The Shopping Center Chronicles – Rent Factors of the Past & Present

The Shopping Center Chronicles – Rent Factors of the Past & Present

Over the years, some of the factors impacting rents at shopping centers have varied almost as much as the stores that occupy the spaces. Other variables have transcended the years and remain constants within the industry today. In this installment of The Shopping Chronicles, we’re examining some of the veteran factors of shopping center rents, and revisiting those that have fallen by the wayside.

 The Base-Overage Rent Myth
The significant difference between base rents and overage rents in shopping center leases was once a well-noted principal in the commercial real estate investment world. Tenants receive a tradeoff between base and percentage rents: tenants paying relatively high base rents paid relatively low percentage rents and had a higher threshold level of sales. And vice versa.  Yet this principal was actually false.  More recent studies have shown that the differences in base and percentage rents are hardly a matter of trading base for percentage rents.

 In 1992, a study was undertaken to examine whether retail shopping center leases differed according to the characteristics of the tenants holding the leases. They started with the premise that shopping center space and services are homogeneous. Two tenant characteristics were examined as potential determinants of rent discrimination: default probability and customer traffic-generating potential. Differences in contractual provisions were also tested, along with whether tenants had a renewal provision, the landlord had a right to cancel before the end of the term, or there was a rent escalation provision entitling the landlord to inflation-linked increases in base rent.  Renewal options (benefiting the tenant) proved significant and results showed tenants with the provision actually paid 8% to 10% more rent. The other contract provisions could not be linked with significant differences to rent.

 The proxy for default probability was whether the store was a national chain or not. National chains had a lower default rate. The proxy for customer generating ability was sales or median sales per square foot of leased area, which assumed that higher sales were associated with greater customer traffic. Both these proxies were negative and significant, showing landlords with lower rents rewarded tenants with these characteristics. Size of the center also mattered, so tenants of larger centers paid higher rents.

 Modern Rent Determinants
Today, most shopping centers base their rent on square footage, but there are several other factors that can come into play. These factors vary by shopping center and property owner, but the most common include:

Customer drawing power: There are several variables used to proxy customer drawing power, including shopping center size, age of center, and whether or not the center had a national anchor tenant (as opposed to one of regional or local origin). Typically, larger, newer centers and those with national anchor tenants demanded more rent when other factors are held constant.

Design of center: Shopping center designs are categorized as enclosed mall design, cluster design, L-shaped center, or U-shaped center. The mall design tends to yield the greatest rents, in comparison to the other three types of centers.

Location: The location of a center also significantly impacts rent, with those in high visibility areas (to pedestrians and motorists) garnering more substantial rents.

Market conditions: Poor market conditions – including decreases in population, per capita income, and vacant space — can have a significant impact on a shopping center’s rent. Vacant space is devastating to not only the property owner, but also the tenants. Center rents decrease about 1% for each 10,000 square feet that is vacant.

 While these factors all have a role in determining a shopping center’s rents, square footage still reigns supreme. Research done in 1998 determined the per square foot rent subsidies paid (and per square foot rents extracted) by the different store types in regional and super-regional malls. They found that anchor stores receive a per-square-foot subsidy of about 72% of what non-anchor stores pay. Additionally, rent subsidies for anchors increased with the size of the shopping mall.
When it comes to shopping center rents, some things will never change.

 This is the second installment in The Shopping Center Chronicles. Visit our blog to read the other articles in this series.