How retailers can reduce their occupancy costs

There’s a famous quote by Jerome Lewis: “A neurotic is a man who builds a castle in the air. A psychotic is the man who lives in it. A psychiatrist is the man who collects the rent.”

On average, 91 per cent of retail is done in physical stores, and approximately 85 per cent of retail stores nationally reside in shopping centres. Talk of their demise is somewhat exaggerated, but they do have to adapt to changing retail conditions, and many are already doing so.

In fact, we know that average sales are generally higher for omnichannel retailers – retail businesses which combine a physical presence with e-commerce – than e-commerce alone. Interestingly, physical store openings across the US, UK and Australia have outpaced closures over the past three years.

There are 1,338 shopping centres in Australia, predominantly located on the eastern seaboard, attracting 85 per cent of overall shopping visitation from a national population of 25 million.

That is approximately one shopping centre per 18,685 Australians.

By comparison, the US’s population exceeds 330 million with 1,100 enclosed shopping centres.

In the Australian retail-trading environment, there is a multitude of space available and high concentration in our capital cities.

So how do lease and tenancy costs get so high, and what can retailers do to lower these expenses?

Since the beginning of time, there have been landlords and tenants – with both parties looking to maximise their investment.

Centuries later, this basic principle of the landlord-lessee relationship still exists, and in today’s retail economy the topic of occupancy costs, being the ratio of rental paid to sales generated, achieves more focus than ever.

As a tenant, there are a number of opportunities to decrease the occupancy cost to achieve a more sustainable business, which is of benefit to both the landlord and the lessee.

Let’s examine two potential scenarios, the first being a prospective tenant at a shopping centre and the second where the existing tenant is considering renewing a lease. Regardless of the situation, there are some golden rules for decreasing occupancy costs that are applicable in both circumstances.

Research, research, and research

A retailer must gather as much knowledge as possible about the centre’s performance, category, and customer profile. As simple as it sounds, I often hear of leases being signed without any prior research being conducted.

Some possible research methods include:

Research by wandering around – using this method, a retailer stands outside the prospective store location and watches the quantity, type and patterns of the customer flow, revealing who is in the area and how they behave.

Are these customers racing past, travelling to the car park, food court or to a major retailer? Or do they genuinely shop and browse in the area?

It is also worthwhile to speak to existing tenants and watch how many customers are actually entering their premises, or shopping in nearby stores, versus just passing by. All segments of the week should be observed, such as Monday mornings, mid-week afternoons, late night shopping, and most importantly the weekend.

Examine demographic compatibility – is the proposed position of the store compatible with the surrounding stores?

Using online census data or information from the shopping centre’s marketing manager, examine the origin, shift, age and disposable income profile of the shopping centre’s primary and secondary customer catchments. Local councils can provide useful information in this regard.

What type of shopping centre is it, and what are the anchors? For example, do major retailers anchor the centre or is it a food-and-convenience centre?

Understand the centre’s performance – as a contributor to the centre performance, a retailer is entitled to fully understand the centre in which they are about to do business.

The centre manager and marketing manager are primary sources of this information. Here are the key performance indicators that should be discussed in a pre-tenancy meeting to help determine the centre’s performance:

• GLA: gross lettable area of the centre
• PSM: sales per square metre for both the centre and the respective category
• MAT: moving annual turnover and per cent movement on a PSM basis
• Customer traffic per annum and percentage movement on prior year
• Average spend per customer – note that a high average spend may be an indicator of affluence in the primary demographic, or low customer traffic
• Category performance and percentage movement PSM on prior year

Align marketing with the centre

Once a retailer is informed about the centre and category performance, the following questions should be covered in discussions with the centre’s marketing manager:

• What is the centre’s marketing plan, including demographic profiles?
• How can the retailer’s business fit into this marketing plan and what specific marketing promotions are relevant to their business?
• What category promotions have worked and how were they measured?

Once this information is provided it can be incorporated into the retailer’s own marketing plan.

Remember that retail tenants pay a marketing levy and are entitled to utilise part of this investment.

Being an active part of the centre’s marketing calendar should increase sales and, in turn minimise occupancy costs.

Further questions to approach the centre and marketing manager could include:

• What is the carpark capacity and the centre’s proximity to public transport?
• How close will the store’s position be to an entrance and what percentage of the centre traffic does that entrance attract?
• What, if any, are the proposed extensions to the centre and could the proposed tenancy be affected in any way?
• What is the history of the previous tenant and why did they leave?

It is worth mentioning that previous leases are registered and held as a public record with the Land Titles office.

Generally speaking, leases are often registered some 12 months after commencement and provide an indication of previous or current rentals being paid within a shopping centre.

Once these fundamental details have been ascertained, the next golden rule applies.

Know your lease

It’s critical to gain a comprehensive understanding of the lease proposal. Seeking independent assessment of the lease, relevant clauses, and costs is a necessary step in this process to understand your current and future financial exposure.

It is critical for a retailer to be completely familiar with the lease renewal terms and the financial impact of the lease over its fixed term. Given a conservative sales forecast, rental should be considered in relation to other costs, and the break-even point identified. A prospective tenant should also enquire as to whether an option period can be secured.

Additionally, is the site rental comparable on a similar rate, per square metre, to all other existing competing merchants within the shopping centre in the same category of business? Knowing the answer to this question will help a retailer to ascertain that all their competitors have the same rental cost base.

Retailers may also enquire as to whether the percentage rental can be lowered to account for unusually high sales in the first few weeks and months of the store’s opening. Additionally, a lease term shorter than five years may be possible.

Flexibility is necessary in the modern retail environment, so having a shorter lease is an advantage. By the same token, it may be possible to secure a guarantee position that is less than the expected norm of a three-month bank guarantee coupled with a director’s guarantee.

Finally, determine whether the landlord will assist with any site establishment works – for example, plumbing.

If a retailer follows these golden rules, they will be on steady ground when it comes to reducing occupancy costs.