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Are empty shops (un)avoidable? – The general concept and the reality are deciding factors (2018)

It almost seems as though the ghost of being unable to lease out spaces in Germany’s pedestrian zones can be seen more and more often. In fact, many small and medium-sized towns and cities can’t deny that more and more shops in traditional city locations are closing because spending power has moved – either to new shopping centres on the outskirts of the town or city, or to the anonymous space of the internet. Without the necessary minimum sales, even the best business ideas can’t survive. And the number of shops vacant for a long period is also increasing in bigger cities. The reasons for this vary widely.

It would be too simplistic to determine whether stationary trade with an attractive range of offerings would be able to survive in a town or city based on the number of residents it has. Therefore, many branch businesses that are growth-oriented have small towns in southern Germany on the top of their priority list instead of cities in the Ruhr area. Key figures corresponding to spending power and centrality that are often quoted by the Chamber of Industry and Commerce (Industrie- und Handelskammer, IHK) and respective economic development agencies have also lost significance. The spending power indicator can, for example, be misleading if affluent citizens do not shop where they actually live due to a lack of appealing shopping options, or if students in university towns and cities actually enjoy being good consumers due to student loans or support from parents, despite theoretically having low spending power. A high centrality indicator solely confirms to a municipality that more is spent inside the city than would actually be available to citizens.

But shopping does not necessarily have to strengthen the central pedestrian zone. It can also be located on the outskirts if there is, for example, a factory outlet centre there, like in Zweibrücken, which has a remarkably high centrality rate. That’s why it’s becoming even more difficult for commercial property owners to determine whether their negotiating position is comfortable in the case of a new lease, or whether concessions are needed in contract negotiations to make the lease sustainable. General rent levels are only of low significance due to the fact that the data basis is often questionable – because what kind of landlords officially report confidential contract details to third parties? And even comparative figures from neighbouring areas are generally non-transferable, as they often have a different timescale or relevance with respect to the industry. Receivables, with respect to professional chain store companies, that are unrealistic due to not being in line with the market are increasingly leading to negotiations falling through, thus resulting in vacancies or interim plans, often paired with a loss of attractiveness for retail in the immediate vicinity.

However, even if landlords accept that the phase of achievable maximum rents is likely over due to the general situation in retail, at least for the time being, this leaves many wondering whether contractual arrangements are still appropriate in the current situation, and if so, what type of arrangements are appropriate.

Are tenant receivables excessive or are they actually in line with the market? Some tenants who are achieving sales that are still good are ‘seizing the opportunity’ to secure good locations in the long-term on more favourable terms and with flexible opt-out clauses.

So where does the truth lie? Has leasing turned into a game of poker on a higher level? In principle, yes – and now more than ever, it requires years of experience and the expert knowledge of specialists who know or are able to classify the market and the stakeholders involved, even beyond the local area. At DOMINO, we have been negotiating contracts in top pedestrian zone locations on a national level for almost 30 years, ranging from Flensburg in the north of Germany, to Konstanz on Lake Constance in the south, and we are well-versed on the subject. In the past, it was mostly enough to bring together landlords and interested retailers, with an agreement generally being reached shortly after. However, today, many parameters that would have been a given in the past are being rejected or altered by well-known chains. As well as rent, the length of the contractual period, special opt-out clauses, rent-free months in the development phase, index regulations, the establishment of possible options up to the mode of return after the contract has been terminated, are all subject to tough negotiation.

Landlords who have had a stable rental position with increasing yields for years and have been accustomed to their prime location property being a ‘sure-fire success’ from a leasing perspective, due to lively demand, are now often completely overwhelmed by new leases. Advertisements in property portals or in the windows of local ‘all-rounders’ often add to confusion and rarely lead to the desired outcome.

Only those who constantly deal with the issue and have a national market overview really know which tenants from which industries are still concluding long-term contracts and which contractual parameters are fair, appropriate and feasible on both sides. Are the building specifications submitted by an interested tenant excessive, or quite usual in the industry? Who bears the conversion costs that are almost always due, and to what extent, and which part of that will relate to the usual value retention of the property, and which part will relate to the special brand identity for the new shop design? Is the interested concept even fit for the future, and is there enough experience in other towns and cities in which the future tenant already has stores?

In fact, there were and are regular waves in pedestrian zones with new retail ideas that then disappear quite quickly again after a short period of time (anybody remember bubble tea?), that are further developed (system bakeries such as BackWerk or BackFactory are expanding into cafés and need new bigger spaces) or that end up undergoing a market shake-out due to mergers after a period of intense competition, e.g. telephone providers. How many shops have been leased by Arcor, Yourfone & Co in their time and then prematurely terminated or liquidated after being taken over? Almost every industry wave follows the same pattern: Initially there is an intense demand for a special type of shop, coupled with a willingness to pay top rent, which is then followed by sobering space shake-outs or closures just a few years later. Leases that had been negotiated for 3-4 years are now often no longer achievable even with bigger discounts, and suitable subsequent uses cannot always be found. It is also questionable whether nail studios, barber shops or tattoo studios should be classified as a desired or emergency solution, or whether such tenant occupation simply reflects current societal changes.

Vacancies are not just found in small and medium-sized towns. More commercial spaces in prime locations, even in city pedestrian zones, stick out as they remain closed often for several months. The reasons for this are often different: institutional investors such as funds, pension funds, etc. have usually determined the value of their commercial real estate for the balance sheet based on the last rental payment. So for example, if you determine in a city like Cologne that, based on demand, a new lease in the highly frequented Hohe Straße would achieve just €25.000,- monthly rent instead of the €35.000 ,- previously obtained, you have two options: you lease the property and have to adjust the book value by around 30% accordingly, or you leave the property empty and hope, whilst accepting several months of rent losses, that you can still find someone who is interested in leasing the space on the previous rental terms so that you don’t have to reduce the book value of the investment portfolio. Then it’s poker on a whole new level!

Conclusion: re-leasing commercial spaces in prime locations is currently associated more with risks than opportunities. The many parameters that have to be taken into account by property owners based on the individual requirements and expectations of the companies leasing properties are too complex. It is most likely only possible to make reliable assessments of the future of stationary retail if you can combine expertise from many years of practice with a market overview of the current general situation in around 300 towns and cities across Germany, which DOMINO focuses on with its consultancy services.