Retailers signal extra short-term leases in a dangerous guess for mall homeowners

American skateboard shoe company brand Vans store seen in Hong Kong.

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Retailers and their landlords are currently embroiled in a high stakes risk game. And it will be a few years before we find out which party is on the winning side.

As thousands of retail leases need to be renewed, their term continues to shrink as companies grapple with an unpredictable future and seek ways to cut costs, remain flexible, and maintain leverage with their landlords even after the health crisis subsides.

However, the risk is a one-way street. For one thing, malls and shopping malls owners could have the opportunity to turn the tables in two or three years by increasing rents or outfitting retailers for another tenant. However, shorter-term deals could also result in landlords having even more vacancies across the board.

Best Buy chief executive Corie Barry said Thursday that the big box retailer’s average rental length is definitely decreasing.

She said the company has about 450 leases due to be renewed over the next three years, or an average of 150 a year. The electronics retailer has closed around 20 of its large-format stores in each of the past two years, but expects to close even more in 2021, she said.

“In the short term, there will be higher lease renewal thresholds as we assess the role of each store in its market, the investments required to meet our customer needs, and the expected return on investment based on a new retail landscape,” Barry said during a conference call with analysts .

The trend is spreading far across the retail landscape and in shopping malls. Apparel companies are increasingly rethinking whether it makes sense to be in an enclosed mall anchored by department stores struggling to attract shoppers and increase sales.

According to VF Corp., owner of Vans and Timberland, the leases for its stores have been shorter for years. They will get out of the pandemic even shorter thanks to recent and ongoing negotiations, according to the company’s CFO. VF Corp. makes the switch to allow the freedom to close deals faster.

“The way we structure our rental agreements allows us to be quite nimble and agile and … we can turn around as consumer behavior changes,” CFO Scott Roe said in a recent telephone interview.

The retailer’s average rental period is around four years, according to Roe and will soon be even shorter as new contracts are signed.

“The landlords have been cooperative and have worked with us,” added Steven Rendle, CEO of VF Corp.. “We both have the same goal, which is to be viable and productive.”

There is plenty of freedom

While it has traditionally been in a landlord’s best interest to get a long term tenancy or 20 year lease in order to limit risk and fill a room for as long as possible, many succumb to the pressures that have been placed in the past 12 months.

With lots of vacant space in many markets across the country, tenants such as retailers and restaurateurs are in a greater position of power. It’s a trend that many real estate experts expect will only multiply from here and become the norm.

According to a follow-up from real estate services company CoStar Group, leases for approximately 1.5 billion square feet of retail space in the US expire this year. That’s around 14% of the retail market. Either these leases will not be renewed and additional retail stores will be closed, or these contracts will be renegotiated.

“We agree with that.”

While short-term leases can pose a higher risk for landlords who then grapple with unpredictable waves of renters moving in and out, they go both ways. Retailers could get a short-term lease, and rents could be higher in the future as the market strengthens.

David Simon, CEO of mall owner Simon Property Group, told analysts during a conference call in early February that tenants were interested in a “slightly shorter term”. Simon is currently signing another three-year leases, he said.

“We are okay with this because in two or three years I would rather negotiate,” than not filling a shop at all, he said. “I think that might be in our best interests too, because … we’re not entirely able to refer to sales to increase the rent,” he said.

“It’s actually a one-way street and it works fine for the vast majority of our retailers,” said Simon.

Beth Azor, CEO of retail property management and development firm Azor Advisory Services, said she worked on a number of short-term super deals during the pandemic. Azor, often referred to as the “canvassing queen” by her social media peers, is helping leasing agents fill vacancies across the country by working with a number of publicly traded real estate mutual funds (REITs).

She recently took up service on the emerging social network Clubhouse, where she has set up spaces for entrepreneurs to set up their business in, and landlords with free space can overhear. The rental contracts have a term of three months to one year. and sometimes that’s rent-free. She calls it “Space Tank”, a piece from ABC’s “Shark Tank”.

Occupancy pays off

Azor says landlords shouldn’t view short-term leases as negatively, especially given the retail location. A tenant – period – increases occupancy, she said, which can come in handy when other businesses are knocking on the door asking for rent relief.

During the health crisis, companies at the national and local levels came to malls and malls owners to try to renegotiate their rents, Azor said. And when a property is full, albeit with some short term leases, it’s harder for a company to argue that their rent should go down. So the occupancy can literally pay off.

Outlet owner Tanger Factory Outlets has also done more short term deals. Currently, about 7% of tenants’ leases are categorized as fixed-term when they are typically between 4.5% and 5.5%, CEO Stephen Yalof told analysts during a conference call earlier this month.

“A number of deals that actually started out as pop-up or short-term leases … we extended the duration of those leases,” he said. “So that seems to be a trend.”

He went on to explain that the REIT preferred to maintain a high occupancy with shorter-term deals over charging rents in 2020.

“We’ll see a lot more local and [temporary] Leasing probably in the first half of the year, “he said.” But we are very proactive with our long-term leasing to replace this tenancy and expand our permanent leasing base. “

However, not all properties seem suitable for pop-ups.

For example, according to Jerome Barth, president of the Fifth Avenue Association, New York’s glitzy Fifth Avenue neighborhood is still largely populated by tenants with long-term leases.

“These will be premium leasing contracts, no matter what … because this is still the world’s leading market,” said Barth. “I think leases will keep moving, and that will be a constant. But people know the avenue will be an exciting place for years to come.”

Disclosure: CNBC owns the exclusive off-network cable rights to “Shark Tank”.

– CNBC’s Melissa Repko contributed to this report.

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