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Commercial Basis: Why are Store Rents So High?

Thought Leadership // Mar 09, 2016

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‘Commercial Basis’ explores how technology, branding and demographic preferences are shaping office and retail real estate in New York City. As these forces break down the barriers from where we live to where we work and shop, Lead Commercial Specialist Alex Cohen will assess the impact on real estate values and opportunities.

The #1 question I’m asked about New York City retail is, “Why are store rents so high if there’s so much retail vacancy in my neighborhood?” This inquiry arises from an observation that appears to contradict a basic microeconomics principle — if supply exceeds demand, pricing should adjust downward. New York City’s retail reality today, however, is not so straightforward.

Without a doubt, the rise of e-commerce has disrupted consumer demand across a wide range of retail categories from books to music to clothes to shoes to hardware and has fueled store closures across these categories and beyond. The rise of urban “big box” venues has also hit small retailers hard. More recently, neighborhood restaurants — which have always had a high turnover rate — face diminishing demand in light of the growing popularity of internet-based meal and ingredient delivery services (obviously, we’re not talking about the celebrity restaurant category). A harbinger of the exacerbating struggles of neighborhood retail is clear on Bleecker Street (east of Sixth Avenue) and on East Eighth Street in Greenwich Village. These retail strips have always catered almost exclusively to the local NYU student population and now see some of the highest store vacancy rates in Manhattan as they struggle to assimilate the buying habits of this most “wired” of consumer demographics.

Despite these trends, the recent stickiness of neighborhood retail rents is a softer echo of how store rents have fared since the great recession in the tourist-oriented retail corridors of Fifth Avenue, Madison Avenue, Times Square and Soho, and gentrifying shopping districts like Bedford Avenue in Williamsburg. Since 2009, New York’s skyrocketing appeal to international tourists, a weak dollar and competition among major consumer brands for exposure to influential shoppers have driven retail rents to new heights and retail values into the stratosphere. At the end of 2015, Bulgari broke all records in renewing and expanding its ground floor store lease at 730 Fifth Avenue (one block from Apple, the top selling store in the world) at over $5,500 per square foot per annum. The escalation of prime Manhattan retail rents, growing much faster over the past seven years than rents for New York offices and apartments, has compressed down retail cap rates (the ratio of net operating income over price) to 3% or even lower for prime locations. Observing this much income and valuation growth, landlords in less dynamic retail corridors have been reticent to reduce store rents despite vacancy rates in many cases above equilibrium.

But the winds of change are apparent, even in New York’s hottest shopping corridors. Brazilian, Chinese and Russian tourists are no longer as flush in disposable spending. The dollar is now strong. And Broadway in Soho, where rents range from $800 – $1,600 per square foot, now has a vacancy rate nearing 20%, as retailers cannot justify rents there in light of sales per square foot for brands found in most mid-to-high end American shopping centers. A time of reckoning may be near.