Retailers and Landlords Clash Over What Counts as a Sale
Rents based on percentage of sales leave room for interpretation as line between online and store sales blurs.
By Suzanne Kapner and Esther Fung Link to full article
March 24, 2021 8:00 am ET
Stores are reopening and customers are streaming back in, which means retailers that withheld rent during Covid-19 shutdowns are now able to pay. But first they have to agree with their landlords on how to define a sale.
Landlords are increasingly offering deals in which retailers pay a percentage of their monthly sales in rent, rather than a fixed amount. Percentage-rent leases give retailers breathing room when sales decline and allow landlords to reap the upside when sales recover.
But there is a sticking point. With e-commerce soaring, some landlords want to include a portion of online sales in the new leases, arguing that physical stores play an important role in many of these transactions. Retailers are pushing back, according to landlords, real-estate brokers and retail executives.
“We’re just looking not to get hurt when they do sales” if the store is involved in that sale, David Simon, chief executive of Simon Property Group Inc., the country’s largest mall owner, told analysts in February.
“If the store interaction is important to [retailers], we don’t want our sales to be reduced because the store is providing a service,” Mr. Simon said.
It used to be that simple math determined the sales generated by a store. But as e-commerce has become a bigger piece of the pie, and some stores use their retail locations for online fulfillment, the distinction between online and in-store sales has blurred.
If an order is placed online, but picked up at a store, should that count as an e-commerce sale or a store sale? Or if an item bought online is returned to a store? If online sales increase after a store opens, are landlords entitled to a portion of e-commerce sales within that store’s ZIP Code?
There are no commonly accepted formulas, making these types of leases tricky to negotiate, according to the industry executives.
“It’s become a very gray area,” said Alyssa Gates, director of North American property for cosmetics retailer Lush, which has 214 U.S. stores. “Especially this past year, when there was so little in-store shopping.”
A Sephora store in Brooklyn. PHOTO: NINA WESTERVELT/BLOOMBERG NEWS
Retailers, including Sephora, which is owned by LVMH Moët Hennessy Louis Vuitton SE, and Everlane Inc., tend not to include online sales in rent calculations, even when those orders are fulfilled at stores, according to one of the industry executives.
A Sephora spokeswoman declined to comment. A person close to Everlane confirmed that e-commerce sales aren’t part of percentage rent calculations for New York City stores, but declined to discuss other locations. It has seven stores throughout the country.
“Landlords don’t want stores used as warehouses,” said Annette Healey, executive vice president of CBRE Group Inc., a commercial real-estate services and investment company. “They want all of the space in the store to be dedicated to sales for that store. But most retailers feel that if the transaction originated online, it’s not a store sale.”
Retailers typically paid a fixed monthly rent that landlords calculated based on prior leases and rents in nearby locations. Cities with higher household incomes and population densities often command higher rents.
As more shopping shifted online in recent years, eroding store sales, retailers wound up stuck in long-term leases they could no longer afford. That trend got supercharged during the pandemic, when foot traffic to stores declined by 30% or more, according to ShopperTrak, which uses cameras to count visitors.
Retailers including Gap Inc. and Dick’s Sporting Goods Inc. stopped paying a portion of their rent during the pandemic. Some of the disputes ended up in court, while others were settled more amicably.
One solution was to make rents variable to better align with fluctuating sales, the industry executives said. In these leases, retailers typically pay 5% to 15% of their monthly sales in rent, in addition to a fixed amount to cover property taxes, common-area charges and maintenance.
Landlords have been offering percentage rents at varying levels for decades. But in the past year, these types of leases have become increasingly common, particularly for mall and street locations that are seeing higher vacancy rates, the executives said. Some rents are structured as a hybrid, with retailers paying a fixed amount up to a certain level of sales and then a percent of sales beyond that threshold.
Sometimes, the agreements exclude that fixed amount. In Manhattan’s SoHo district, Italian fashion retailer Pinko this month signed a yearlong sublease amounting to $30,000 a month or 15% of sales, whichever is greater.
The Bal Harbour Shops mall in Miami has launched an online platform, called Marketplace, for its tenants. PHOTO: MARIA ALEJANDRA CARDONA FOR THE WALL STREET JOURNAL
The downside for landlords is that percentage rent is unpalatable to their lenders, making their properties more difficult to finance. Investors want the guarantee of a steady income stream and covenants in their mortgages often require landlords to maintain rents above a certain level, the executives said
“The more percentage-rent deals that landlords do, the greater the push to include e-commerce sales in rent calculation,” said Amish Tolia, the co-CEO of Leap Inc., which operates physical stores for online brands, including Faherty, Naadam and Goodlife Clothing.
Mr. Tolia said all of his leases are based solely on sales generated by stores and don’t include an e-commerce component, even when online orders are fulfilled at stores.
But he said conversations with landlords on the subject are becoming more frequent. For instance, he said, landlords want to know whether e-commerce sales increase within a specific radius after a store opens and what percentage of e-commerce shoppers visit that store.
Some landlords are launching their own online platforms for their tenants, in part to help them succeed but also to give them a clearer view of physical stores’ influence on online sales. Bal Harbour Shops in Miami recently launched one such platform called Marketplace.
Real-estate brokers said the haggling has made lease negotiation far more complicated.
“Ten years ago, you’d say this is the rent and hand over the keys,” said David Abrams, chief executive of Masonre, a commercial real-estate brokerage and advisory firm. “Today, I have to be part psychologist and part accountant.”
Write to Suzanne Kapner at Suzanne.Kapner@wsj.com and Esther Fung at esther.fung@wsj.com
Appeared in the March 25, 2021, print edition as 'Web Sales Muddy Store-Rent Math.' Link to full article