For Retailers, Business Is Back and Landlords Say No More Rent Discounts

Many landlords slashed rent prices as they struggled to fill empty storefronts during the first year of the pandemic. Some felt compelled to accept a portion of monthly sales instead of a fixed rent amount from tenants whose businesses collapsed because of government-mandated closures and social distancing.

These arrangements helped retailers stay afloat, and prevented landlords from losing valued tenants.

Now, landlords are having a much easier time filling prime retail space and are far less likely to agree to these concessions, said Ed Coury, senior managing director at retail-brokerage firm RCS Real Estate Advisors.

“They’ll just say, ‘Covid’s over; those days are done,’" he said.

Landlords’ increasing leverage is another sign of retail real estate’s recent strength. Store openings outpaced closures for the second straight year in 2023 after years of net closures, according to research firm Coresight Research.

Consumer spending remained resilient last year despite high inflation and recession concerns, and Americans’ views on the economy are improving at the start of 2024. This, coupled with scant new construction of retail real estate, leaves landlords optimistic that retailers will be vying for limited available space for the foreseeable future.

Vacancies at U.S. shopping centers fell to 5.3% in the fourth quarter, the lowest level since real-estate firm Cushman & Wakefield began tracking the metric in 2007. Average asking rents rose to $23.70 a square foot and are now nearly 17% above 2019 levels.

“We’re seeing our highest occupancy in the 17 years that I’ve been at Time Equities," said Ami Ziff, managing director for national retail at the private real-estate investment company, which owns retail space in 29 states ranging from open-air shopping centers to enclosed malls. “Massive, massive rent growth."

Retail’s strong position stands in contrast to the office sector, where owners are grappling with oversupply and a drop in demand because of remote work. To sign leases, office landlords are upping concessions such as months of free rent and cash gifts to tenants.

It is a fairly recent turn of events for retail real estate, which for years struggled with retailer bankruptcies, changing shopping habits and the rise of e-commerce. The pandemic delivered a short but severe blow, and retailers that did renew leases or open new shops during this time were often able to secure favorable lease terms.

Percentage-of-sales agreements proliferated in 2020 as landlords sought to keep restaurants and other retailers from going out of business. Enclosed malls, which experienced prolonged closures during the pandemic, saw revenue from percentage-of-sales rent agreements jump in 2021, according to data firm Green Street. At one point, these arrangements looked like they would outlast the dog days of the pandemic.

Nearly four years later, in-person dining and shopping are booming, and landlords are loath to sign leases that leave rent collection subject to the unpredictable ebbs and flows of their tenants’ monthly sales.

Paragon Commercial Group, which owns mostly grocery-anchored retail properties on the West Coast, agreed to accept a percentage of sales from less than 5% of its tenants early on in the pandemic, said co-founder Jim Dillavou. But these arrangements required retailers to repay their full rent bills within one to five years. All of Paragon’s tenants survived and repaid the rent they owed, he said.

“For a tenant we believe in long term, our strong preference is for a fixed-base rent structure," said Dillavou, whose firm has since partnered with the Dallas-based Lincoln Property Company to run its West Coast retail properties.

That is in part because percentage-of-sales arrangements can lead to “uncomfortable conversations" if a landlord doesn’t believe the tenant is doing everything possible to maximize sales and therefore rent payments, Dillavou said.

More significantly, lenders don’t like these rent structures, making it more difficult for landlords to finance or refinance loans on retail properties with percentage-of-sales arrangements.

Retail landlords’ negotiating power isn’t absolute. Older, tired properties still have to offer concessions and accept lower rents to attract tenants, Coury said. Most landlords are still spending to renovate or build-out retail spaces for new tenants, and these costs have escalated along with construction prices.

And percentage-of-sales arrangements are more common now than they were in the past, although they most often take the form of tenants paying a base rent and then a percentage of their sales once they hit a certain threshold. So when a restaurant or other retailer has a strong year, the landlord collects this so-called overage rent.

These arrangements open another window into retail’s current strength. Even owners of enclosed malls, who historically have been more open to percentage-of-sales agreements, have been pushing to convert leases to fixed-rent structures with overage rent, said Vince Tibone, Green Street’s head of U.S. retail and industrial research.

Kite Realty Group Trust, which owns open-air shopping centers, saw revenue from overage rent increase 44% last year compared with 2022.

“Our retailers are doing quite well," Chief Executive John Kite said. “We get some of that upside."

Write to Kate King at kate.king@wsj.com