With Tenant Demand Declining, Could Percentage-Based Rents Fill The Gaps For Industrial?

As the saying goes, three makes a trend. Amazon, Gap and American Eagle Outfitters have all launched logistics-as-a-service platforms in the past few months, looking to monetize their expensive supply chains by lending capacity to smaller retail companies.

The motivation is clear: Aggressive industrial expansions have driven prices past what smaller companies can afford as they struggle to shorten delivery times to online customers. But American Eagle subsidiary Quiet Platforms is offering a different flavor of service than what Gap and Amazon have created.

Rather than use its existing footprint, Quiet Platforms seeks to take short-term space left behind in the current leasing environment and operate a basic last-mile fulfillment operation on behalf of its users, said Kris Bjorson, international director of JLL Americas’ industrial brokerage, who is leading the JLL part of a partnership with Quiet.

Quiet announced a partnership with JLL in December.

The crux of the JLL-Quiet model is signing leases where rent is a percentage of revenue. That practice has history in the retail sector but virtually no track record in industrial, multiple industry experts told Bisnow.

It is a bet that economic conditions have gotten tough enough to motivate owners of commercial real estate to cut deals on space they can’t lease. 

“I’ve heard about it in retail for sure, but never for industrial,” said Colliers Senior Vice President Brad Boone, who works in the firm’s industrial practice in the Philadelphia region. “If it’s happening in industrial, then it must be in a relatively small subset.”

The arrangement that JLL has been seeking on behalf of Quiet has a triple-net structure with no minimum for base rent. Quiet and its retail client would always cover property taxes, utilities and operating expenses, with the revenue calculated from Quiet’s tracking of inventory leaving the given location, Bjorson said.

Rather than compete with market rents, Quiet would add value by covering carrying costs for an owner until a more permanent use for a space can be found.

“It’s a unique situation for every owner, whether it’s the underwriting of a corporate sublease, the delayed redevelopment of a Class-C asset in a different class, or something else,” Bjorson told Bisnow. “Everyone’s in a different position.”

So far, Quiet has been targeting blocks of space ranging from 25K SF to 75K SF, though it has no set maximum or minimum footprint, Bjorson said. Quiet doesn’t need much more than open floor space and three or four dock doors, so it can even use an office building’s first floor without much in the way of tenant improvements.

The standard use case for one of these locations would be a retailer’s “edge fulfillment” center, Bjorson said — not a place to store large quantities of inventory, but a basic line of picking and packaging for the last leg of a product’s journey to the customer.

“We’re just finding real estate alternatives that are willing to support us on that type of solution,” Bjorson said. “And as you can appreciate, in some markets, where there’s 0% to 2% vacancy, that’s nearly impossible. So we’re seeking flexibility in terms of asset class.”

Percentage rents became more commonplace in retail in 2020 as landlords worked out deals with tenants to keep them afloat when foot traffic was nonexistent. Landlords exchanged certainty in their revenue for keeping a space active and capturing some upside for when business returned. 

Industrial leasing is no longer the feeding frenzy it was for two years, but times are nowhere near as desperate as they were for retail in the first few months of the pandemic. And even in retail, an issue popped up with percentage rents that is every bit as concerning for industrial: Lenders wouldn’t get on board.

“I can’t imagine a lender agreeing to that,” said industrial developer Wendy Berger, president and CEO of WBS Equities. “I mean, at the very least, you’d need a base rent and then upside.”

For owners of older suburban offices and big-box retail properties vacated by anchor tenants, covering the cost of property taxes, utilities and property maintenance may be the best they can do in the current environment, where potential tenants are looking elsewhere and the cost of full-scale conversion to industrial is infeasible. As much as industrial conversions have been discussed, most owners of such properties are still stuck in that position, Berger said.

“I don’t think prices have come down enough on these assets to make the numbers pencil out for conversion,” she said. “I’ve heard lots of talk, and I’m sure there have been pockets where it’s been done, but I don’t think I’d be able to find 100 deals where that’s worked.”

In all but the highest-rent and highest-tax markets, those nonrent costs likely max out 20% of the total monthly cost at a triple-net industrial property, though in some areas the ratio can hit 30%, Boone said. In many townships, a retail or office property has a higher tax bill than industrial, presenting either an added expense or an outright obstacle for developers seeking a conversion.

One particular niche for Quiet could be helping developers with speculative warehouses that tenants don’t want to fill all at once, Bjorson said.

A major occupier with a national presence has the leverage to lease, say, 425K SF of a 500K SF building with an option to take the last slice at a later date, Boone said.

“That happens all the time, where a tenant wants to grow into a space,” Boone said. “And typically, if it’s a really strong tenant, landlords will just allow it and essentially take a lower revenue for the entire building … It’s always a challenge, but to have a group out there going after short-term, flexible leases is definitely a value-add.”

Unlike true triple-net deals, percentage-based rent agreements always make for a hands-on relationship between landlord and tenant — the former is materially invested in the latter’s success rather than its mere survival. So, while Quiet and JLL are marketing a win-win deal for property owners, it is not exactly a quick buck.

“The Quiet Platforms vision is that landlords can become business partners as this evolves,” Bjorson said. “There will be more transparency, and at the end of the day, that benefits the customer … We’re not expecting it to be embraced by the whole marketplace.”

The appeal for smaller retailers is clear, especially ones seeking to avoid using Amazon's marketplace. Industrial rents are unrealistic, particularly when seeking a new space that can shorten delivery times, and standard third-party logistics operators can have inflexible cost structures of their own.

“Retailers are not in a position to push all of the higher costs onto the consumer,” Bjorson said. “It’ll get to a point where we just would opt out of having things sent to our house and just go to a store to pick something up.”

If the client base for Quiet’s idea is smaller retailers, that could be all the more reason for lenders to get jittery about a percentage-based rent deal, Boone and Berger agreed. Yet the types of properties Quiet and JLL are targeting would already be looking for a creative solution, and the weight of American Eagle and JLL’s brands may help ease such concerns.

“[Bjorson] is important to every client in every market, because he reps some big tenants,” Boone said. “I bet if he’s doing it, it makes sense in some way.”