stuck with hard-to-fill vacant properties that may generate no income for many months.

For other tenants, the decision to renegotiate existing leases may not be driven by necessity, but, rather, opportunity. As retailers across-the-board are witnessing a drop in sales, the sales figures that were forecast in 2007 and 2008, upon which lease rates were set, have been drastically less than anticipated. As a result, retailers are demanding that their lease rates also be adjusted to current sales figures in order to retain sufficient profit margins.

Though office and industrial landlords can remain relatively resilient against the renegotiation of existing leases, the same cannot be said of retail landlords. Office and industrial landlords can choose from a large selection of companies spread across a variety of business types to fill a vacant space. However, for retail landlords, the tenants that surround a vacant space will directly impact the types of retailers that can occupy it, because they don’t want to be in direct competition with each other. This problem is then further compounded by the fact that there are fewer retailers to choose from, because many retailers have gone out of business due to bankruptcy. As a consequence, retail landlords may be having a harder time filling vacant property in today’s economy than their industrial and office counterparts. Consequently, retail tenants seem to have developed the greatest negotiating power.

As a result of this extra bargaining power, some retailers are expanding. The opportunistic retailers include large, strong companies that are utilizing the current market conditions to negotiate more space and lower rent rates in preparation for when consumer spending increases. The other expanding retailers are those whose sales have actually grown in recent months as a result of the decline in consumer spending. In today’s price-conscious climate, eating out has become a luxury. However, certain low-cost fast food restaurants are actually growing their businesses as customers look to eat out without overspending. These types of retailers are able to take advantage of the exceptional lease rates being offered and are expanding.

Other investors have not been so fortunate. Sales activity remains stagnant, as sellers continue to set their prices well above what buyers are prepared to pay.

By the first and second quarter of 2010, we may see sellers lower their prices as the inventory of available product continues to increase. This, coupled with the loosening credit markets, should lead to a resurgence of sales activity, which in turn will work to heal the market. When demand does return, it will be an exciting time, as an influx of new businesses will sprout up to take the place of those that have fallen.

Until then, tenants with the necessary capital can lock in exceptional lease rates and terms, in order to capitalize on what will once again be a flourishing retail market.