The future of retail: A real estate perspective

The COVID-19 pandemic is having a major impact on the retail sector across the world, revealing growing conflicts between the interests of landlords and tenants and accelerating trends that are likely to permanently reshape the real estate and retail landscapes in significant ways.

Retail leasing

When the pandemic first hit, the short-term focus of retail landlords and tenants was on preserving cash flow. Most landlords took a pragmatic view of the difficulties in which retail tenants suddenly found themselves and many were willing to agree to give short-term relief in the form of rent-free periods, rent reductions and/or rent deferrals. However, as it has become clearer that the pandemic is likely to be a longer term phenomenon, tenants have increasingly started to call for more fundamental changes to the way retail leases work. Institutional landlords have had to start thinking about longer term re-gearing of leases, to preserve value in their investments.

Many retailers are now calling for a shift from open-market-based to turnover-based rents. Such arrangements are usually structured as a combination of a fixed base rent, topped up by a percentage of the turnover generated by the retailer at or in connection with the store. Proponents argue that it is fairer for landlords and tenants to share in both the upside and the downside, and that where landlords are incentivized to help drive turnover, everyone wins. This model has been successfully implemented at scale for some time by forward-thinking landlords like Value Retail at its outlet shopping locations around the world, including Bicester Village in England and Kildare Village in Ireland.

But the turnover model has its challenges, including how turnover and customer data can be accurately collected and shared, and whether turnover should include online and click-and-collect sales. For most professional landlords (and their investors and lenders), the uncertainty in predicting rental income, and the effect that would have on the ability to accurately value premises from an investment perspective, makes turnover-based leases unattractive. So, instead, many landlords, who are also worried about the potential impact of large-scale insolvencies or restructurings, are now increasingly focusing on re-gearing (the process of amending existing lease terms), such as by agreeing rental to changes in consideration of tenants waiving break options or agreeing to longer terms. Both landlords and tenants are also acknowledging the need to include provisions governing what happens when tenants are forced to close for pandemic related reasons; negotiating such issues is keeping property lawyers busy.

Retail insolvencies and rescue

The impact of the pandemic has already forced the insolvency of some high-profile retailers, and this trend is likely to continue, if not accelerate. Many have been forced to consider availing themselves of corporate rescue or restructuring arrangements. Debenhams went into administration for the second time in 12 months in April 2020. Cath Kidston closed all 60 of its UK stores and surrendered its leases as part of a pre-pack administration rescue deal with its Hong Kong-based owner. Interestingly, that deal involved the owner buying the brand (IP rights), e-commerce platform and wholesale business only, and walking away from bricks-and-mortar related liabilities. Boohoo did something similar in June by acquiring the online platform and brand IP of Oasis and Warehouse from Hilco Capital (which had acquired only those parts of that business in a previous administration). The possibility of retailers cherry-picking the valuable parts of their businesses will no doubt make many institutional retail landlords uneasy, as will the likelihood that a considerable number of retail premises will be empty once the full impact of the pandemic is known.

Technological innovation

There is now a clear opportunity for landlords and tenants to collaborate in the use of technology to their mutual advantage, and proptech is likely to play an ever-increasing role in the retail sector for the foreseeable future. Tech-savvy landlords are investing in ways to closely monitor customer related data, and tenants are using more and more sophisticated methods to monitor in-store turnover, footfall, and customer spending habits. Provided that such data is collected, processed and shared in compliance with relevant privacy regulations, it can be used by all concerned to identify problems as soon as possible, drive tailored initiatives to improve the overall shopping experience, and boost individual store performance. This will be increasingly the case as high street and shopping centre premises become more and more about showcasing brands. But there will need to be a culture shift in the minds of most landlords and tenants towards a more collaborative and transparent relationship, which may take some time.

Conclusion

It is still too early to say how the effects of the COVID-19 pandemic will play out. But what does seem clear is that the rigid traditional leasing model is going to need to evolve in a way that demands more flexibility, pragmatism and long-term thinking from landlords. Retail leasing needs to become fairer and rents more sustainable. Some way needs to be found to make the liabilities associated with retail premises less onerous. Landlords and tenants need to start thinking more in terms of their shared interests and work together to develop a mutually beneficial relationship.