Retailers find no respite from high rents amid slim pickings

Retailers find no respite from high rents amid slim pickings
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First Published: Mon, Jul 09 2007. 12 12 AM IST
Updated: Mon, Jul 09 2007. 12 12 AM IST
Mumbai: Even as reports trickle in of a softening real estate market across India, especially for residential property, a relative shortage of appropriate commercial space suitable for organized retail formats is hitting retailers of all hues, from luxury brands such as Escada to Esprit and value retailers such as Pantaloon and Reliance Fresh.
“My heart breaks every time I sign a lease agreement at a marquee mall location because I know that there’s no way I can make money at those rents,” says the managing director of one of India’s largest premium branded men’s apparel retailers, who did not want to be named. “But I have to be there from a brand positioning perspective.”
“Rentals as a percentage of sales are at 7% in the US, 18% in the UK and 31% in India,” says Dilip Jiwarajka, managing director, Alok Industries, which directly owns a value retail chain in India, and another in the UK through an associate company. “At the current lease rentals, it makes little sense to expand our retail chain in India unless sales and profitability improve dramatically to compensate for the lease rent.”
The problem is not with value retailers who follow the ‘pile it high and sell it cheap’ philosophy alone.
Tommy Hilfiger India CEO Shailesh Chaturvedi says a higher percentage of sales value is going to the landlord as rentals than to the parent for the cost of the product.
“Some of the rentals being quoted are totally out of whack and while some outlets for some retailers may be loss leaders, that can’t be a strategy for all of them,” says Jai Mavani, executive director with consultancy firm KPMG India Pvt. Ltd.
“Premium high street locations of an international standard (for instance) are in short supply forcing luxury retailers to pay a premium when such scarce space becomes available,” notes Chankaya Chakravarti, managing director, real estate investments, with private equity fund Actis Advisors Pvt. Ltd. Chakravarti says what’s considered premium high street in the Indian context is not really comparable to international destinations such as Bond Street in London. As a result, these retailers are not being able to target the right audience despite paying high rents.
Even if the development is right, the location within the development may often be inconvenient. Retailers unable to afford high rentals for being on the ground floor of a mall find themselves on the first or second floor as a result of which they often do not get exposure to the kind of buyers they should get at the first instance.
While retailers are hurting, mall developers are smiling. Higher rentals have been fuelled by competition among developers and hoteliers who are bidding up rates for prime parcels of land in key metros. Since rentals are calculated as a percentage of the cost of the developed property (between 12% and 14% per annum), high real estate costs flow through to the ultimate users.
Unlike residential developments, which have seen buyer volumes dip as much as 50% in some cases as banks hike home loan interest rates, suitable commercial real estate remains in short supply. “We are living in unprecedented times. The industry needs about 300 million sq. ft of retail space over the next five years compared to 40 million sq. ft coming up over 1,500 malls nationally,” says Suresh Singaravelu, head, retail infrastructure, Reliance Retail Ltd.
A larger portion of the space under development too is not really designed with retailers’ needs in mind. These companies need to accommodate creation of alleys for supermarkets and need spaces designed with low running costs on air conditioning and lighting in mind. “There’s a 20% gross margin in food retail. If you ask them to pay 15% of sales as rentals, then it won’t work,” says Singaravelu. “In the US, food retailers spend around 0.6% of sales on rentals, while for Southeast Asian retailers it’s 1%. In India it’s seven times this amount,” says Upamanyu Bhattacharya, CEO, TruMart the supermarket division of Piramyd Retail Ltd.
KPMG’s Mavani proffers another reason for high rental costs: cross-subsidization. According to him, developers quote very low rentals to attract key anchor tenants who serve as a magnet to attract shoppers to the mall. “Since there are not many anchor tenants, they have the ability to squeeze developers on rates. To make up for these low rates, developers end up quoting very high rentals to other retailers in the development,” says Mavani.
The situation facing retailers today is a far cry from just a year ago when private equity investors were reluctant to invest in any retail project for fears that an oversupply would lead to a lot of malls failing. Indeed, rentals were expected to fall and many retailers were wary of signing up large spaces for fears that these would be available at throwaway rates in the coming bust. But this has not happened.
“Half of the malls stuck on the drawing board have been held up for environmental clearance. Others are delayed due to shortage of personnel available to complete construction. Some developers are stuck due to the debt tap being turned off by banks. As a result, very little supply has come to the marketplace,” says Chakravarti.
The short supply has forced retailers to adapt counter-measures to ensure their bottom line is not hurt. Supermarkets such as TruMart, for instance, are focusing on distant suburbs of bigger cities or smaller towns for expansion. “We are not tying up too many properties today for expansion as retailing is not workable on exorbitant rentals. We are going slow on signing up properties for the future,” says K.K. Rathi, chief financial officer of Pantaloon Retail (India) Ltd.
Retailers are also working overtime to boost sales at existing outlets to counteract the higher rentals. “We are making up higher rentals through higher sales per sq. ft by ensuring better productivity and better merchandise is available in the retail space. We need to have store sales growth of 20-25% per annum instead of 10-15% to compensate for the higher rentals,” says Vikram Rao, business director, textiles and apparel, Aditya Birla group.
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First Published: Mon, Jul 09 2007. 12 12 AM IST