I don't get how commercial real estate works.

Miscellaneous and Personal Stuff I Must Share
1

There is a strip mall by my house that has been vacant for years. The mall sits at the corner of “Busy and Busier” street. The drive by traffic alone should be enough to keep any aptly run business viable.

Yet, it sits vacant. Why?

Also, on my commute to work, there is another strip mall that sits vacant. And meanwhile, just one mile further down the highway, they are building a new frick’n strip mall!

I just don’t get it!

I’m slightly peeved because we could use a good Chines take out in our neighborhood. I keep hoping some business owner will come in and set up shop, but it hasn’t happened yet.

2

Are there “For Lease” signs up, or is it boarded up and fenced in? They may just be abandoned.

3

No, the property is well maintained. It sits on the same lot with a McDonald’s, a Kroger, a Bank, and a few other businesses. All of which are doing well.

4

There’s probably part of your answer. The property is owned by an absentee landlord, most likely a corporation, and they can make a suitable profit from the rents that they are currently collecting. Therefore there is no pressing need to find tenants for the empty parts.

5

It’s not uncommon for commercial property to sit idle for years. If the owners own the entire lot, and they have other paying tenants, they can afford to wait for one that will pay their price; they can be picky about who they will rent to, preferably a “name brand” store that will sign a long-term lease. Renting to an “undesirable” business, like a liquor store or a tattoo parlor might get them money now, but it will likely reduce the value of the entire property. It’s better to just let it sit empty and wait for the “right” tenant.

6

A possible explanation is that the landlord is greedy.

I’ve known more than one thriving business that was forced to relocate or go out of business because the landlord got greedy and demanded a large increase in the rent. One of those locations (in a thriving strip mall) sat vacant for at least a year after the business moved out.

7

I also see cases at least at the relatively lower end of the commercial market that don’t seem to make sense. In my neighborhood it’s empty store spaces on the first floors of mixed commercial/residential buildings. This is not a depressed area, big gentrification and increase in population in a dense urban area in recent decades. But there are some store fronts, off the main drag albeit, that have been empty for literally a decade or more. Somebody owns these buildings, is paying property tax on the full value, collecting rent from the apartments (they aren’t abandoned buildings) but…hard to explain. Maybe they own the building outright with no debt so they think ‘it doesn’t really matter’ but that’s crazy. This is an area where a cheap small store rental would be $5000+ per month, bigger more desirable stores on the main street are way more. And these people collect zero year after year, maybe because they can’t quite get some target amount? It’s puzzling. This would not be true of buildings owned by publicly traded companies, or any kind of professionals who own a private RE company. Those latter have their faults surely, but mom and pop and other amateurs are the only people who ever think ‘there’s no pressing need’ to rent an empty space for an extended period.

8

Commercial property can be stupid. Landlords have a price they want per sq foot, and they aren’t going negotiate down on that. It doesn’t matter if the place is vacant, they will not lower their rates.

Now, the reason for this is complicated, and I only fully understand parts of it, but first, you have lease guarantees. If I sign a lease with a landlord, then I have to pay through the terms of that lease. If I go out of business, I still owe on the property, unless someone else rents it first. So, if I am out of business, but still paying $18 a foot, then they have no incentive to give it to you for less than that. I don’t know how long a lease can go, but I know that that was the case with some of the units I was looking at when I was opening my place.

You also have the rental price as a collateralizable revenue stream. If you claim that you can rent the unit for $18 a foot, you are going to get better credit than if you are renting it at $14 a foot. If they rent it for less than they are claiming to their creditors that they can get to it, their credit may be called into question. The sell value of the property may be impacted as well, if it is rented for a lower price.

Keep in mind that leases are usually at least a 5 year, 5 year, meaning that the tenant has the option to unilaterally renew or choose not to renew at the 5 year mark, so the unit may be in use for a decade. The property owner may not want to get locked into having a cheap tenant for 10 years, when he is expecting the area to come around, and the units to be filled out with full paying tenants in a few years.

9

I was also thinking of the greedy landlord who believes the property is worth a certain amount, regardless of what the market seems to be telling him. Other possibilities:

The vacant properties are tied up in some sort of legal/financial limbo. Liens, back taxes owed, contested inheritances, something along those lines.

They’re brownfields. If there was ever a gas station, dry cleaners, or other tenant that left behind environmental contamination, the new owner will be legally liable for its cleanup. Still a hassle even for a new owner that takes advantage of programs designed to limit their liability.

Traffic issues make a property less than desirable, e.g., access to or from Busy and/or Busier St. is poor. No median breaks for left-turners, too close to the intersection to easily get there from the opposite side of either road, etc.

The stink of failure. If one strip mall failed at these locations, it suggests that the next one could, too.

No one wants to be the first one to re-occupy either facility, so whoever owns it may have a hard time finding renters. A single open business in an older, otherwise empty strip mall looks kind of pathetic and may well convey the impression that it’s on the way out, not in. By contrast, at that brand new strip mall, it’s easy to think that the remaining stores will be filled in shortly.

10

Here’s another possibility.

In the local news is an article about a big grocery store that moved out of a strip mall location here a couple of years ago. The space has sat empty since then, and rats and vagrants have moved in and the surrounding commercial tenants are pissed off, not to mention locals who really want another grocery store there.

The article said it’s looking like the original grocery store chain is purposefully keeping the space empty, continuing to pay rent on it, because they don’t want any competitors moving in. They do have other stores a few miles both north and south of this empty space and don’t want their customer pool diluted.

11

Keep in mind if there’s already a McD’s they won’t be very happy to see a Wendys go in. If there are already four or five paying businesses in the strip mall, that’s going to limit, to some degree, who he can rent to without rustling feathers of the current paying tenants.

12

And this is (one of many reasons) why you see fewer and fewer independent businesses and more chains.

If you or I decide to open up a non-Hallmark stationery store and we set it up correctly (i.e. not a sole proprietorship), then you or I would not be liable for the debts of the business. But if we open a Hallmark-franchised store and it goes under, the lessor can reach out to Hallmark to keep the lease payments flowing.

This does over-simplify things a little, which is why the contracts tend to be very, very long. The lessor will put in qualifiers that try to insure his 5 or 10 years of payments, the lessee will try to put in clauses that offer an out.

13

Some possibilities:
[ul]
[li]The owner may have gone bankrupt in the Great Recession, such that everything on the site has been frozen in place while it has taken years to sort out the ownership. [/li][li]The owner of the site may be planning a large-scale new project and is waiting for leases to run out on the rest of the property. [/li][li]There may be some dispute with the locality about zoning, or between owners about various rights. [/li][li]There may be something toxic in the ground.[/li][/ul]

14

I am set up as an LLC, but I still am personally on the hook for the lease guarantee, the landlord insisted it be that way, as I am sure he is aware that I would not be liable for the debts as an LLC, especially as we were just starting out when we leased, and he had no reason to believe that we would still be in business a year later.

So, yeah, I go out of business, and I personally still owe another 5 years of rent on this property (just renewed my 5/5 year). Bit of a risk… I actually am not sure if bankruptcy would clear such a thing.

One thing to always remember, have everything in writing. Any “understandings” you may have with you landlord are not worth the paper they a re written on, and worth even less if he goes to sell to someone else.

15

Most landlords will require a personal guaranty from the owner of the LLC, as will most people who extend them any credit.

I don’t believe that a franchisor will guarantee any kind of lease to a landlord either.

16

On the second there are leases around gteed by the parent companies of chains ie the franchisors. There’s a big market for so called ‘triple net leases’ where the ‘landlord’ is really just some remote investor buying the property contingent on a long term lease which is entirely managed by the tenant, which is in some cases the corporate level of the franchising chain and who sometimes also gtees the lease payments.

Some franchisors will do this because it makes sense as part of facilitating their expansion, but doesn’t expand their balance sheet as much as buying the property themselves and leasing it directly to their franchisee. And of course they get more out of the franchisee if they make this deal then if the franchisee can arrange a lease completely on their own. And on the other side the purchaser/lessor gets a significantly lower rate of return leasing with a corporate gtee than not. Especially if it’s an investment grade public company franchisor, like Dollar General say. If it’s a public junk credit or private company franchisor (Yum! Brands ie Taco Bell etc, or Church’s Chicken) then the deal is priced for a higher return to purchaser/lessor. Or the lease might not have any franchisor gtee, but in those cases in the 3N market the lessee is usually a not so tiny franchisee LLC which owns multiple franchises of that chain in a particular area. In that market, 3N leases, the lessees are usually not single location LLC’s, even with a personal gtee.

17

Also, if a franchise operator goes out of business, if the franchise is the guarantor, then they can take over the space, and sell the franchise to someone else.

If the lease is entirely in the owner’s name, then it would require at least a couple extra pieces of paperwork to get it all straightened out.

18

I’m very familiar with personal guarantees, I just didn’t want to get into the weeds with the details. A good lawyer will try to protect the lessee as much as possible, often depending on how much the lessor needs the income.

Most strip malls will try to have an “anchor” tenant. That’s the tenant who, as long as it is paying, covers the mall owners “nut” (expenses). Everything after that is gravy. A good anchor is expected to drive traffic to the mall, which in theory should help the smaller stores. It isn’t working as well as it did, hence high turnover and empty stores.

I’m fairly familiar with this subject, but my wife is an SME. Franchisors sometimes do guarantee leases, and her firm collects on a good number of empty commercial lots from former big name tenants.

19

This sort of thing happens even in prestigious, highly desirable areas like the West Village and SoHo in New York City.

When my wife and i visited New York last summer, i was quite amazed at how many vacant storefronts there were in these neighborhoods. Especially since these places, especially SoHo, are packed with foot traffic, and are also home to a whole lot of high-end retailers, from large national chains to internationally-recognized luxury stores to small exclusive boutiques.

This phenomenon of vacant storefronts in the middle of a prosperous gentrified city is, in considerable measure, a function of landlords who expect rents to keep going up and up, and who are apparently unwilling to accept that market rates can travel in more than one direction. The New York Times has done a few articles on these neighborhoods over the past few months, looking at the causes and the effects of high rents.

Bleecker Street’s Swerve From Luxe Shops to Vacant Stores

In a Thriving City, SoHo’s Soaring Rents Keep Storefronts Empty

In places like Bleecker Street, older established neighborhood businesses were forced out as the area became more and more popular, and rents went through the roof. The first NYT story talks about a long-term tenant who had to close when his lease was up and his landlord raised the rent from $7,000 to $45,000 a month. Another, who was paying $2,500 tried to negotiate when her lease came up for renewal, but couldn’t match the landlord’s demand for $35,000.

That’s market forces , right? That’s just how it goes.

But now the landlords are finding that the rents they’re charging are, for most retailers, simply not sustainable. Some big companies like Nike are, as the second story notes, willing to pay massive rents and even take a loss on the store in order to raise their profile in a prestigious, high-traffic neighborhood of a wealthy city. But most retailers can’t sustain this model. As one real estate company spokesperson says in the second article, “I don’t know any retailer who can survive while paying 50 percent of their revenue in rent.”

In areas where everything is retail, this might not matter too much. So what if there are some empty storefronts, right? If the landlord is willing to sit on a property and not rent it out, denying him- or herself the revenue, why should anyone care?

The problem is, in places like the West Village, that this trend has killed part of what made the neighborhood attractive and pleasant for the people who actually live there. There used to be pharmacies and bookstores and butchers and grocery stores in the neighborhood, but none of them can afford to stay, and you can’t buy your medicine or your dinner supplies from Marc Jacobs or a boutique cupcake store.

This is what authors like Jane Jacobs and more recent urban planning critics mean when they talk about livable cities. And it’s why some people are encouraging city councils to do things like slap an extra property tax on vacant storefronts in places like New York, increasing over time, in order to pressure landlords to accept more reasonable rents. I’m not sure that any of these proposals will bear fruit, but it will be interesting to see what sort of city “market forces” end up creating in places like New York.

20

I don’t know if those NYT articles address it, but one part of the problem is owner turnover. NYC properties have appreciated greatly, and there is great incentive to sell to a new owner. Old owner may have been banking profits at $7,000/month but new owner, having paid significantly more to acquire the property, won’t be able to make his mortgage payment with that. So new owner ups the rents and hopes a Nike/AT&T/Walgreens/etc. will take his storefront and pay his price. But only so many of these will open (and they are already ruining NYC with their homogeneity). This isn’t just happening in NYC’s prestigious neighborhoods. It’s happening in (nearly) every neighborhood in every borough. It’s a little different from the strip mall situation, as NYC has the foot traffic.

Also, one cannot discount the effect the internet has had on physical retail operations. Back when I was young, we went to a stationery store in a strip mall for our school supplies (because we could get there without parents) or to Modell’s (which, at that time, was just like K-Mart). And we had to accept what they had. Now, we visit Staples/Office Max only if we need it right now. Otherwise, we get exactly what we want (not settling for what the store has) usually in 2-3 days, and it’s cheaper (even cheaper than when I was in school, adjusted for inflation). People have a ‘great’ idea for a store, only to find the people who do stop in are only doing so to see and handle an item that they are going to buy online. Any shop that itself does not aggressively sell online is dead before it even opens.