Finding and Keeping Mom-and-Pop Tenants

The Right Local Tenants Can Make the Difference between Mediocre and Exceptional Return.

By David W. Popp, CCIM, CPM, RPA |

Mom-and-pop operations have always been the lifeblood of neighborhood convenience centers. But given the growing dominance and the generally sound balance sheets of regional and national chains, is there a need to continue to market and lease retail space to these small, local businesses?

The answer is yes, because today, too many neighborhood and convenience centers are languishing in marginal return mediocrity with occupancies hovering between 70 percent and 85 percent. To realize the full economic potential of these assets, those stubborn 1,000- to 2,500-square-foot vacancies must be aggressively marketed to enterprises that can pay market rents, complement the tenant mix, and add measurable value to the property. Often, the right kind of mom-and-pop tenant fills this role, making the difference between minimal and exceptional return.

What is the "right" kind of local tenant? It is a retailer that contributes to a center's intrinsic value. Prospective buyers capitalize a property's net income stream based on a market-driven cap rate; but that cap rate may be adjusted based on the perceived quality and general creditworthiness of the tenant base.

Analyzing Small-Business Finances
Therefore, the key to finding strong local tenants is being able to evaluate their financial profiles and assess their future business prospects. Begin the evaluation by asking the following questions to help identify successful and potentially successful local tenants. (At the same time, request financial information on a standardized form that can be readily compared to local market and industry standards.)

• How long has the prospective tenant been in business?
• What is the annual sales volume on both a gross and a per-square-foot basis? What are the rates of increase?
• Who is the target customer and what is the perceived trade area?
• How is the inventory financed?
• What are the pricing strategies for merchandise or services?
• What are the gross and/or net profit margins?
• What is the markdown policy for slow-selling merchandise?
• How much is spent on advertising? Where does the business advertise?

Responses to these questions serve a dual purpose. First, they create an objective assessment of the tenant's potential value. Second, the questions likely will spark a dialogue that will provide insight into local tenants' overall sophistication level. If potential tenants do not understand standard retail terms and concepts such as sales volume per square foot, gross margin, or trade area, it is likely that they will be temporary users of valuable space rather than contributors to the value of the center.

When evaluating new business ventures, rather than inspecting historical records, assess the soundness of the business plan. Projected sales and expenses should be measured objectively versus local and industry norms and in light of current economic and market conditions. Interview the mom-and-pop's personal banker to gauge the banker's assessment of the business's viability and to see if it has discussed establishing either short-term business loans or a line of credit for the proposed enterprise. Also obtain a personal credit history and request a list of both personal and professional references to survey. Investigate to see if the mom-and-pop has managed other businesses prior to launching this venture and inquire about the fate of any former undertakings. The more relevant information that can be gathered and analyzed, the easier it is to assess the likelihood of economic success.

Finding Appropriate Tenants
When seeking local tenants to occupy selected vacancies, it is important to understand their motivation in determining a location. Because typical mom-and-pop operators provide convenience-style goods and services (their patrons will likely live or work within a three-mile radius), their prime objective is to find a center that attracts customers.

Location, surrounding demographics, aesthetic appeal, ease of access, occupancy level, and tenant mix all are prime factors in assessing a center's ability to draw shoppers. In addition, the presence of a well-known anchor or a history of successful performance can be invaluable lures.

A simple-yet-effective method of finding the right mom-and-pop tenant is to examine the tenant mix at established centers. Comparing their occupant lists with the rent roll and the rosters of competing properties may identify specific business gaps that exist in the market that can be targeted.

Generally speaking, retail service tenants, particularly those whose businesses are not overly dependent on the whims of the economy, tend to be more successful over time than those operations that require large initial inventories or whose fate may be tied closely to the latest fashions, trends, or styles. Dry cleaners, post and parcel shops, insurance agencies, and hair salons, for instance, all have relatively modest start-up costs and a largely inelastic nature of demand for their services. A downturn in the economy will not likely result in a significant loss of customers. However, when considering hair salons, be sure to ask about the stability and tenure of the employees. The loss of several stylists can severely disrupt a salon's revenue stream if customers follow departed employees to competing establishments.

Businesses such as specialty dress shops, T-shirt outlets, or the latest rage, cigar/humidor stores, are burdened with high-capital investments and are, to a large degree, dependent on notoriously fickle consumer tastes and trends. Either an economic slump, which will have a disproportionately large effect on disposable income, or a change in consumer preferences can have a disastrous impact on the store's viability. Other types of mom-and-pop businesses that face difficult odds include book, videocassette rental, computer, sports supply, and hardware stores. The proliferation of category killer superstores in each of these industries has rendered these smaller niche outlets all but obsolete.

When seeking the right type of mom-and-pop tenant, consider complementary uses to businesses that already exist at the center. Examples include pairing a bike shop with a children's clothing store, a nail salon next to a hair studio, or an ice cream shop by a movie theater. The advantage of an already-established target market presence at a site can be a very valuable enticement for a fledgling mom-and-pop enterprise.

Evaluation Criteria
When evaluating the desirability of mom-and-pop tenants for a retail center, have specific criteria in mind for an objective point-by-point analysis of the tenant's suitability. By definition, a typical mom-and-pop will not have the name recognition, customer drawing power, or financial resources of larger, more well-known competitors. Nevertheless, certain expectations still should be met to ensure a solid contribution to the economic vitality of the property. Some factors to consider are listed below. These include a retailer who

• pays rent and other charges on time, generates sales and traffic at or above industry norms, and creates community interest and enthusiasm for its business;
• abides by the lease requirements such as operating hours, permissible signage, required advertising, and lease restrictions;
• maintains an attractive store stocked with appropriate inventory levels with products properly displayed for the current season;
• strives for expanding sales volume that translates to increasing profit margins;
• understands that advertising and marketing costs (typically 2 percent to 5 percent of sales) result in sales gains; and
• tracks and compares sales and profit performance with various local and national industry benchmarks.

Cultivating a Relationship
When structuring a lease with a prospective mom-and-pop proprietor, you most likely will not be dealing with a broker or real estate department specialist. In most cases, the store owner, the primary business stakeholder, the decision maker, and the on-site manager will be one and the same individual. The hands-on nature of these enterprises provides an opportunity to spend considerable time with the store owner discussing the prospective business and, as a result, allows for a better internal assessment of the store's prospects for economic success.

Developing an ongoing rapport can be a critical factor in maintaining both the financial and aesthetic vibrancy of a store. Often, a property operating team can enhance its relationship with the mom-and-pop tenant by offering suggestions and/or subtle guidance—emphasizing that it is in your mutual best interest that the business succeed.

Another approach is to provide small-business proprietors with information that will help them reach their target customers more effectively and operate their businesses more profitably. A plethora of market research is available on everything from retail demographics and industry performance standards by Standard Industrial Classification (SIC) code to operating expense analyses and category averages for net sales, net income, and net profits. Evaluation using these benchmarks provides a sound basis from which to compare individual stores with industry norms.

Consider creating a library of retailing resources that includes not only these indices but more general publications on subjects such as inventory control, effective merchandising and display, and other topics that may be of concern to these businesses. A collection of these periodicals can prove valuable to the management staff as well as to the local retailer.

In addition, seminars and training sessions often can be scheduled for little or no cost. The neighborhood police department, for instance, may be willing to conduct educational programs dealing with in-store security and shrinkage problems (typically defined as employee and customer theft, casualty losses that are not reimbursed, and the incorrect pricing of merchandise or services) as well as centerwide security efforts. Consider providing merchants with a resource list of professional consultants in buying, advertising, and small-business finance or sponsoring incentive programs for sales and customer-service achievements by stores and individual sales personnel.

Recognizing the Tenant in Trouble
Despite lessors' best efforts to qualify and monitor a property's tenant mix, inevitably some of the center's local tenants will experience financial difficulty. Mom-and-pop operations typically are marginally capitalized and generally operate with a very thin safety net, so an unexpected or prolonged downturn quickly may lead to failure and insolvency.

The telltale signs of a struggling tenant include:

• changes in rental payment patterns, such as checks arriving later and later each month;
• declining sales figures (a lease provision requiring the reporting of gross sales is important regardless of the presence of a percentage rent clause);
• reduced inventory levels or marked down inventory that remains unsold;
• poor maintenance and upkeep of the store;
• elimination of advertising, marketing, and sales promotions; and
• personal observation and rumors—other retailers, particularly tenants within the center, often are quick to notice another's difficulties.

Once it becomes apparent that a local tenant is experiencing cash flow problems, evaluate the costs and benefits of working to resurrect the tenant. In many instances, trying to save a failing tenant is a poor investment of time and resources. The maxim that it is cheaper to keep than to replace a tenant is true only if the tenant is keepable—don't simply postpone the inevitable and run up the amount of the delinquency. Local tenants do not have the corporate resources to pay a sizable outstanding balance.

However, as a general rule, unless the surrounding market is exceptionally well leased, the center is fully occupied with a waiting list of qualified replacements, or the tenant is clearly unsustainable, it usually is worthwhile to make an honest effort to salvage the tenancy.

Tenant Workouts
There are as many strategies and opinions on navigating the tenant workout process as there are troubled tenants. But with local tenants, a number of points take on added significance. An objective, realistic analysis and assessment of the tenant's future business prospects is critical. To justify an investment of time, capital, and resources in the revival of the tenant's business, review the tenant's financial records (given the nature of the tenancy, keep in mind that comprehensive, audited statements will not be available), the economic climate, the level of local competition, and any other factors that would allow an educated appraisal of the store's ongoing viability.

It is essential that the tenant view itself as the main stakeholder in the proposed workout arrangement. The agreement must be bilateral; in exchange for giving the proprietor the time and terms in order to survive, the default is eliminated over time in specified amounts at predetermined intervals. This scenario prevents a series of landlord concessions. Lease modifications, whether rent reductions, rent deferrals, lease term changes, or changes in hours of operation, should be balanced by a corresponding responsibility from the retailer.

The tenant also should be required to meet some minimum level of established performance standards in order to continue to receive landlord assistance. These can include concise and measurable goals in the form of payment dates and sales benchmarks or more creative objectives such as required advertising levels or working with an outside consultant.

A change in the lease's use clause may be appropriate if it allows the tenant to carry additional merchandise that produces a higher margin and generates a renewed excitement in the store. Lease changes should be used very selectively; other tenants could view them as rewards for poor performance.

Any additional capital that the tenant pledges as security, either in the form of an increased security deposit, a personal guarantee for all outstanding balances, or a recordable security interest in the personal property of the store, increases the tenant's financial stake. This, in turn, creates more incentive for the mom-and-pop to succeed in restoring profitability.

The ultimate goal of a workout is either a revived tenancy capable of paying market rent in the near future, or a quick, accommodating return of the leased space. All steps to revive a troubled tenancy should be taken with these aims paramount in mind. Ideally, by utilizing a comprehensive management approach that includes careful selection and qualification as well as ongoing evaluation and monitoring, local tenants will flourish and will not require a landlord-controlled bailout.

The Future of Mom and Pop Tenants
In general, developers of new speculative retail centers are reluctant to target mom-and-pop operators. They prefer to market to more well-known entities that will serve as draws for other tenants. Additionally, the higher finish-out cost of first-generation shell space works against the typical mom-and-pop proprietor. Given the risk inherent in contributing higher finish-out allowances, developers prefer to invest in the deeper financial pockets of regional or national credit tenants. Further, well-capitalized tenants often will supplement the owner's allowance with additional funds, an option that often isn't feasible for the mom-and-pop tenant.

Consequently, the recent proliferation of superstores and category killers occupying gleaming new suburban power centers and regional centers has caused some to question whether the much-smaller mom-and-pop tenants have a future. Similarly, the growing trend of expansions, mergers, and takeovers in the retail industry has contributed to pessimism regarding the ability of local operators to compete with the purchasing power and efficiencies of these regional and national conglomerates.

Although it may be tempting to focus all marketing efforts on attracting and retaining well-known retailers, don't write off a significant portion of the retail market by summarily dismissing the mom-and-pop tenant. Despite the fact that these small, local, family-run businesses continue to cede market share to larger, more-sophisticated, and better-capitalized competitors, mom-and-pop stores still can be valuable contributors to neighborhood or convenience-style retail centers. These merchants may have everything at stake, often investing their lives and financial worth in their businesses; what they lack in size and sophistication they may make up for in hard work and a drive to see their businesses succeed. Given a healthy financial profile, a sound customer base, and understanding of their market, mom-and-pop tenants can be a welcome addition to any center, increasing its profile as a profitable, attractive investment.