A great location has fixed rent.
Rent that is fixed like cement makes locations great for retail tenants. Fixed rent is not ideal for landlords. That said, fixed rent still brings landlords meaningful benefits.
For tenants, it is much easier to settle into a groove if they only have to withstand the variations of insurance, utilities and tax expenses from the landlord. Adding an annual increase in rent to the equation makes long-term tenancy more difficult, especially for small independent retailers. Landlords seek annual rental increases to generate more net operating income (NOI) and improve their property’s debt service coverage ratio (DSCR) among other things. These sound business practices are not without risk. Many landlords are creatures of habit from the inflationary days of 20-30 years ago and seek 3% annual rental increases to ‘combat inflation’. We haven’t lived in an inflationary economy for some time now. As a result, most national tenants push back on this deal point, but local tenants don’t know that they should or don’t have the leverage to strike this deal point from a lease. But then again, how significant is three percent anyway?
In a five-year lease, a 3% annual increase turns into a 12.5% increase over the first lease year at the end of five years. If labor, shipping, raw material, tax, insurance and net rental costs were to increase commensurately, tenant margins will most certainly erode, even with steady single digit revenue increases. Tenants can’t always raise prices annually to combat increases in uncontrollable expenses. Therefore, a fixed rental rate might just give the tenant the breathing room and insurance to keep its health tenancy in a property. A steady and quantifiable rental rate allows tenants to better forecast their expenses and maintain occupancy and NOI for the landlord throughout the primary term of the lease, thus the paradox. Is it more important for a landlord to have annual rental increases that elevate NOI and DSCR but potentially reduce the likelihood of retail tenancy? Or, is it more important for a landlord to maintain retain tenancy and experience a flat NOI and DSCR? These real-life scenarios have real opportunity costs that can’t be answered without a better understanding of the landlord’s investment criteria, available tenant pool and competing retail projects.