The Reason Fixed Commercial Rents Could Be the Latest Pandemic Victim

Rather than forcing stores and chains to go bankrupt, landlords are exploring revenue sharing arrangements that may give tenants greater flexibility to weather current and future disruptions to business. JL

Konrad Putzier reports in the Wall Street Journal:

A growing number of companies want to switch from long-term leases with fixed monthly or annual payments to flexible arrangements that include revenue sharing. Fixed long-term leases dominate the real-estate market. But the economic shutdown exposed a dangerous flaw in the model: Companies’ revenues can plummet from one month to the next, but their rent obligations remain constant, putting many firms in danger of default. Lacking sales, retail and office tenants are asking for rent relief (or) to waive some rent in return for a share of future revenues.

With the coronavirus pandemic undermining even profitable businesses, some companies want to overhaul a core tenet of the real-estate industry: steady and predictable rent payments.

Fixed long-term leases dominate the real-estate market today and have for centuries. But the economic shutdown exposed a dangerous flaw in the model: Companies’ revenues can plummet from one month to the next, but their rent obligations typically remain constant, putting many firms in danger of default or even insolvency. Lacking sales, many retail and office tenants are asking for rent relief.

But a growing number of companies are looking beyond short-term cures. They want to switch from long-term leases with fixed monthly or annual payments to more flexible arrangements that include revenue sharing.

Some property owners say they are open to the idea.

“The days of being the landlord as an overlord to collect rent are over,” said Michael Phillips, president of real-estate investment firm Jamestown.

As the coronavirus started spreading, the company set up a task force to help its tenants handle the fallout and later set aside $50 million for loans and other aid, Mr. Phillips said. He expects to see more short-term leases and revenue-sharing arrangements as stores gradually reopen.

A number of retailers are already asking landlords to waive some of their rent in return for a share of future revenues. Ross Stores Inc. said last month that it would pay a rent equivalent to 2% of sales when its stores reopen. Guesst, a New York-based technology company, recently launched software to help retailers and landlords manage revenue-sharing arrangements.

Co-working giant WeWork, which had been looking to switch to more revenue-sharing arrangements before the pandemic, has accelerated the shift over the past month and hired two brokerage firms to renegotiate its real-estate deals. Some apartment-hotel operators, suffering from a downturn in tourism, are also looking to lower their real-estate bills and are willing to grant property owners a share of their profits in return.

Lease alternatives can come in many forms. Some firms sign deals that include a few years of revenue sharing upfront, followed by a period of fixed rent payments. Other deals include a low monthly rent, topped off by a share of revenue. Still others include no rent at all.

Despite the appeal, brokers and landlords expect fixed leases will remain the norm. Mortgage lenders, which put a premium on stable income, are a big reason why. They tend to offer better terms for properties with long-term tenants because they are viewed as a safer investment.

Although the pandemic has exposed that perceived safety as an illusion in some cases as tenants simply stop paying rent, landlords and banks still prefer leases. And some retailers are looking to benefit from the economic crisis by locking in long-term leases today at low rents.

There are also practical challenges: Opening up the books to a landlord can be tricky, and some businesses may struggle to show how much revenue is down to a particular location. “There’s just a lot of pitfalls,” said Joe Learner, vice chairman and Midwest region lead at brokerage firm Savills.

But even if leases aren’t going anywhere, the days when they were the only option may be over.

“Most epidemiologists don’t believe this is the last” pandemic, said Naveen Jaggi,   president of retail advisory services at brokerage firm JLL. “You better build your business plan to accommodate future disruptions.”

Mr. Jaggi said a growing number of international retailers had already begun asking for shorter-term leases or revenue sharing last year amid uncertainty over the future of bricks-and-mortar retail, he said. Some clients in the food-and-beverage sector are now looking to approach their landlords about revenue sharing, he added.

These arrangements aren’t all new. Hotel and mall operators have had them for decades. Neiman Marcus and other luxury retailers at New York City’s giant Hudson Yards mall pay their landlord a percentage of sales rather than a fixed rent, brokers said.

But the practice is spreading to new sectors and growing in popularity as economic turmoil makes it harder for companies to predict how much money they will make in years to come.

“A leased co-working unit is like putting debt on your house. You owe a certain amount, and then it magnifies all of the swings,” said Jamie Hodari, CEO of the co-working company Industrious, which largely switched from leases to management agreements long before the pandemic.