Small Is Beautiful at the Mall

Cost-cutting and consumer convenience is driving shift away from larger stores.

By Laura Kennedy, Researcher-Reporter, the Kiplinger letters

March 4, 2009

America's retail footprint is shrinking. And not just because the industry will lose about 40,000 more stores than it gains this year, when the recession causes retail sales to drop at least 1%.

The trend toward smaller stores is picking up steam. Initiated by the popularity of mini-marts, aimed at consumer convenience, the move away from larger spaces is now fueled by cost-cutting. Sharp sales decreases are making it difficult for many retailers to cover the rent. The broad expansion of retail space over the last decade resulted in many rent agreements tied to developers' construction costs rather than store productivity, and now retailers can't keep up even though some landlords are willing to negotiate.

One solution to tight budgets is fewer square feet. Even typically large stores, such as Wal-Mart and Safeway, among others, are trying sized-down prototypes. The Gap announced last summer that it was cutting the size of some of its stores to save on rent. And earlier this year, OfficeMax announced plans to open "mini-marts" in the Seattle area for easy access to pay-as-you-go copy machines and office supplies such as printer ink.

New inventory management tactics are helping the shift to smaller stores. As retailers continue to slash product orders in preparation for reduced consumer interest, they'll need less space to sell the merchandise. Some retailers will shave space from current store locations, but they'll mostly incorporate changes into new store prototypes, according to David Jacobstein, chief advisor to Deloitte LLP's Real Estate Practice. "On balance, the [new stores] will shrink rather than grow," he says.

Landlords will likely appreciate the change as well. The closures of big department stores and the liquidation of anchors, such as electronics retailer Circuit City and discount apparel retailer Steve & Barry's, have left mall owners with big holes that are hard to fill. In the long term, smaller stores will help fill some of the gap.

Even so, retail rents are expected to fall 6% to 10% this year. It's a short-term expense reduction for retailers on current store space. With more and more stores going dark, "landlords are not in the position to gouge [retailers] in terms of their rent," says Abigail Marks, an economist for Torto Wheaton Research, a real estate research firm. "[Retailers are] trying to jump at the opportunity to use this upper hand to renegotiate their lease terms."

Along with lower asking rates, renters are demanding and getting other concessions: bigger improvement allowances, caps on increases in maintenance fees and clauses that let retailers leave if desirable neighboring tenants vacate. Some retailers will also ask to lengthen their leases in exchange for remaining in a specific space. Developers will have to do more to lure new stores in, too, with offers of spaces complete with decorations and fixtures and other lease offers.

"Every one of these [concessions] has happened in the past," says Jacobstein. "We'll just see more of this than in the last four to five years."

For weekly updates on topics to improve your business decisionmaking, click here.