Thursday, October 2, 2008

One last thought on GGP - percentage rents

I usually do not write thrice in one day about one company, but General Growth is a major Chicago player, and its stock just plummeted more after the complaint about the short-sale listing. (So maybe I should be more concerned if the market was.)

In addition to debt coming due and the inability to access credit lines, I can see two reasons why there might be declining revenue at the company that could impact its bottom line.

One is revenue from base rent. If tenants are filing bankruptcies are walking away from malls, you get less money. And the prospects of replacing those tenants aren't great, though there might be a temporary bump in the holidays.

Another is percentage rent, also known as overage rent. For you novices, percentage rent is when a tenant pays, as additional rent, a percentage of its gross sales, usually over a certain amount (known as the breakpoint). Sometimes the breakpoint is based on monthly sales (which might differ based on the time of year, given that sales are higher in December than in March), sometimes it is based on annual sales.

On more aggressive deals there may be a higher percentage component and a lower base component, thus giving the landlord the benefit of a good store but also the burden of a bad one. (Sometimes landlords can kick out retail tenants for failing to reach certain goals, though I doubt you'll see much of that these days.)

In a bad economy, retail (including restaurants, which seem empty lately) outlets are not selling as much. This means that percentage rent will decline or even disappear if the breakpoint is not reached.

Not a huge percentage of GGP's rent revenue comes from percentage rent, but the amount is increasing annually. According to its annual reports, GGP's overage rent revenue was 2.7% of total rent revenue in 2003, and 4.4% in 2007. Thus, while the numbers are not huge, the company seems to be relying a little more on percentage rent. I don't know what sales are looking like right now, but could that make a large difference?

Maybe, maybe not. But I do know that the subject came up in the 2Q 2008 conference call and the 4Q 2007 conference call (both specifically concerning restaurants). And guidance was moved downward because of many factors, including overage rent. So this might already be priced in.
(Simon, by the way, is just as reliant as GGP on percentage rent if not more so. But its stock price is actually up about 1% YTD compared to -62% at GGP.)

The point? A slowdown in the economy would potentially impact landlords not just from a base perspective if tenants blow out of leases, but existing leases would also potentially bring in less revenue as gross sales decline. So think about that as you negotiate retail leases.