As one of the hottest topics in retail real estate, portfolio optimization has become an absolutely crucial process for retailers who want to survive and thrive in the current retail environment. So, what is portfolio optimization exactly, and why does it matter? In this post, we’ll also cover how a systematic and ongoing approach to portfolio optimization can create big savings, the four common strategies pursued in portfolio optimization, and how the process optimizes occupancy cost at the store level across the entire portfolio.
Every Store Needs to Be a Great Store
Today, every store needs to be a great store regardless of the size of the portfolio. So, how do you determine what is a great store? A location is a strong performer if the ratio of revenue to occupancy cost is healthy. With the ideal ratio determined, the retailer’s portfolio must be examined to determine which locations are healthy, which need lower rents, which need to be relocated and which should be considered for closing. This multi-pronged approach we call portfolio optimization is not new. It has always been part of a solid long-term strategy. Only now, because of the economic, competitive, and consumer factors that have put pressure on retailers, it is no longer an option and it has become a priority.
Taking it down to the most basic concepts, a store only needs a few things to be successful. Shoppers need to know the brand and where to find it, the location needs to drive sufficient traffic through the doors, those shoppers need to have a compelling reason to spend money there, and the purchases need to be converted at targeted price points to drive revenue and profitability. If any part of this fails, the location could fail. On the other hand, with an ongoing and successful portfolio optimization strategy, you are constantly making changes that will better serve your shopper – and your bottom line.
These strategies play a big role in getting the maximum value out of a location. In other words, as Steve Dawkins, SRS’ COO puts it, “Retailers need to be in the right locations, at the right size, with the right features, and with the right occupancy cost in order to survive and thrive.”
Big Savings from a Systematic Process
Portfolio optimization can be a daunting procedure and just as complex as opening new stores. However, with the right systems, processes, and people in place, you will continually realize maximum value out of your portfolio, which is essential to any long-term portfolio strategy.
Understanding a current portfolio in its entirety is necessary to begin the process. First, store sales, expenses, and underlying occupancy costs are needed, followed by demographic and psychographic criteria to determine what is a great store. Then, underlying market rents are collected and all of those criteria together create a grading system for store performance. It is crucial that all of this data is available to key decision makers, and every location needs to be evaluated to develop a location strategy. When evaluating stores in their portfolio, retailers and their real estate advisors further scrutinize locations that are underperforming according to a multitude of criteria. This requires top-notch GIS visualization and analysis tools as well as market knowledge from local professionals within the market. Perhaps more important is having the right team in place on the client and real estate service provider side who can use those tools, interpret the data, and apply local market knowledge.
That’s where working with retail real estate experts who have time-tested experience, local expertise, and a platform that streamlines the complexity of portfolio optimization adds value. A good partner will become an extension of the retailer’s real estate team, creating an effective team structure that includes an account executive, advisory board, account managers, and transaction coordinators, all while using quality research and proven technology. With repeatable templates, strong communication channels, and project tracking, stores are able to be systematically evaluated and ranked. Those rankings coupled with local market knowledge of viable real estate solutions reveal what is recommended for the future. With an order of priority established, the appropriate team members can get to work on each location that needs attention, whether it’s reducing or restructuring the rent, extending the lease, relocating the store, or disposing the location through a sub-lease or a sale.
The Four Common Strategies Pursued in Portfolio Optimization
#1: Rent Reduction and Restructuring
If a store is struggling, it could be that the market has shifted and the rent is now above what the market will support. A discussion with the landlord may result in the option to reduce the rent before a more severe strategy of store closure. On the other hand, if a store is performing well, the retailer may be able to negotiate a reduction in rent or some other cash consideration in return for the early exercise of one or more options. This “blend and extend” tactic is often a win-win for both the retailer and the landlord.
#2: Adding Term
For a store that is a keeper, but no further contract options exist, negotiating a term extension at an attractive rate, or adding new term with incentives like free rent periods or tenant improvement funds can ensure the continuation of a profitable store at appropriate occupancy costs.
For a store that is a strong revenue generator, but in a location where the rent is well above market or the market rent itself is just too high, the overall financial performance of the location will struggle. If the trade area is desirable, relocating to a different location with lower rent can level out the health ratio and the store will better capitalize on the market’s strong revenue potential.
There are times when none of the prior strategies mentioned will result in a viable store for continuing operations. In that case, the best strategy is store closure and mitigating losses through disposition. Dispositions can come in a variety of forms. Retailers can choose to sell an owned asset. They can choose to sub-lease a leased asset. Or they can attempt a lease buyout, among others.
For leases, these decisions are typically a function of the amount of time left on the lease term. For a location with a very short amount of lease term left, it may make the most sense to let the lease run its course and come to the end of the term, which will ultimately close the store. For a lease with short to medium term left, the likely course of action is to attempt a buyout of the remaining term. For a lease with a moderate to lengthy amount of time left on the term, a retailer will likely choose to procure a new tenant to sublease the space. Further, once a space is sub-leased or a new tenant has been identified with specific deal terms, the retailer is in a good position to approach the landlord about a buyout for that lease, ultimately removing them as the middle man between the new tenant and the landlord. Another avenue can occur when an interested party wishes to purchase the space, which would allow the retailer to approach the landlord for a price in order to determine if the difference in the interested party’s offer and landlord’s price makes more sense for a buyout. As you can see, it takes creativity and persistence to design the right path for disposing of a retail property and each location requires a customized approach.
Portfolio Optimization Creates More than Savings. It Creates Value.
With so many moving parts involved with handling leases, most in-house teams are consistently working at capacity, and that means it is not likely that all lease actions are being performed to their best ability. By working with a third party focused on portfolio optimization, retailers can maximize the results of these strategies and do so more quickly. A third party can take on much of the negotiations, freeing up capacity for the retailer’s real estate team and allowing all lease actions to receive the time and attention needed. A third party can also handle conversations with landlords that might be difficult to approach for the retailer, which helps preserve their relationship. And because third parties are compensated directly from the savings they find for the retailer, they are incentivized to maximize those savings, making it an ideal situation for the retailer.
Since 2010, SRS has saved more than $1.6 billion for our clients through portfolio optimization and freed up their internal capacity to focus on other critical business functions. We would be honored to work with your team on this complex, yet crucial process. To speak to someone about our portfolio optimization capabilities, please reach out to Janie French.