Property owners, take notes ✍️

It’s me, Abby, and I’m back with the third and final installment of my manifesto newsletter series Things Landlords Get Wrong About Indie Retailers, and this time I’m done complaining. As the old adage goes, if you don’t have anything nice to say, better to say nothing at all. But also, if you see something, say something…know what I mean? So maybe that maxim needs an update - if you see something messed up, say something...and then propose a solution!

We hope that our newsletter is a salve for the clickbaity headlines pronouncing the death of indie brick-and-mortar retailers. Amazing mom-and-pops are doing their thing all day every day, just as they always have and always will. And yet, the commercial real estate system within which they operate tips the scale towards failure from the start. In part 1 of this series, I talked about landlords who only want to lease to nationals. Part 2 found me bemoaning the unfavorable deals indies can be forced to take.

So if you’re thinking, Abby, has the Desitin gone to your head? I come to your newsletters to escape the doom and gloom about independent retailers, and you are seriously bumming me out! – don’t worry. Today I’ll get constructive.

It actually is possible for landlords to qualify their risk when renting to locals, but offering different (read: inferior) lease terms is the wrong approach, because it increases the likelihood of the very outcome they’re aiming to avoid – closure. 

🏊 If you’re worried a swimmer won’t make it across the river, don’t strap weights to their ankles. Choose a swimmer that you believe can make it.

In other words, the way to mitigate risk better is to get smarter about vetting prospective retailers. We run a whole seminar on this topic for landlords and place-based professionals (interested? Reply to this email!) and we really could write an entire book on the topic. In the interest of time, we’re bringing you just the sparknotes.

💰 Is the budgeted occupancy cost realistic? 

If you’re a retail landlord, and you only have time to learn about one retail success metric, occupancy cost is the one, and you’re in luck because it’s very easy to calculate. A retailers’ occupancy cost is the ratio of their rent to their sales – in other words, what percentage of their total revenue goes towards their rent. Different business types have different industry benchmarks, but 10% is a good anchoring point. Full service restaurants would like to be closer to 6-8%, and some users can go as high as 15%, but once you start to approach 20%, you’ve got a problem.

So, when you’re reviewing a prospective tenant’s P&L projections, make sure the occupancy cost (the rent you expect divided by the sales they project) is in that healthy range. 

We're sometimes called in as the rescue squad when retailers are struggling to pay their rent. It’s downright heartbreaking when we look back at the original business plan – the same one the landlord saw before the lease was signed – and see that the occupancy cost they budgeted for was unhealthy from the start. $95k in rent and $350k in sales? That’s a 27% occupancy cost. 🚩🚩🚩 

Very few retail businesses have the margins to be able to operate with a rent-to-sales ratio that high – projections like that should be a blinking neon red flag to a prospective landlord. And you can bet your biscuits that if a retailers’ projections show a profit with a 27% occupancy cost, they’ve severely underestimated the rest of their expenses.

💳 Where’s the working capital?

I mentioned the importance of working capital in the previous newsletter – it’s like the oil in an engine. It’s not what propels a business, but without enough of it, the machinery seizes and even a good engine can’t run. It takes more time than many people anticipate for a new business to find its footing, and paying all of the business’ expenses is not optional even when sales are slow. 

So when you’re reviewing the retailers’ capital budget, make sure they’ve allocated a significant chunk as working capital. And when you’re reviewing their financials and sources of funds, make sure it’s accounted for. Contingency funds are the easiest ones to cut from the budget, particularly if the retailer has underbudgeted in the first place, which is why the lack of working capital is such a common failure point.

If anyone should care about sufficient working capital, it’s the landlord, because when there’s not enough cash to go around, guess what gets paid last (or not at all)? Rent. Products, labor, supplies…these are all things that MUST be paid in order to keep the doors open, so they'll always get paid first, whether it’s fair or not.

🤝 Teamwork makes the dream work

Every retail business starts with a first location, so being a first-timer is not, in itself, disqualifying. In the absence of operating history, you have to consider the background of the primary owner-operator as well as the team supporting them. You’ll want to make sure that either they or a key team member have…

• General brick-and-mortar retail experience. Experience being a customer is wildly different from serving customers, and you don’t want the rigors of retailing to be a surprise to your tenant as soon as they open for business.
• Experience in their particular industry. A hair stylist opening their own salon has a pretty clear picture of what it will look like to run the place, but if a prospective retailer doesn’t have industry experience, you’ll want to make sure they’ve either got senior team members or active advisors who do.
• The professional team they’ll need to complete the transaction, all with retail expertise. At a minimum, you’d want to see a broker, a leasing attorney, an architect and a general contractor – or at least an indication that the retailer knows that they’ll need to hire these professionals

Of course there’s a lot more in the business plan to evaluate, but those are my top three. 

📝 Please take note of what was not on the list – a prospective retailer does not need to have ten existing locations, millions of dollars in the bank, or an affiliation with a franchise. Even with those advantages, a brick-and-mortar owner needs a business model that keeps their occupancy cost at a healthy level, sufficient working capital to start strong and ease growing pains, and a team that covers all the bases – there simply is no substitute.

Of course, a thoughtful business plan can still go sideways, and even the best-qualified retailers can fail. But nothing in business, leasing, or life for that matter is certain. National brands close stores. Franchisees run out of money. Personal guarantees don’t magically create cash where there is none. We can manage risk, but we can’t eliminate it.

Independent retailers deserve to be judged on the strength of their business plan and offered lease terms that give them a fair shot at succeeding. Landlords who learn how to do that will get stronger operators, more interesting businesses, and yes, tenants who can actually pay the rent.

That’s my manifesto. Thanks for coming along for the ride.