Appraisal Matters

It’s easy to see what’s going on with retail and regional mall vacancy rates - just Google and read articles posted on line.  What if I said that everything all the media outlets are telling you about retail vacancy rates is dead wrong?

I know what you’re thinking.  A regional mall’s vacancy rate is easy to figure out.  There’s nothing to it.  Just count up the space that’s vacant, divide it by the total space in the mall and you’ve got the vacancy rate.  What if I told you there was more than one vacancy rate?  How about if I suggested that there are lots of vacancy rates?   Permit me to explain my madness.  How else can I be cured?

Physical Versus Financial Vacancy Wordplay

Have you ever looked into the definition the media uses for “vacancy”?  You’ll be hard pressed to find a definition quoted in any source.  The most common usage of the term vacancy is what I’ve mentioned above.  The problem is that there are many definitions for vacancy and what is reported with my above explanation for the term is usually misleading and doesn’t tell you the truth, the whole truth and nothing but the truth.

My blog about The Regional Mall Temporary Tenant creates an interesting implication.  If you could square footage occupied, you’re implying that all tenants are equal.  The temporary tenant is very different from the other tenants in the mall because they are under a license agreement, not a lease, and they can leave with hardly any notice.  They are there not to make money for the landlord but to pay some of the common area maintenance and create the appearance that the mall has a higher occupancy rate.  I submit that there is an “physical” vacancy rate, which is what is reported, and there is a “financial” vacancy rate.  I’ve seen an example where a mall has over 30 percent temporary tenants who are all paying only part of the common area maintenance, so although that mall was 75 percent physically occupied, financially it was only 45 percent.

Let’s take the above and turn it upside down.  What about the mall where a high-credit, publicly traded company has vacated its space but continues to pay rent on it until the lease runs out?  You’d think the reason is not to be sued for breaking the lease, but this has very little to do with it.  The real reason is they want to keep their high credit rating so they can borrow at low rates and it is bad business to have the word go around the “XYZ Retailer” has defaulted on one more more leases.  So what we have is a physical vacancy that is lower than the financial vacancy, just the opposite of the above.

Taking it even further, how do we classify tenants that have accepted “rent abatements” or deferred rent?  What about those that are not paying any rent and waiting to be evicted?  What about a bunch of tenants that are behind on their rent?  Do you treat them as financial vacancy or do you coin a new phrase?

Physical Versus Economic Vacancy Wordplay

That’s all well and good, but how do we account for dead space in the mall?  This may be space that’s walled off behind a temporary tenant taking up on a portion of the available space.  The inline bays that are too deep and not wide enough or the movie theater that left the mall has space that cannot be used for anything without above-market and high renovation costs.  The latter is an example of functional obsolescence.  So if a mall has a 20 percent physical vacancy and 5 percent dead space, should we say the vacancy is still 20 percent.  What we have is essentially 5 percent of the space that is unusable permanently or for an extended period of time.  It seems to me the physical vacancy should be 15 percent and the economic vacancy is also 5 percent instead of reporting it all as 20 percent.  Later in this blog, you’ll see where I’m going with this.

Frictional Vacancy

Frictional vacancy is the vacancy that occurs between tenants.  It is a nature recourse of tenant rollover.  Using the example above, if I said that all of 20 percent vacant space was an anchor that left and a new anchor is scheduled to move in within the next 60 days, is it fair to say that the center is 20 percent vacant?  Physically, yes, but in this case it’s better to classify the vacancy as frictional vacancy.  This example works better in strong economies rather than weak ones, but you get my point.

Vacancy Characteristics

So let’s stick with the 20 percent physical vacancy for a moment.  What is that comprise of?  Is that just one anchor that’s vacant or a bunch of inline bays?  Is the vacancy clustered together as in a dark anchor wing?  Is the vacancy mostly or all of one class of tenant?  What is more meaningful:  that a regional mall is 20 percent vacant or that all of the vacancy is in fashion stores?  The latter tells me that this mall is not competitive in this important category and that some other mall or malls are attracting these types of tenants away.  What is more meaningful:  that the vacancy sits in two large pad site buildings or as inline bays within the mall?  They’re all part of the same mall, but the pad sites/buildings and the mall itself are very different types of properties.

Putting It All Together

So now we see that there can be multiple definitions for the term vacancy and that no matter how it is defined, it may overlook the key dynamics of why the vacancy is this amount.  Now let’s take it a big step further.  Let’s apply this to every mall that is a part of our survey (that could also include every regional mall in the country).  Can you see the potential for error?  Do you see the potential to report a statistic in an unfair manner?  Even the lowly physical versus economic vacancy rate example above can make a big difference when it’s applied to all the malls in an area, state, region or the entire country.

So the next time you see that retail vacancy rates are 6 percent, ask yourself if that’s what the real vacancy is.  Better yet, ask what the real vacancy is after after you subtract financial vacancy, frictional vacancy and economic vacancy, as I have defined them!

John Simpson, MAI

Note:  Although this discussion uses regional malls as an example, many of the concepts also apply to community or neighborhood shopping centers.