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What’s in Store: Fundamentals, Flexibility, and Franchising

Chris Ressa and Karly Iacono
Episode #: 286
What's in Store: Fundamentals, Flexibility, and Franchising

Guest: Karly Iacono
Topics: ICSC Las Vegas, retail industry trends, franchising, recession, interest rates, lease structures and terms, retail fundamentals

Chris Ressa and CBRE’s Karly Iacono are reunited for the first time since ICSC Las Vegas broke in May. They share their three takeaways from the show.

What You’ll Learn:

  1. How is the positive sentiment among retailers driving trends?
  2. How will interest rates impact pricing?
  3. What’s driving lease terms?
  4. Franchising growth is a significant trend that is here to stay.
  5. The importance of real estate fundamentals and retail execution.

About Retail Retold:

The Retail Retold Podcast highlights community retailer stories from across the country and gives a behind-the-scenes perspective from business leaders in both retail and real estate industries. The show’s episodes contain valuable insights that help solve the needs of entrepreneurs and real estate pros. Join host Chris Ressa and new guests weekly for amazing insights and thought-provoking stories.


Karly Iacono  00:07
Welcome to What’s in store, the show where we cover hot topics at the cross section of retail in real estate. I’m Carly Iacono. And I’m joined by my co host, Chris ReSSA. Chris, great to see you. How are you today?
Chris Ressa  00:19
I’m doing great. How are you?
Iacono  00:20
Living the drea. Loving summer, playing lots of golf. Life’s good. How about you?
Ressa  00:25
I played more golf last year, but I’m getting back into the swing of things with golf.
Iacono  00:30
No pun intended?
Ressa  00:32
Pun intended, actually. You know, they say, you can pick up where you left off? I’m like, where I was in August of last year, not where it was in like October, I was hitting the ball pretty well in October. So I’m trying.
Iacono  00:46
Is it month by month for you?
Ressa  00:49
Yeah, that’s, that’s where I’m at.
Iacono  00:50
I’m not at that level yet. I’m not good enough to be competitive. So it’s fun. But I think when I start to get better, then I’m gonna take it seriously. And it’s gonna be a whole different world.
Ressa  01:02
I’m not competitive with anybody. I’m playing competitive with myself in trying to improve, right? I want to, I want to be out there and be like, oh, this person can play golf. Well, that’s the goal, right?
Iacono  01:15
Yes. But I’m not quite there. But happy to say I went to my first outing. It was all commercial real estate people and it was fantastic. So excited to get out there more. When I told my instructor I was going to my first outing, he went, “Oh, when?” I told him, “In two days!” So, what are we gonna do for the next hour to make this work? But it went well, it was great. So no complaints.

So we have a lot to cover. We’re just coming off ICSC Las Vegas, which was record numbers for the show. We want to talk about that. And then really take our takeaways from ICSC and kind of extend that forward into what we’re seeing for the rest of the year. So start off with, I know the answer already, but tell everyone listening, how was ICSC for you? Just a broad picture.
Ressa  02:09
I think from from my vantage point, it was really good. You know, most of my meetings were with retailers. And a very positive because retailers are dying to open up stores. So that was great.

I think I have like three big takeaways from ICSC Las Vegas. So the first one I would say, and I don’t know about you, and you could comment on this as well, as I didn’t hear the R-word at all. Recession. Did you hear the R word?
Iacono  02:41
That dirty four-letter word that it’s way more than four letters? I did not. Yeah, I did. Once. That’s a great point.
Ressa  02:48
I think that was good. And there were some not stellar earnings reported coming into Vegas. And that usually rings people’s heads, you know, about like, Oh, are we going into recession? And there’s some headline news about consumer debt and a bunch of other things. And so I would have thought I might have heard it, but I didn’t hear the R-word. So that was surprising. Yeah, I thought I might hear the R word. And then we didn’t. So that was one. Two….
Iacono  03:17
Wait! I think I had to jump in with one. You can’t just do all three! I have to keep you in line!

Okay, so one thing, the elephant in the room that, of course, someone was talking about in my world was interest rates, right? And when is the Fed going to cut rates? So, of course, we know all of this, we would be rich, famous, and good-looking. But we don’t exactly. So I think the consensus is two rate cuts. At least, that’s what CBRE is putting out. I personally feel like we might only have one. Nobody’s really that excited about talking about exactly when rate cuts are going to happen. It’s more, what does that mean for the market. And I think the interesting shift that I felt at Vegas and believe will continue through the end of the year is even if we get a 25 basis cut and a 25 basis point cut in September, that’s not going to materially change pricing. Even if we get 50 basis points by the end of the year. I don’t feel like that will be a true impact on cap rates and pricing overall. So there was an acceptance of market conditions, although a lot of people wish they were different on one side or the other depending on whether you’re a buyer or a seller in this market. But there’s an acceptance that maybe this you know, interest rate bailout that a lot of people were hoping for 100 basis points this year is just frankly not going to come and pricing even if we get a modest cut is what it is so that I felt like it was a big shift from the wait and see until everything changes mantra that we had last year.
Ressa  04:52
Is that another way of saying that you think the rate cuts are already priced in?
Iacono  04:59
Such a good question. It really depends on the property property type. In some cases, I don’t think interest rates have been priced in enough, we still have a lot of negative leverage deals. In some cases, I think they have and we’re seeing spreads really widen. So that was a very political-sounding answer. I know it depends. Is that true is the true answer. But I think that for the deals that the sellers were waiting for interest rate cuts before they became realistic on pricing, they might be sorely disappointed that that 25 basis point cut does not make buyers suddenly want to take a neutral or even negative leverage deal, because there’s still a lot of that product on the market.
Ressa  05:43
I do think interest rate cuts will open the pool of buyers. Because there will be deals that if you got a 50 basis point cut that that is, you know, enough for some deals to make it work or not work. So I do think it’ll open the pool of buyers will impact pricing? I don’t know. But I think it’ll open the pool of buyers. If that happens, we’ll see.
Iacono  06:11
Well, I think there’s that inflection point, right, some deals are still negative leverage, and maybe they’re upside down by 75, or 100 basis points, or 25, in that case, isn’t going to be material, but some are already neutral or, you know, slightly positive. So I think that would make buyers jump in. Yeah. And it also kind of signals the bottoming of the market, which I think is important too. So it’s not that it’s irrelevant. If the Fed cuts rates, it’s just I don’t think it’s going to be a huge windfall, and prices are going to shoot up, and cap rates are going to tumble down. As soon as that happens, I
Ressa  06:45
think when you bought matter so much today, right? So if you bought in 2021, that’s different than if you bought it in 2014. And you’re trying to sell it so Right,
Iacono  06:57
right. Yep. Yeah. All right, well, now jump in with your number two.
Ressa  07:00
So my number two use the acceptance of market conditions, what I would say is, you know, we talked about on the store side, the, you know, the supply and demand for space, and that there’s no supply, and there’s excess demand. That’s still true. And last year in Vegas, that was talked about a lot. But, I hadn’t really seen it in a significant way translate into terms that translate into more spaces being leased. And so maybe we had to chew up some space. But I think now there’s an acceptance that landlords have some leverage, because of the lack of supply. And, you know, I heard retailers talking about I’m going to do what I have to do to open up stores, which I hadn’t heard before. And I think that is a big shift.

And, you know, we spent from and I don’t think it’s all going to happen at once I think it’s incremental, spent from you know, call it Oh, eight to 2019 of the commercial lease in retail, you know, got more tenant-friendly, friendly, year by year terms swaying. And so it won’t shift overnight. But I think it’s starting to now. So every lease that gets done, you’ll see it start to balance out a little bit more as more and more leases get done. And I think that’s a good thing to get a little more balanced than it was because, you know, some of the provisions were pretty tough you had to do in 2009 to make deals. And you don’t have to do that today.
Iacono  08:41
Is there one provision or one part of the lease that you think will shift the most as this competition for space continues? Or is it just overall lease form?
Ressa  08:52
I think, you know, the thing people focus on the most one term is rent, right? So I think rent growth is happening. And I think the other side of that is cost. And so but if we take that aside, I think the next piece of it is two things, things that relate to time and flexibility. So I think that’s the things that for long term holders concern them the most. And those are the things that were, you know, really in the tenants favor in 2008 to 2019. You know, when there was term, you know, early termination rights, flexibility around things like assigning the lease flexibility around a whole bunch of what what might cause a remedy rent, whether this is a co tenancy exclusive. So I would bucket it into two categories where the flexibility is going to be less for the tenant, and the time is going to be more favored for the landlord, whether that’s free rent periods, whether that’s time to get An open, right, you know, things like that. And I think time to get open is one where everyone wants to get open sooner, yet the lease allows for the significant time periods to get open. And I think that is, you know, it’s wearing on everybody.
Iacono  10:16
Is there one point of friction that you would like to see ease between landlords and tenants in terms of the lease structure? Or the timing? Is there one thing that you’re like, if we could just come to a meeting of the minds on x, the process would be smoother.
Ressa  10:32
I think the biggest so it’s, it wouldn’t be necessarily on timing and flexibility. It would be on the the balance of landlord and tenant work to get store open. I think that is the biggest one in both time and cost. And what the actual scope of work is in the deliverable is changing every day. And it is a really, really challenging thing to get through it is, you know, if you talk to a leasing person, they would tell you, it’s the where they’re spending the most time right now is the work letter.
Iacono  11:14
I’ve heard that actually referenced from quite a few guests that we’ve had on the podcast saying what is as is anymore, right? Is it mean no violations? Does it mean utilities are working? Or does it mean just as is? You get what you get good luck. So you know, even things that you didn’t think you had to second guess in terms of tenant landlord work, or we’re kind of coming into question
Ressa  11:35
100% Yeah, really, that? The LOI? I’ll say, as is and then the lease will come in. There’s a landlord work letter. And you’re like, like, I’m not I said, as is Yeah. But you have to provide these base conditions. Correct. Right. And I’m like, well, that some of those don’t exist. So it’s not really as is.
Iacono  11:51
So I could see that going back and forth. But better to align it on the front end probably have to deal with it later. Interesting.

So there are three buckets of buyers who are active right now. And as you and I were chatting earlier, thankfully, transactions seem to be picking up we’re getting more loi as we have a lot of deals coming to market, which is great. But there are more looks on the deals that we’re bringing to market, and there are more actual offers coming in. So, all very positive, still a big spread between bid-ask; it’s not easy, but I do think things are starting to shift a bit. And the pools of buyers that are getting things done are one, anybody who’s buying cash, which is typically your private client, 4 million and under. So the small deals, the QSR, some of the discount stores, those are still moving with cash buyers, although, of course, they’re not plentiful, but they’re out there.

The second bucket is yield buyers; they’re looking for a spread between interest rates and cap rates and are looking for positive leverage. And, you know, it could be any different number of the investment thesis, it could be long term lease with the lesser known tenant could be credit, whatever their thesis is, they’re looking for financing that works and a positive spread. So that’s where all of your seven and a half cap rate plus deals are moving, because you can get you know, debt in the high six is too low 7% range. So those deals have a lot of activity, which is great.

The third bucket is really interesting. And I would argue this is probably where you come into play in your company a little bit more. And that’s the more professional buyers who say, we don’t really care what the cap rate is. That’s just a number. Right? That’s a quick snapshot in time. I mean, you care, of course, and it’s just gonna go away once. We don’t overpay, I’m not saying overpay let me finish with that. Okay, I knew that was coming. But what is the true return on the property? So what other levers can you pull on that asset? So your cap rate could be a four cap on in place income, but maybe the center is 60% vacant? Sure. That’s not you know, that’s not really a four cap? That’s a whole strategy going into that. So cap rate matters less not? Not, not at all, I will say if there are other levels, levers to pull, so are you kicking a tenant out and raising the rent, you have an LOI for a vacant space already in hand like is there a way to work that asset to make it make sense in six months or a year and that’s the the more strategic buyers that are out in the market really looking for opportunity and trying everything they can to find it and put money out. There’s not a lot of vacancy in the market as you know. So it’s a bit challenging to find the piece that’s challenge that right to find the properties where you can do this repositioning but but that group of buyers is very active as well.

So I think the one thing that’s slow still are trade buyers and those are the ones who you know are coming out of typically other asset types into net lease and into neighborhood retail and they’re looking for just placing those proceeds, that market is still slow, because it’s heavily reliant on other asset trades. So when that comes back, I think we’ll be very happy. But we are grateful to have the other three buckets sort of, you know, dipping their toe in again.
Ressa  15:17
Got it. Okay. I love that articulation of the different kinds of buyers out there. So, the third for me is franchising. Okay? I think that franchising has, has to be one of the biggest and the growth in franchising, one of the most significant impacts to retail real estate in the last 20 years. And I would argue majority of it positive, if you look at, there’s all these new concepts. One of the reasons is because they’re franchised, that’s how they can grow so quickly, and they can grow at scale. It’s through the franchise model, especially when you think about, you know, some of the other forms of venture capital know, all this stuff that either is on the sidelines are more expensive today. And it’s not just on the small shop, right? You think about retailers like Planet Fitness and Sky Zone. And now we have pickleball franchises, there’s a there’s a ton of franchise concepts that have chewed up space. And generally speaking, we’ve always had local tenants and shopping centers. The The biggest difference today is now they have a brand name on the door versus their, their, you know, whatever their local concept name was, you know, 30 years ago, and we still have the local tenant, of course, but I think, you know, I was walking around the floor for a bit and I couldn’t believe the amount of franchise concepts that had boots and we’re trying to scale up. And I think franchising is, you know, been a big boon for the retail real estate industry. And the growth in franchising has certainly helped. Does
Iacono  17:12
that scare you at all as a landlord in terms of watering down credit, if there’s less corporate expansion? And it’s all? Not all but heavily driven by smaller franchise concepts? Or do you love that new diversity of tenants because they can grow faster? And we have all these new concepts? Or both?
Ressa  17:32
I didn’t say we had less corporate Oh, okay. Expansion, I just said we added explosive franchise expansion. Okay. So I think that, you know, you can would you rather have a local hair salon or a great clips, that’s the choice today, right? And the answer is, I think it depends, right? Love them both. But now you have more options as a landlord because of the explosive growth of franchising over the last 20 years. And I think, you know, I don’t have the stats, but it’s just astounding how many franchises there are in the world today. And they keep coming on. And they’re also incubating like new concepts that are making shopping centers diverse, that maybe wouldn’t be able to grow if it was just a local entrepreneur, and now that they’re, you know, to that corporate that to be the next Chipotle, which is a corporate store. So there are way more successful franchises than we give credit for. And some of them are more sophisticated operators, you know, you know about all the multi unit operators who in the franchise world, there are groups out there that have hundreds of 1000s 1000s of franchised stores. So, that credit profile is just as good, if not better than some of the corporately owned stores. Very true. So I think this is really interesting. It’s obviously played a big part in occupancy in America. And overall, I think it’s a good thing. But I’m shocked. We’re not talking about it more, because you go to any shopping center in America, and there are franchise concepts in it today, just about an almost every one. Do
Iacono  19:25
you think that is the more sustainable way for the small business to grow? I guess the second piece to that is how egregious are these franchise fees? I don’t know the answer to that. But is it always a better path because you’re standardizing a concept you have branding behind you, etc? Or could it be that maybe you’re giving 20% Whatever the number is, of your sales to XYZ company and that makes it harder to turn a profit?
Ressa  19:51
I think a couple of things. I think one, they’re all different from a fee perspective. Okay. Right. And I think when you’re looking at The ways that you can scale a business, I think the first thing is like, should this business be scaled? There are some businesses that are great businesses. But like they say it’s on Shark Tank all the time. But it should say it should be it’s a million and a half dollar business, and it shouldn’t be $100 million business. And it can’t be $100 million business. Right. And so it, you know, scaling, a business that doesn’t have, you know, a bad business isn’t a good idea. So let’s put that out there. Right. Like I, I think that’s scaling a bad business, or even scaling a business that maybe doesn’t work on a national scale or in multiple markets, not a great idea. There’s some great businesses, high margin businesses, their million dollar business, throw off a great cash flow, but they shouldn’t be $100 million business. And then I think you look at, okay, let’s take the business that can scale. And what are the paths to do that, right, you can raise equity. It’s harder now. You can lever it up. You can and or you can franchise and there are other ways, obviously, you can use cash. But franchising is there’s a process to get through to be able to franchise. But you know, a lot of people are navigating now, there’s a lot of education around how to do that and set up to be a franchise. And I think it’s here for a while. Sounds
Iacono  21:27
like a net positive, then I think, positive. And as a side note, I think it would be a lot of fun to set up a shark tank style day for DLC, when you have an opening in one of your shopping centers and have all the tenants and franchise concepts come in and do their presentation in a set amount of time. Shark Tank style, and you and Adam can can rate them and decide if you want to invest. So we so there’s oft as well, just so we’re clear,
Ressa  21:53
there are there’s a lot in like the mid 2000s, there was a lot of there was a lot of talk about that to be a to like Shark Tank spaces, right? I haven’t heard it too many stories where it was successful, like, you know, to incubate concepts, like have a Restaurant Week, where have all these this find all the restaurants who want to open up a location great chefs, you know, have a restaurant space, you know, make it a you know, give away a space or something like that, in order to get the greatest operator and find the next, you know, Guy Vieri. I haven’t heard of like, it really like translating to massive success. There. I’m sure there’s some but yes, I’ve seen the Shark Tank idea. For spaces.
Iacono  22:43
That’s interesting. Yeah. All right. So maybe we’re won’t bring it back just yet. We’ll keep noodling on that idea. The the last takeaway I’ll share today is something I’ve touched on recently. And that is an increased focus. I think last month, I mentioned this on retail fundamentals on the underlying real estate. And, and I think you were shocked because from the the multi tenant acquisition side, that’s the first thing you look at, right. And I share that often we will value the lease term and the tenant and the credit profile even before we factor in where it is in the US. As inventory builds, which is in net lease, it is an uninjured retail. As inventory builds, the underlying real estate fundamentals become even more important. And also as tenants continue to try to grow and supply constrained markets, lack of available space, and the competing area gives more security to the assets of course that already built. So we’ve got a few things factoring in that buyers have a lot of choices for net lease and unanchored retail and a lot of cases. And as they’re sifting through that inventory, I’m having more conversations that maybe the less risky move is to buy a midterm lease a little more yield, but get that a location that you’ve you really want and feel good about that over time, you can boost rents, instead of get the 15 or 20 year deal in small town USA, where we’re not sure what the growth trajectory looks like. So it’s just a mental shift in prioritizing the deal Analytics, which is interesting.
Ressa  24:21
Got it. And that can. So you were right. That continued in Vegas. That was definitely,
Iacono  24:25
absolutely and a lot of the meetings is we’re going because we have a ton of deals on market right now was okay. What are the demographics? Where is that what’s the closer traffic drivers are university nearby? Is this instead of Oh, interesting, what’s the yield and tell me more about the tenant if it wasn’t a tenant that the buyer was already used to. So the the focus and again, this is not new real estate fundamentals have always been important, but now I think we’re leading with that. Whereas it used to be one of the other points you know, kind of in the middle of the conversation right and as inventory tightens. that will kind of come back into balance. But right now, it’s, it’s a huge factor as to whether or not a deal has a lot of offers or it doesn’t. And it’s harder to move. So got it interesting shift, for sure. And what is your your last piece of wisdom you’d like to share with us today?
Ressa  25:19
Well, I think one of the things I think that is interesting is, you know, and I talked about this recently with the guy Simeon Siegel, is that the normalization of retail again, and I think that today, we like to say when like, a retailer is doing good or bad, it’s, it’s, we like trends and patterns. And so we say it’s something from a macro economic indicator, and that’s why the retailer is doing good or bad. More often, the not. The reason that the retailer’s doing good or bad is because of their execution, and how good of a retailer they are. And we don’t give that enough Credence. And I think, because there’s moments in time where that might not be the case, right? When we talk about, like, the past few years, in a supply constrained environment, like, you might not have had to be that good. You just needed to have the product available. Like, I’ll never forget, I was looking for diapers and COVID. And they were saying three weeks, and I’m like, online, and I’m like, Well, how does that work? And that’s gonna be pretty. So where was I going? Like, it wasn’t my retailer of choice. It was who had diapers. Right. Right. And so now that we’ve waned through waded through all that, like, and there’s some, we’re not talking about the R word. And now I think it’s like, what retailers are connecting with their consumer have excellent leadership of operational, excellent, it’s and have a product and service that people value. Those retailers are winning. And those are like the fundamentals of retail. And I think that’s a good thing. I think, I think the people who have all that want that to be the differentiator, and not just some mac availability of product, right, like,
Iacono  27:24
seems kind of unfair, if that’s the rule, right? Just get the toilet paper faster, right sale, not like who makes a better product at a better you
Ressa  27:31
know, what I mean? So I think that is a good shift. And so, you know, the point I would put out there is, you know, don’t just take like a retail or not doing well as some major macroeconomic trends, sometimes businesses, you know, they’re living breathing things, they’re not working right now. And they need to be fixed, or sometimes they’re just, they’re gone forever. And so it might not be because of the macro economics, it might just be that that, you know, doesn’t work right now, or might not work anymore. And the ones who are winning, you know, we should look at is it because of their execution? Or is it because of, you know, some outside force, right. And so, I think that’s a good thing. And that’ll be, you know, clearly a differentiator and all these new concepts that have come to life, like who’s good? No
Iacono  28:24
more excuses. I’m hearing either the brand and the business works. And it executes on a good product, or it doesn’t, right. Yeah. age old capitalism. So glad to hear we’re getting back to that. And it does seem like it will make retail stronger overall. Yeah, take out those, I guess, external excuses.
Ressa  28:42
You know, what I mean? And or, or external positive force. Right. Right. Right.
Iacono  28:47
You know what I mean, chopping up the business or Yeah, right. Right.
Ressa  28:51
What if we had all this free money enter the system, right? That was just this excess cash to go. And now we’ve been through quantitative tightening where money’s come off the sidelines. So I think, you know, retailers who execute are going to be just fine.
Iacono  29:08
continually improving asset type. One that I know we’re both very bullish on, and I think all those factors come together to make a really, truly nice, stable quality product. Yes. It’s a great business to be in, for sure. And I think on that note, we will wrap Awesome, good stuff. To everyone listening. That was what’s in store with Carly and Chris.

We are so happy you joined us, and we will see you again very soon.

Thanks so much, Chris.

Ressa: 29:59
Thank you.

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