New Rent

While in Downtown Los Angeles a few weeks ago, I saw a large sign—like an oasis in the desert—for Dunkin’ Donuts coffee at a subway stop. Instinct took over and I followed the sign’s directions down into the station, but alas there was not a Dunkies to be found. Taking revenge, I went to Starbucks. That’ll teach Dunkies for trying to fool me with its outdoor advertising! It’s a rare occurrence when advertising costs a company business.

Unlike this misadventure in advertising, the effectiveness of bricks-and-mortar retail real estate as a billboard is undisputed. The power of the store as an advertisement has only increased in the omnichannel age, making it increasingly likely that consumers will buy a retailer’s products online after seeing its signage or walking through the store.

Health ratios (rent as a percentage of in-store sales) are the most common metric used by landlords and retailers to determine how much rent a tenant can reasonably afford. Percentage rent is largely disfavored by landlords and their lenders for being too difficult to underwrite or subject to manipulation.

As online sales become an increasingly large percentage of total retail sales (Williams Sonoma, 53% online, J. Crew, 44%; Nordstrom, 27%), a similar challenge emerges to calculate the percentage of total online sales attributable to a physical store presence. This determination is further challenged by the difficulty of calculating net proceeds due to both the cost of shipping and the cost of returns (see CBRE’s recent Reverse Logistics report). Some of this can be mitigated by the buy-online/ship-to-store or BOSS concept, as detailed in another CBRE report, but it remains a challenge.

Despite these difficulties, retail franchisors are increasingly effecting online sales within their brick-and-mortar locations. The strategy combines the “billboard” of the physical store with traditional advertising in the local market or “trade zone,” benefitting franchisees with a certain percentage of on-line sales. This trade zone approach has filtered down to store managers, who are increasingly bonused not only on in-store sales but total trade zone sales. Trade zones currently are determined by zip code, but more refined metrics are on the way. As retail sales evolve, some landlords believe they should be entitled to a piece of these trade zone online sales too.

The challenge is determining the applicable trade zone and how the sales within it are accurately measured. Some companies like Visa and Experian are solving this by selling their credit data, which includes information on exactly where sales occur. There also are an increasing number of location-service providers that, through “Wi-Fi pings” and other means, are getting closer to pinpointing the exact location of an online buyer. While I still get annoyed with retailers who ask me for my phone number at the point of sale, this was an early and raw means of trying to narrow down the trade zone too.

The science of retail is still evolving to give a more accurate reflection of the value of physical stores far beyond just gross sales. This value includes the net online sales attributable to physical stores.

This “new rent” will enable both landlords and tenants to make more informed decisions in a rapidly changing retail landscape. It also will facilitate objective value appraisals by lenders and buyers. Unreasonably high or low rent is unhealthy for the long-term sustainability of the industry, and retailer “health” can no longer be accurately measured by in-store sales alone.

By Spencer Levy, Chairman & Senior Economic Advisor, Americas Research, CBRE.