Why The New Wave Of Covid-19 Is Especially Detrimental To Retail Landlords

While a shopping center might not be as disparate as last year, foot traffic has decreased compared to the previous few weeks, thanks to the latest wave of Covid-19. The Omicron variant has emerged just in time for the prime shopping season around the world. According to data by Placer.ai, a foot traffic analytics firm, traffic was up last week 1.9% from 2019 across all retail categories in the U.S., which is significantly lower than October and November, with comps over 3% for most of those months. Super Saturday, December 18^th, illustrated a more prominent drop than Black Friday’s comps. For instance, Target’s TGT traffic was down 3.1% on Black Friday compared to 2019, and that gap increased to 6.5% on Super Saturday. In addition, Sensormatic Solutions, another company that tracks traffic to retail stores, reported shopper traffic in the U.S. decreased 26.3% on Super Saturday compared to 2019.

So, why is the decrease in foot traffic detrimental to landlords?

Most retail real estate deals include a base rent and a percentage rent where tenants pay landlords a fixed fee each month plus a percentage of their in-store sales. That percentage varies but usually sits around 5-15%. This structure has been around for a while. However, the added vulnerability at this stage in the pandemic is tenants have likely negotiated or re-negotiated leases to weigh heavily on percentage rent to lower their risk. Given the vast number of vacant units that existed at the pandemic’s peak, many landlords would have agreed to this altered deal structure.

In addition, landlords have more short-term deals due to the increase in flexible leases since the start of the pandemic and the popularity of pop-ups during the holiday season. For instance, Aspen has recently become a pop-up hub. In many cases, short-term deals rely heavily on percentage rent due to the nature of filling vacant space that would otherwise be empty and an opportunity cost to building owners.

Tenants favor percentage rent due to its flexible nature, but it has long been frustrating for landlords. One of the more recent issues is how sales should be defined. As stores become less transactional and more of a billboard for e-commerce, many landlords argue the sales used to calculate percentage rent should include a component of online sales. Studies have shown that a store lifts online sales from 23% to 33%, but that varies across studies. It’s not easy to measure, and it’s difficult to know where to draw the line.

As the latest wave of Covid-19 takes over, tenants will continue paying their base rent and operating costs, but there’s a good chance their percentage rent will be less than anticipated. As a result, they will lose sales from foot traffic, but customers who intend to purchase will convert online, which leaves landlords taking the brunt of the loss.

This issue isn’t new. Landlords have been dealing with it throughout the pandemic. Still, it shows the continued vulnerable state of real estate and how landlords are affected by the public’s fear reaction to the ongoing pandemic. It also illustrates the highly complex nature of percentage rent and the evolving structure of retail real estate deals.