Photo: Getty Images/toondelamour
Should landlords get a cut of online sales?
Retailers are pushing property owners for more flexible lease terms due to the extraordinary disruption caused by the pandemic. One of the tradeoffs landlords are seeking in return is rent as a percent of online sales.
The requests come as many property owners struggle to meet mortgage obligations. Vacancies are on the rise and many retailers and restaurants have been unable to pay rent.
Omar Eltorai, analyst at Reonomy, told GlobeSt.com that he believes percentage lease agreements, typically used by large retailers, will become more widespread “to accommodate significant business interruption better.”
Typically, the percentage-leased concept involves a fixed component of lower base rent plus a variable component based on a percentage of sales generated at the property.
Adding a variable component tied to a proportion of a tenant’s online sales has been explored for several years given the “halo” boost physical stores provide to online sales. A 2018 study from the International Council of Shopping Centers found opening a store helps boost traffic to a retailer’s website within a given market by some 37 percent on average during the quarter that follows.
The appeal for online rent attribution is reportedly being heard louder given the accelerated digital shift amid the pandemic. Fast-growing omnichannel practices, including BOPIS, curbside pickup and ship from store, all require stores to work.
Retailers in the past have countered the threat of rent tied to online sales by noting that online sales often earn lean margins. They also assert that they’ll be paying rent on both stores and online warehouses.
Figuring out a formula to compensate landlords for in-store’s influence on online revenues promises to be complex. Stores are already facing challenges compensating in-store associates for omnichannel actions.
Exploring the issue for The Wall Street Journal, Carol Ryan suggested retailers entering new lease agreements would have to “open their books to landlords in a way they aren’t used to” to explore the links between online and offline sales. She wrote, “Rather than passively collecting rent, property owners will more than ever be partners in their tenants’ business. Negotiations between the two sides aren’t going to get easier any time soon.”
- The Percentage Lease Concept is Poised to Spread – Globest
- 2017 ICSC Canadian Shopping Centre Law Conference – International Council of Shopping Centers
- Physical stores key to retail success, study finds – International Council of Shopping Centers
- Store Landlords Face a Battle for a Cut of Online Sales – The Wall Street Journal
- Malls File for Bankruptcy or Shut Their Doors as Pandemic Pain Spreads – The Wall Street Journal
- Retailers, landlords battle over who foots the pandemic bill – Crain’s New York
- Retailers reject landlords’ plan for a cut of online sales – The Australian Financial Review
Discussion Questions
DISCUSSION QUESTIONS: Would including a share of online sales in store leases make sense? How would such lease arrangements be structured to be fair to both retailers and landlords?
Poll
BrainTrust
This is a controversial but an interesting idea that warrants further investigation. The pandemic has fundamentally changed the economic relationship between some retailers and landlords. The sad fact is that both groups are being negatively impacted. While the concept has merit, the devil is in the details. I doubt that a one size fits all approach will work. Finding a formula that will be equitable for both parties will be challenging and vary greatly depending on the retail category and the unique characteristics of the retailers and the landlord.
This is a very interesting idea. I am curious to see where this goes and how something like this could be scaled up across the country – a lot of rules would have to be in place to define if and when this would happen.
So if I’m a national retailer, with multiple locations in a market, will I be expected to include the performance of all my locations in the market in the calculation for my lease payments in one given store? That’s exactly the implication I see here. Digital channels are another channel, just similar to another store. Thinking of the halo effect, if a retailer has multiple stores in a market, that bump in sales due to physical locations is most likely being influenced by exposure to a number of locations, not just one.
Um…no.
Hahahaha — epic boss answer!
What? absolutely not. Not unless the landlords want to chip in on the shipping costs.
Maybe 10 years ago or even more I went to the Levi’s store to get the correct size and preferred style. I didn’t buy the jeans then, but went home and bought them on Zappos. Since then, I have probably bought more than a dozen pair online.
Should the landlord get a cut? It makes sense. But how is it accomplished? The complexity could be mind-boggling. It may be easy to attached my sales to my local store here in NYC. But how do you deal with the shopper who lives in California or Texas or even NJ?
Net-net, a retail space has value. As more and more and more business goes online, the value related to brick-and-mortar sales decreases, but the value of the space does not for the retailer. The answer is write the agreement for what the real value of the space is to the tenant and move away from the override on sales.
My initial and visceral reaction to this idea was a resounding “no way.” Paying commissions to landlords based on online sales certainly has many potential downsides, and admittedly I have not spent a lot of time considering them all. However after spending a couple moments contemplating this idea, I wonder if there are upsides to landlords being paid commissions only on e-commerce orders that are fulfilled in the store? That would eliminate the issue of landlords double-dipping on e-commerce sales from multiple stores in any given market. It would also minimize stores’ exposure to commissions for online sales outside their market. And it might even incentivize landlords to play a more active role in supporting their tenant stores with order pickup logistics and marketing. Definitely worth further consideration, in my opinion.
Percentage rental leases were much more predominant in the past. Years ago we did shared risk leases. A lower dollar rental base followed by a percentage of sales, normally 3 percent of cash sales, 4 percent of credit sales. Today, if I were doing this, I would expect any smart landlord to go along to keep the tenant, but there would be a ceiling sales limit and then a return to the base lease agreement.
The idea certainly has lots of merit. The line between the physical store and the online site has been completely blurred. There’s a direct line between seeing a brand in real life (the store) and the success of the online business. If I were a retailer demanding a straight percentage of sales deal for my rent, I’d be open to the idea. Of course, if I’m paying 8 percent for the store, I’m not paying 8 percent of my online sales. But certainly there’s a win-win angle here to explore.
It makes no sense unless the retailer is out of other cost reduction options. Perhaps the physical store aids online sales. I’m not convinced by the causality of the relationship. However landlords need to manage space and retailers need to operate their stores.
In order to include online sales in the calculation for a percentage lease agreement, the role of each specific store in the customer’s online buying experience needs to be examined. What is the store being used for? If it’s click and collect, then there’s a strong argument to be made for the sale to be included in the store’s sale total, as it played a role in delivering service to the customer. If it’s fulfilled from the store (picked and packed) but shipped to the customer, the fulfillment process is different, but the same argument can likely be made. For pure online sales, shipped to the customer from a location other than the store, the sale belongs to the online channel as the store had no hand in delivering the service.
They say in Vegas, the house always wins. While mall landlords would love to apply that saying, the playing field, or gaming tables, have moved to a digital space that continues to disrupt the role and function of space and the redefinition of consumer value. Sorry landlords, that dog won’t hunt.
In short — it makes a great deal of sense, but only if you are a landlord. If you are a retailer, not so much — as in none.
As long as the landlord only receives a percent of net sales (including returns), I think it has merit.
Shades of grey. Technically (accounting wise) the sale occurs when (maybe not where) the product is fulfilled.
So if it’s curbsided … probably … if it’s buy online and ship from store … less clear.
From a practical standpoint, the landlord probably has the right to anything that goes through that store’s POS device, and a right to audit and balance to that. If the product is reserved online, and picked up in store, the landlord probably gets a cut, yes. If the retailer’s systems are set up so that a ship from store goes through the store POS (like Instacart), also likely yes.
Beyond these not completely clear delineators, it quickly goes to really muddy. In principle, the retailer owes the mall for the traffic the mall generates. The claim to the physical mall generating online sales gets rather but not completely tenuous.
It all comes down to negotiation. But I’m be cautious on both sides. Location is worth a lot — so a good location which increases store sales will probably also have some impact for online sales.
BUT — I’ve never liked contracts which dig for money too far removed from the value that’s being added.
If the negotiation leads to a desperate need for a variable rate, then maybe a bonus from online sales would be appropriate. But a share of online sales? All I see is disaster on both sides at some point in the future.
Regardless of how interesting it is, it doesn’t align with the value to the retailer. The only piece that might make sense is the advertising or brand value appeal for having a physical location. Don’t expect retailers to dive into this option unless they are distressed or are able to cull a fire sale deal from their landlords. If anything, it will result in successful retailers increase buying of property rather than leasing.
Percent of sale is not a common or sought after model for many businesses, not just retail (though there are exceptions) — and to focus on just the digital sale as a non-digital entity makes it all the more misaligned. Where this will work is where landlords or PE already have some level of ownership of the retailer or retail brand.
Commercial rents tied to online sales is a flat “no” for me — and probably not such a great idea for landlords if it causes retailers to recalculate the value of remaining in physical locations.
BIG however: Enclosed malls, especially, are not well configured to enable low-friction store pickup. It might not be out of line for a landlord to invest in an attractive, easily-accessed curbside pickup facility and charge reasonable service fees to tenant retailers.
Fellow BrainTrusters: Have any of you observed a model like this? It is worth exploring?
I completely understand the logic of this, and can see where the landlords are coming from with thinking they are entitled (love that word) to a chunk of online sales if the sales are being fulfilled from that physical store location. However this does not seem like a viable strategy to me.
Sorry but no. You are a retailer with 1,000 stores. You have 200 landlords who cook up this type of lease agreement. That is easy — you stop at a minimum fulfilling online “ship from store” orders from those 200 stores and you potentially discourage “pick up in store” orders at those stores either via a small discount at other locations nearby or in some other way.
This move would push more retailers to set up warehouses (lower cost than a mall rent for sure) to fulfill online orders from and then cause more stores to close. Some of these stores that would otherwise be shut down are being kept in place due to doing a high volume of online orders. These landlords need to understand that a closed store is not getting you any rent at this point with so many malls having so many vacant spaces. Maybe they could try this at a few A malls, or in some big cities (though those are emptying out of retail, so no shortage of space there either).
Just like customers have choices where they shop, retailers have choices who they do business with as a landlord too. Many choices.
Short answer: no. Longer answer: NO!!!
The thinking behind tying (physical) sales to rent is simple and makes sense: the location itself contributes to the higher sales, so the tenant is willing to pay more for the location. What’s the logic here, other than the obvious fact that a successful company — i.e. a lot of sales — will probably pay more than an unsuccessful one?
If Wave 2.0 sends the economy into free fall again, and the idea of “fairness” is that everyone is made whole … regardless, then we’ll see very little of it.
As with most landlord lease discussions, it depends upon the balance of power and status of retailer financial health. If the retailer is doing well, they don’t need to engage in changes to lease terms. If the retailer is struggling, some concessions may be made, and a share of physical store revenues or proportion of store sales above a certain level may be warranted. If the retailer is in distress, share of all revenues may be part of the Hail Mary solution – but maybe start with BOPIS sales only? The growth of BOPIS during the pandemic strengthens the case to include online sales in any rent-based deals.