From Digital to Physical: New Considerations for Retail Leasing with the Rise of E-Commerce into Physical Spaces
The rise of e-commerce and the struggle many brick-and-mortar retail stores face is nothing new. Customers are increasingly choosing to shop for clothes, furniture and even groceries from the convenience of their own homes. More recently, however, this shift in the way consumers shop has given rise to new types of retail stores – small showrooms and “pop-up shops.” While showrooms are not entirely new concepts, purely digital companies are increasingly opening up physical showrooms where customers can see and touch merchandise before deciding to buy, while the actual transactions often remain online. Pop-up shops – another retail store model – allow retailers (often online or seasonal retailers) to have a physical presence for a limited duration to essentially test run whether a permanent store would be lucrative.
By positioning online products in front of people walking through malls, popular shopping districts or city streets, online companies with showrooms or pop-ups may gain new customers that would have otherwise never heard of their company. Digital retailers can utilize these spaces in high traffic malls or trendy neighborhood streets as essentially a giant billboard advertising their online products, thereby transforming physical space into a powerful marketing tool. Tesla was an early pioneer of this concept by showcasing their cars using mall showrooms rather than selling their vehicles through traditional car dealerships.
These new retail models could provide an opportunity for large institutional landlords to realign their business incentives with the ever expanding world of e-commerce. While traditional brick-and-mortar stores may be on the decline, landlords may have an opportunity to recoup costs by leasing small retail space to digital companies seeking physical space (whether for purely advertisement purposes or short term sales). While landlords might ultimately prefer to lease space to large, long-term retail tenants, showrooms and pop-ups present an opportunity for landlords to generate rent from otherwise vacant space or failing retail stores. Additionally, pop-up shops and showrooms tend to create a certain amount of buzz, which can generate increased foot traffic to the surrounding area.
Given the unique nature of these retail spaces, showrooms and pop-up pops present new considerations for retail leasing agreements. For example, if showroom spaces are not generating actual in-store sales, retail productivity data such as sales per square foot becomes obsolete. Without these common measures, traditional rent calculations between landlords and tenants may need to be reconsidered. For example, many retail leases include percentage rent provisions, which provide that if the tenant achieves a certain amount of gross sales in a given year, they will pay a percentage of such gross sales to the landlord as additional rent. However, for retailers that generate most of their sales online, both tenants and landlords should understand how to define tenant’s gross sales and whether a percentage rent structure makes sense.
Additionally, pop-ups might not want to enter into burdensome and lengthy lease agreements for a short duration lease term. Instead, pop-up tenants may want to consider entering into a license agreement with simple business terms. The flexibility of a license agreement could also be advantageous to landlords, as license agreements generally allow a landlord to terminate the lease at any time and do not create an interest in the land.
While the emergence of these hybrid retail establishments can be advantageous to both online retailers and traditional landlords, it is important for both parties to consider the unique circumstances before entering into any legal arrangement for shop space. With the ever changing landscape of e-consumerism and experience-focused retail, the leasing industry may need to get creative with landlord-tenant agreements.
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