Apr 17
Working with municipalities to seal retail deals is a win-win for many retailers and cities.
By X Team International Partners David Larson and Kenneth Katz
The ability to work closely and collaboratively with cities and municipalities can make or break a commercial real estate transaction. Many iconic and transformative projects would not have been possible without cooperative and constructive engagement between developers and municipal leaders.
Whether it is working closely with the city council and local government officials to secure tax reimbursements and grants for signage, or bringing national retailers and municipal planning authorities together to negotiate terms for mutually beneficial leases and contracts, cooperation is frequently critical to making deals happen.
Understanding why it matters, why it can be effective, and what priorities and perspectives need to be addressed to successfully navigate the negotiation and deal-making process is something that should be a part of every developer’s – and every municipal official’s – professional toolkit.
Impact and Implications
The impact of getting a deal done can be profound – with implications for companies and communities that extend far beyond the bottom line. Because this kind of collaboration often makes deals possible that would otherwise not be financially viable, the growth and progress of communities can be heavily dependent on developmental deal-making. It is especially important for up-and-coming neighborhoods and communities in need of redevelopment: places where the immediate social and commercial realities have not yet caught up to the area’s long-term potential.
On the development side, the economic benefits of a tax break or grant is clear. But understanding the economic implications on the civic side of the ledger is also important. Cities and towns of all sizes derive significant economic benefits from retail. Because the dales and (to a lesser extent) property tax revenue from even a small handful of large tenants can be dramatic, municipalities are highly incentivized to have retailers inside their city limits.
Freedom and Flexibility
Understanding the important of working with municipalities is just the first step. Knowing how to make those partnerships happen – and to do with efficiently and consistently – is just as essential.
Whether the issue is attracting profitable and high-profile retailers to a market, or keeping existing quality retailers in the market, the mechanics are similar. When a retailer is considering signing or renewing a lease at a lower rate than the developer can or will accept, all parties need to come together to establish whether a deal can be reached that accommodate the interests of the retailer, the developer and the municipality. In the case of existing, high sales volume retailers, cities, frequently have a strong vested interested in not losing the significant sales tax revenues. In the case of a prominent or successful tenant, municipalities often recognize that even if another big box tenant could be found to fill the space, finding one that does a similar sale volume can be extremely difficult. The difference between a good store and a bad store in terms of sales tax generation can be massive, making the municipal value equation a relatively straightforward calculation in many instances.
There are a number of different vehicles that developers and municipalities can use to make a project feasible or a tenant lease workable for all parties. Two of the most common are Tax Increment Financing (TIF), public financing that essentially subsidizes current priorities with projected future gains in tax revenue, and Tax increment Reinvestment Zones (TIRZ), where a municipality reimburses the landlord a certain percentage of sales and/or property tax income for a set period of time, making it possible for the landlord/developer to use those monies to incentivize a new tenant or sweeten the deal to retain and existing tenant. While TIFs and TIRZs employ different mechanics, the same basic dynamic is at play: redistributing funds to bring competing interests into better alignment. The key is to provide added flexibility to get projects and deals done that otherwise might not get done, and to re-lease space that otherwise might not have been releasable. When done correctly, they create not just a win-win, but a win-win-win.
Competition and Communication
The realities of an evolving marketplace have made civic and corporate cooperation more important than ever. Today there are fewer true impact retailers and fewer large regional developments, so every potential transaction is inherently more competitive. Consequently, whether you are dealing with a new or existing development, municipalities are feeling the pressure to be more aware, more responsive and more proactive. Many are already aware of the need to be actively networking, building relationships, establishing lines of communication, and working closely with brokers and developers. In the current context, cities have more skin in the game. Municipal interests are a critical third party in what used to be a primarily a two-party process, and municipal entities are frequently a much bigger part of the negotiating process between landlords and tenants.
While more and more municipalities understand the need to be an engaged participant in the retail deal-making process, there are still those that simply do not fully appreciate the urgency. For those that fall into the latter category, it is incumbent upon developers to educate them and communicate clearly. Walking municipal representatives through the numbers and helping them understand the ins and outs of a deal is a process, and that process can take time – especially in cases where a deal might need the approval of the city council.
At a time when many cities are strapped for cash, the appeal of a solution that eschews redevelopment or high-profile tenants in lieu of simply inking a number of second-tier retailers cannot be underestimated. But decisions made in fear, and without an appreciation for the long-term strategic impact on the region, are rarely going to be wise investments.
Context and Consequence
Any negotiation requires an appreciation for context and circumstances. Not only is every development and every municipality different – with its own civic, personal and commercial/financial dynamics – but the tenant itself may drive the need for creative commercial deal-making. Developers and municipalities alike both need to recognize that different tenants can require very different negotiating strategies. Starbucks, for example, may be a nationally prominent and profitable brand, but the number and ubiquity of Starbucks coffee shops limits municipal competition. Contrast that with a retailer like IKEA, which makes it known that there is only going to be one store for an entire expanded metro area. Competition for an IKEA – and the sales tax revenues that an IKEA generates – can be fierce, making the negotiating process a very different animal.
Location and context are also important differentiators that need to be considered carefully. Thriving and competitive retail areas with tenants waiting in line will be unlikely to have incentives lined up, while average and/or up-and-coming areas are much more likely to be heavily incentivized. The bottom line is that the realities of commercial real estate have changed, and in this new and more competitive environment, collaboration, communication and deal-making between developers, retailers and municipalities are more important than ever. Failure to consistently and successfully leverage those negotiations can be a deal-breaker.