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Starbucks' Schultz Predicts Retail Rent Decline

There's an old adage in commercial real estate leasing: 5-6 of every 7 years will bring upward pressure on rents (in favor of landlords), and only 1-2 of those same 7 years bring downward pressure (in favor of tenants). The smartest tenants work to predict and take advantage of those rare cyclical soft years, by correctly timing new commitments (if their business allows), making longer-term leases when the market is softer (locking in lower rates for longer periods), engaging in early renewal negotiations (often called "blend & extend"), and more.

Reuters and others are reporting that Howard Schultz, Founder & Executive Chairman of Starbucks, believes we now entering one of those tenant-friendly periods in retail real estate - and he expects this one to be long and deep, due to the macro trend of consumer purchases shifting away from bricks & mortar.

Schultz' prediction was apparently captured in a leaked inter-company memo, circulated after he spent several weeks touring US markets. In the memo, Schultz said:

“Over the last few weeks, I have been in a number of U.S. cities and observed firsthand the abundance of empty storefronts across the country, in prime A1 locations ... We are at a major inflection point as landlords across the country will be forced (sooner than later) to permanently lower rent rates to adjust to the ‘new norm.’”

However, obtaining concessions from savvy landlords is rarely as simply as telling them about a quote from the news and insisting on lower rent. The savvy tenant will "kick up some dust" - and educate themselves - by exploring multiple options in the market, even if the preferred location is clear or "stayput" is likely. The tenant must also seek to understand the landlord's complete situation, as much as possible - ownership structure, cash flow, debt vs. equity, capital reserves and asset condition, and their complete rent roll, and prospects for other tenants.

The smart tenant will avoid talking about "a deal" until they have traction on both items above: (1) truly understanding the market, and (2) understanding the landlord's situation.

Then, in working a deal, they will not negotiate "headline rent" alone (the main number that distracts most people) - instead they will insist on simultaneously considering all the major lease economics:

  • term (including delayed start if appropriate),

  • headline rent,

  • free/abated rent period,

  • tenant improvement allowance,

  • existing condition of premises,

  • landlord work (and value thereof),

  • rent indexation or escalation (and caps/collars, if any),

  • operating expenses or "CAM" (including base year and caps),

  • rentable vs. usable floor area (aka load/loss factor)...

  • and sometimes a few more!

Only by looking at all of these numbers at the same time can the tenant determine a "net effective rent" (basically the sum of all expected cash outflows over the fixed term of the lease, minus the sum of all expected cash inflows over the same fixed term, divided by the usable floor area).

If the tenant is negotiating an early renewal, or a "blend & extend", then the numbers can get a little more complex... but it's not impossible to drive great value with a little effort and a bit of math skills.

Even when vacancy is high, Landlords often will be reluctant to lower "headline rents", due to complexities around asset valuation, debt servicing and bank requirements, and sometimes just plain ego. So tenants who read Schultz' words and go chasing after their local landlord for a lower headline/face rent may not be so successful. With more than 14,000 locations worldwide, Schultz and his store development and real estate teams at Starbucks have surely become experts in negotiating leases, and you can bet they will be testing all the levers to achieve the best net effective rent.

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