Over the last decade we experienced two transformative real estate cycles. First, we experienced a commodity market in sales with unprecedented financing with securitization, along with a compression of cap rates due to finance availability. Then we had the crash, which reversed all that.

Real estate is no longer a commodity. There’s a severe change in the economy which impacts retail, and all other properties. There’s also a return to underwriting financing, similar to the way we conducted business in 2001 to 2002. So how does this impact the retail investment and ownership market going forward?

There’s no doubt there was a significant expansion of retailers during early 2000. In addition to the availability of financing for properties, there was an availability of financing for tenants, including corporate and Mom & Pop. 

The private retailers, the Mom & Pop shop space operators, utilized home equity to finance their businesses and provide inventory financing. In some cases, shop space tenants expanded aggressively from one or two locations to five or more. When the home equity market crashed, this period of rapid growth stopped.

Unfortunately many of these retailers shouldn’t have expanded as aggressively, but capital was available. Now the Mom & Pop retailer had lost its backstop, and as the economy turned and their businesses declined due to a slowdown of consumer spending, their entire business plan was impacted. They were no longer capable of meeting their obligations to landlords, suppliers, or employees. Even if they were good operators, the reality was, if they had overextended themselves, they were now unable to stay open for business. 

When the Mom & Pop operator closes, it affects shop space, leasing and occupancy. And the greatest hit has been markets with the greatest growth and expansion. Without the capital to survive, the shop space is left empty. The landlord, depending on their financial situation, is now faced with either working with the tenant, perhaps lowering rental rates or providing concessions. But this impacts their cash flow.

The overall result is a domino effect. The shop spaces are where you can get higher rent, and that’s where your profit is. But when they’re impacted, you’re impacted. So depending on the loan, the next step is likely a workout with the lender or loss of the property. Even junior and major anchors expanded into thousands of locations only to then close hundreds or go out of business altogether. The loss of a 40,000-square-foot Circuit City can impact a project severely. Maybe you can re-lease it, maybe you can’t. The survivor is the well-located major market center and/or the low leverage owners. Going forward retail owners must look at their centers as a business, not as an investment strategy.

There has to be a much more acute awareness of and communication with the tenants. The landlord needs to understand each tenant’s business and in many cases work to enhance that business, whether it’s through marketing, campaigning or even special events, all at the local, community level.

The landlord has to think about how to attract the local community. The owner or someone associated with the owner needs to lead the marketing effort with the tenants, even to the point of offering business consultation. So if the tenant says “I have this issue” the landlord needs to think about how they can help. They don’t necessarily have to pay, but maybe the center needs a website, where they can provide access to coupons. The tenant – landlord relationship should be transparent.  The benefit is that the landlord really gets to learn how their tenants are doing, consult with them, and remain aware of any potential negative situations. The owner must be invested in the tenant’s success because their success also means they’ll pay the rent.

Retail needs to change. Look at bed & breakfast operators. They’re the best hoteliers in the world. They have websites, lots of pictures and when the customer shows up, they work to personalize the stay. That is what I believe will happen to the retail experience. It will evolve into back to basics, down to the intimate level. And the owner is going to have to adjust to what that means to his investment in both the property and working with the shop space operators.

Rich Walter is president of Faris Lee Investments, a retail advisory and brokerage firm specializing in commercial real estate with offices in Irvine, CA, New York City, Phoenix and Las Vegas. He helps direct the firm and actively participates in transaction negotiations on behalf of Faris Lee Investment’s clients. He has more than 30 years of hands-on experience in the commercial real estate and banking industry. His specialty lies in acquisition and disposition advisory services including distressed asset/portfolio/loan dispositions, brokerage, debt and equity structuring and placement. Throughout his career, he has been directly involved in more than 3,500 real estate transactions totaling in excess of $7 billion in value.