Which way to the cashier?

There are no two ways about it - internet shopping has become a feature of Polish life. The online sales market has been growing rapidly. The findings of the Polish 2012 e-commerce market through the eyes of Internet users' survey, which was conducted by Gemius for the e-Commerce Polska Polish Chamber of Digital Economy, reveal that the value of the internet economy in our country increased by over 20 pct last year and growth of 21.4 pct is predicted for this year. In 2014 e-commerce is expected to exceed 4 pct of the total value of Polish retail sales. "The predictions for 2013 point to a market worth PLN 21.5 bln. In 2012 it was PLN 17.5 bln, of which 7 bln was generated by purchases in e-shops, and over PLN 10 bln by internet auctions. So this market needs to be examined while also taking into consideration the second-hand goods sold online," says Marcin Gudz, a retail space leasing manager at BNP Paribas Real Estate. By comparison, in 2012 the value of the European internet retail market came to EUR 200.5 bln. The estimated value of the global e-commerce market this year will be USD 1.3 tln (according to eMarketer). Back in Poland, according to the ROPO in shopping centres' report produced by Market Side, last year every fourth Pole looked at a product in a shopping centre but bought it somewhere else. This is the so-called ROPO effect (research off-line, purchase online). Customers choose a product in a shopping centre, but they buy it outside the mall, usually online. Around 19 pct of Poles (the sample included 1,100 people) bought online goods typically offered in a shopping centre. The fact that these are also the consumers who are generally targeted by shopping centres might also be a problem - they are often single, young, well-off and well-educated people. The goods that Poles buy online most often are books, records, household appliances and audio video equipment, shoes, cosmetics and clothing. "The popularity of internet sales has been constantly growing in Poland. We cannot escape this trend and it will keep on developing. However, the large annual growth in this sector in Poland results from its low initial base and the short history of e-commerce in our country. On the American market, which is a benchmark here, the share of internet trade in overall retail sales in 2011 was estimated at only app. 16 pct with only slightly higher last year - and the trend dates back to as long ago as 1995 and the birth of Amazon. I would rather say that the two trends have complemented each other in Poland so far," comments Andrzej Czarnecki, the development director of RTV Euro AGD.

Location counts
Do they really? Investors and developers are already seeing the negative effects of the growth in internet sales. This is not in terms of lower footfall in retail facilities, but the aspects which directly translate into finances - so-called turnover rent and the reduction in areas leased. In the latter case, this has already become the norm for grocery and electronics shops. "Chains are limiting their operating costs by reducing the areas of the stores they lease in shopping centres by as much as 50 pct. They are paying lower rents and they do not have to incur the costs related to the ?logistics and insurance of goods during transport," adds Marcin Gudz. A source of worry for developers is, however, the phenomenon of converting shops into goods collection points. This could lead to changing a regular store into a showroom that does not generate any turnover, and instead would only be used for exhibiting goods. Such a scenario is possible for the Polish market, but in a dozen or so years. However, its consequences can be seen already. There are a growing number of tenants who run traditional businesses and an internet shop at the same time. This gives them the possibility to reach more customers, but the turnover generated by the e-shop is not always treated as the profit of the physical store of the operator. "Indeed, such an approach has been evident for some time. The market is forcing us to behave in certain ways. It is possible to pick up the goods in our shops, but this does not make them merely goods collection point. You need to take into account where the transaction is processed as a fiscal receipt: in the physical shop or in the internet store," adds Andrzej Czarnecki. The key issue is the place where the payment for the purchase was made. If it takes place via the internet shop, it does not contribute to the profits of the shopping centre outlet. In this way some of the money from the turnover rent 'escapes' via the internet channel. "Turnover rent is indeed lower when the proportion of internet sales grows in the transactions of a given company, but I would not say that this is due to internet sales alone. Besides, the turn-over rent is actually only a value added on top of the base rent - it does not matter for the banks financing the development or the business plan of the developer," points out Andrzej Czarnecki.
This has also been noticed by the companies that lease retail space. "A problem occurs when tenants do not agree to enter transactions from an internet shop in the books of the physical outlet. In the past everybody agreed to this, nowadays only a few do so. The majority consider online sales to be an element of their strategy and marketing, which does not have any connection to the activities carried out in the shopping centre," says Wojciech Cieślak, the president of the board at The Blue Ocean Investment Group (BOIG).

Various configurations
There are many different models for determining turnover rent. Most often it is an additional fee on top of the fixed rent and shared costs. When a certain level of turnover is exceeded, the tenant pays an agreed percentage of the results in addition to or instead of the fixed rent. This is the most popular solution, but there are a lot of configurations - everything depends on the arrangements between the parties. "The turnover rent is never treated as the main source of income by developers, and when a facility is sold, the buyer never treats it as a secure income because it is not possible to determine its real value. Tenants usually agree to pay this kind of rent, which ranges from 1.5 to 10 pct of the turnover value. It depends on the industry which a given tenant operates in. Retailers with higher margins, such as clothing stores, accept a higher percentage of the turnover rent, i.e. 8-9 pct. Meanwhile drug stores or supermarkets accept a turnover rent at a maximum level of 3-4 pct. The average turnover rent amounts to app. 6 pct. In cases where the rent is paid in the form of percentages of the turnover above a certain limit of the financial results, it reflects well on the functioning of the facility and the condition of its tenants. That is why experienced developers monitor the rent to turnover ratio," explains Wojciech Cieślak.
Another issue is turnover rent which is paid by the tenant as the basis of their financial obligations towards the developer. Then it is the investor's main source of income, and when it comes to transactions made on the internet, there could be a serious impact on the results generated by the shopping centre. "This form of turnover rent is a financial tool that tenants with strong negotiating power try to secure for themselves when there is a big risk in entering a given mall. Due to this the risk is supposedly minimised - they do not pay a fixed rent, only some part of their turnover, and consequently they transfer the risk of failure onto the developer," says Andrzej Czarnecki. "It allows the tenants to diversify their costs. I am not against such solutions because it is a good option for first or second generation centres, which tend to be undergoing modernisation nowadays. Tenants in prime projects are able to pay a regular rent. However, in the case of some locations where a few projects are being developed at the same time, turnover rent is the preferred option for tenants. Of course there is the group of most desired tenants - the so-called anchors - who have a strict expansion policy and will not opt for signing a contract, even one based on turnover rent, for a store that is, for instance, the third in a given town, if there is a risk of decreasing the turnover in another outlet by perhaps 15 pct. This allows them to avoid the cannibalisation of these stores," adds Marcin Gudz. So the retail facilities considered by tenants to be less attractive are those that are struggling with decreasing incomes from turnover rent. "This can be a significant problem for a developer in such a case. I do not believe that investors can currently include provisions that prohibit the collection of goods ordered on the internet in their contracts. Furthermore, the level of rent is the outcome of a number of factors and ultimately depends on the negotiations. If both parties agree to the conditions we have mentioned, the matter could be resolved. However, I doubt whether developers are currently able to impose more restrictive requirements related to rents onto tenants. Developers must realise that their room for manoeuvre is limited. There is no way of stopping certain changes," claims Andrzej Czarnecki.

To establish new rules
However, investors are making certain attempts to secure their interests by introducing provisions that limit or prohibit treating stores in shopping centres as goods collection points. "The majority of contracts currently being signed on the market contain a clause that says that a product sold is a product paid for in the outlet. Meanwhile tenants point out that goods sold on the internet do not belong to the physical stores because the receipt was issued by a completely different business entity," claims Wojciech Rudzki, a trainee legal counsel employed, among others, by the 4F chain. It is hard to negotiate with a stronger party, but there are some ideas for replacing turnover rent. "In my opinion developers will move away from turnover rent towards increasing the fixed rent or the maintenance charges. There are, for example, some proposals for changing turnover rent into shared costs. The lessor can easily measure the footfall generated by a given shop. We can guess that the more people visit a shop, the more transactions are concluded. Reducing rent by increasing the maintenance charges or fees calculated on the basis of the footfall and the flow of customers into individual outlets would make it possible to move away from treating the shops as showrooms. It would require a change in the approach to the settlements between the developer and the tenant. It would also give less attractive projects a chance - everyone would have to declare that they believe in the project, which would make it look stronger in the eyes of the banks financing it," argues Wojciech Rudzki. However, market players have criticised this idea. "The idea of replacing turnover rent with a fee based on the footfall in a given shop would be very difficult to implement. Not every person who visits a shop is a customer. Tenants in certain locations could have a lot of so-called empty footfall. In such cases it would be necessary to establish the purchasing power of specific locations and the average size of customers' shopping baskets. Eventually it would all be based on the receipts anyway," explains Wojciech Cieślak. However, Andrzej Czarnecki claims that "such a solution would punish the tenants who focus on marketing and active customer acquisition. Including the footfall fee in the operating costs also seems not to be very realistic. There is currently a heated debate about how to draw up principles for settling these costs."

Not only the internet is to blame
The ROPO effect does have a financial impact on shopping centres, but the problem starts much earlier - at the stage of planning and leasing the mall. The projects that tend to have the biggest problems with decreasing income from turn-over rent are those competing with other projects during their commercialisation stage. "The current market is tenant-oriented. The possibility of speculative development has also come to an end. However, if a developer is aware of all these factors and is able to identify a pool of tenants who will ask for turnover-based rent that is accordingly calculated in advance, they have a good chance of being successful. It is the investors who are giving tenants the opportunity to negotiate rents down to the minimum, as a result of which the profitability of centres is suffering. The number of tenants is not increasing at the same rate as the number of projects. Let's examine one such case; three projects being developed in a given town. Each of them wants to have anchors tenants. The anchors receive offers from the investors. They consider them to be overpriced. As a result the negotiations come down to the level of turnover rent. And this is when the problems start," remarks Marcin Gudz. The competition and its effect on the market is one of the factors that is encouraging the signing of contracts at much lower levels than in the times of a balanced market. "The oversupply of retail projects has also led to another trend: tenants biding their time. They are postponing their decisions to open in a given centre in order to observe its operations. We receive the first data six months after the opening of the mall and that is when we can start negotiations. If tenants believed that they were going to profit in a given project, they would not put off the decision about opening there because, regardless of the development of the internet market, they have to maintain their traditional channel and will continue doing so," adds Marcin Gudz. In such a situation the investors' revenue, which is lower anyway because of the amounts already disappearing via the internet, also contributes to upsetting the retail project's financial stability. "The balance of power is at the moment good for tenants. However, a very precise market mechanism is at work here. If the situation deepens, the development of shopping centres might stop being profitable after some time. After that the market balance will return. Tenants will then have a choice: either to start building themselves or to start accepting higher rents," believes Wojciech Cieślak. What can be done to avoid such a desperate state of affairs? "In my opinion, the only solution in this situation is verification: which projects are being developed and which ones the market is prepared to absorb. That is why it is very important to research the market and the customers' needs well. You need to analyse the location thoroughly and adjust to it, as well as to the habits and preferences of local consumers. You need to check whether the market really wants what the developer considers to be good for it. If developers do not take such factors into account, the imbalance of power on the market will only deepen," concludes Marcin Gudz. How much are developers losing due to the ROPO effect? There is no way of accurately determining this. On the one hand, turnover rent is included in nearly every contract, and on the other its amount depends on the individual arrangement. Neither tenants nor developers are willing to share such information. According to the Polish Council of Shopping Centers, the average monthly turnover in 2012 (based on 78 shopping centres) amounted to PLN 855 per sqm of leased space. The value ranged from PLN 709 net per sqm in the weakest month (February) to PLN 1,273 per sqm in (the best month) December. There is a rule in the retail sector which says that you sign a contract for the difficult times. Tenants have long accepted the truth in this. Now it is time for developers to do the same.

One rent is not like another
Turnover rent is a special kind of monetary remuneration paid by the tenant to the lessor for using the premises. The remuneration can take a form of a monthly, semi-annual or annual rent. The turnover rent is calculated based on revenue data which is regularly provided by the tenant to the lessor. The turnover rent could be the tenant's basic payment, but it could also be an additional payment on top of the basic rent that is calculated differently, for example, as an amount to be paid per?sqm. The basis of this calculation is any turnover generated by the tenant (a kind of basic payment) or an amount derived from the turnover as stipulated in the lease contract (if it is an additional payment). The turnover rent can be expressed as a fixed amount established in advance (e.g. PLN 50,000 for the entire outlet or EUR 5 per sqm), an amount that corresponds to a percentage of all the tenants' turnover (e.g. 1 pct of all the tenants' turnover), or an amount that corresponds to the difference between the percentage of a tenant's turnover stipulated in the contract and the rent paid by the tenant on a different basis (e.g. per sqm). Wojciech Rudzki, trainee legal counsel