Department Retail Stores & Rents

By Maxwell O. Ramsland, Jr., MAl, CRE and James R. MacCrate, MAI, CRE, ASA

Introduction

As reported by Newsweek, the United States is over stored as retail construction continued in 2007 and 2008 by unregulated financial lending practices.  New retail construction does not generate new business; it creates competition for finite sales volume.  Numerous retail bankruptcies have occurred, retail stores are closing, and vacancies are increasing.  In addition, retail sales have declined as indicated in the following chart as more space has been added to the market compounding the negative factors affecting the department stores, shopping centers and retail establishments.  

Chart 1

One can clearly see that retail sales peaked in 2007, while additional retail space came on to the market and retail sales were falling.  It is important to remember that adding more retail space to the market does not usually create demand or increase retail sales.  It divides existing sales and takes away sales from existing retail stores.   Therefore, this would tend to indicate that the value of retail space unencumbered by existing leases must be falling.  The value of retail space is directly related to the volume of retail sales per square foot.  Total consumer expenditures in retail stores can provide useful information to properly analyze the value of retail space.  The U.S. Census Bureau announced total retail trade sales were up 3.0% (±0.7%) from July 2009, but 6.0% (±0.7%) below last year, July 2008.

 

Definitions

The income approach is usually developed to estimate the market value of retail space, including department stores and shopping centers.  The income that is derived for retail space, such as department stores, usually comes from two sources – base rent and a percentage rent which are defined as follows by the Appraisal Institute.

 

Base Rent – The minimum rent stipulated in a lease.

Percentage Rent – Rental income received in accordance with the terms of a percentage lease; typically derived from retail store and restaurant tenants and based on a percentage of their gross sales.

A minimum rent is usually stated in the typical retail store lease, although a straight percentage lease is occasionally encountered.  An overage rent clause provides the landlord with the potential for additional income if the retail store is successful.  Overage rent is defined as follows.

 

Overage Rent – The percentage rent paid over and above the guaranteed minimum rent or base rent; calculated as a percentage of sales in excess of a specified breakeven sales volume.

 

Based on the above definitions, if retail sales volume declines as is indicated by current trends, the value of retail space must be negatively affected.  The percentage lease makes the landlord a partner in the tenant’s business and provides the lessor some protection against inflation, but works against them in the current environment and values decline.

 

Market Rent for Retail Stores

Market rent for retail stores, such as department stores, as noted above, is traditionally based on the store’s actual productivity, or actual sales and includes a portion of fixed rent per square foot, up to a given breakpoint level plus one or more percentages of sales to a maximum percentage of sales.  The typical department store rental pattern is presented below; this pattern demonstrates that as sales increase, rent per square foot increases, but that percentage rent increases at a decreasing rate.  The following chart indicates the trend in percentage rents as the retail sales volume increases.  The data was compiled from Dollar & Cents of Shopping Centers from 1990 through 2008 by Ramsland & Vigen, Inc.

 Chart 2

Extraction of 2009 Estimated Retail Sales per Square Foot For Department Stores

The Urban Land Institute’s Dollars & Cents of Shopping Centers: 1990 – 2008 provides an authoritative chronology of department store and shopping center rental and sales.  The following graph identifies the 18-year chronology of median sales per square foot from 1990 to 2008 for department stores.  Retail sales at department stores have fallen 7.4% for the first eight months of 2009 in comparison to the first eight months of 2008 that has been incorporated into the graph.

Chart 3

This would tend to indicate the market value of department stores continues to fall since there is direct correlation between retail sales volume, market rent and market value unencumbered by any existing leases. 

Percentage Rent over Time for Department Stores

The following chart indicates the trend in the median percentage rent reported and the calculated median percentage rents over time.  The 2009 estimate is based on a regression equation assuming that retail sales remain unchanged at department stores, dropping 7.4% for this calendar year.

Chart 4

The range in percentage rents is quite narrow but can be quite misleading because of the manner in which department store leases are structured (base rent plus overage rent at declining percentages) results in the following relationships: as sales increase total rent per square foot may increase; and, as sales increase, rent as a percent of sales may decrease.  Therefore, the total contract rent as a percent of sales may actually increase in 2009.

 

Total Rent vs Total Retail Sales per Square Foot

Ramsland-Vigen, Inc. collected the total retail sales volume and the total contractual rent obligation on department stores over a period of years.  These included the base rent and the overage rent.  The following chart summarizes the relationship between the total rent as a percentage of retail sales per square foot per square of building area.

 

Chart 5

As sales go down, rents go down but at an increasing rate.  The preceding chart clearly indicates that the total rent (base rent and overage) as a percentage of the total retail sales per square foot declines as the total retail sales per square foot increases at department stores.

 

The following article, Department Store Sales Comparisons for August 2009 indicates the trends at several department stores in the U.S.  In addition, retailers fight another day as U.S. shoppers returnretail vacancies hit multi-year highs Retail Sales Fall as Auto Drops, and flat retail sales are anticipated for the holidays.

 

We would like to acknowledge the contributions of  Shannon Luepke [SLuepke@ramslandvigen.com] for her research for this particular blog.

©2009 MacCrate Associates LLC.

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About Jim MacCrate

Real estate appraiser and valuation consultant for more than 30 years specializing in reviewing real estate appraisals, risk management and quality control.
This entry was posted in Real Estate Investments, Real Estate Market Analysis, Real Estate Valuation Methodology, Retail Stores and tagged , , , , , , . Bookmark the permalink.

14 Responses to Department Retail Stores & Rents

  1. Bob Marks says:

    Good Analysis

  2. Bob Marks says:

    Well Done.

  3. John Healy says:

    Jim…good article…lots to think about…John

  4. Tim O'Sullivan says:

    Jim,
    Excellent article. As an owner of retail properties, I hope you’re wrong but suspect you’re right. Although I agree that a lot of retail space has come on-line in the last few years, is there any accounting for retail space that has been taken off-market (through re-development, demolition, etc.) It seems to me that a lot of New York retail space no longer exists because of the number of condo buildings built where retail formerly existed. It would seem this would create a shortage of retail space (at least in Manhattan). Thanks again.

  5. VZMann says:

    Jim, Thanks for the information.
    I am looking forward to happier days!

  6. Allen Fitzpatrick says:

    Thank you Jim. I appreciate all that you do.

    Allen

  7. jmaccrate says:

    Your statement is correct, but you are not bringing any new business to the area. You are dividing the total volume of retail sales among more stores, reducing the sales at other stores in the market competing for the same total dollars.

  8. charlie says:

    I don’t agree with the statement that “it must be remembered that adding retail space to the market does not usually create demand or increase retail sales.” While retail sales have fallen over the past few years due to the slowdown in residential growth and the recession, that statement is not always true. Many retailers have learned that if you add stores closer to a pocket of people that already be shopping your stores, they increase their store visits and purchases.

  9. will says:

    Thank you for your most accurate accessment of the state of commercial retail property.Keep up the good work.W.

  10. Bob Von Ancken says:

    Enjoyed reading your inciteful study.

    Bob

  11. abe tebele says:

    One factor that doesn’t seem to be factored in is profit margins. Now that a glut of retail space has been added surviving retailers have resorted to huge markdowns to spur any sales volume greatly squeezing profit margins in some cases to zero. This translates to decreasing rents and store closures when net profit shrinks below the cost of capital.

  12. marty tessler says:

    Jim-great piece of analysis. The one thing that needs to be presented which you may have done elsewhere or I overlooked it is the amount of supply of space that was added in the runup of the CMBS securitization follies. The country was becoming overstored and hence the cannibalization of sales/sf productivity=too many deals producing too many stores chasing fewer $$ supported by dwindling cap rates a/k/a “cap rate compression” based on false market expectations and assumptions existing in the minds of appraisers who blindly followed the downloadable cap rates, IRR’s and growth rates that were swallowed hook, line & sinker that have now produced the sunken market. We also forgot that the market is cyclical…….and what goes up must come down.

  13. Nicely presented article. What is disturbing is that when you look a the respective tables that use time for the x axis, it looks very much like deja vu all over again when compared to the early ’90’s, just that the drop off is deeper. If this holiday season does not pan out, things could get very ugly for landlords and their retail tenants. January could be a very interesting month. As the Chinese proverb (or as some interpret it to be, a curse) states, “May you live in interesting times.”

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