Sunday, March 4, 2012

Mall Rentals in India - A Mugs Game.

I wonder if any of you have attended any of the annual events where all the stake holders of the Retail fraternity come together to discuss and debate the issues concerning the industry, showcase the developments and honour their peers? If you have, and when there, if you have spent some time in the study of these various stake holders, it would have been impossible for you to have missed the following: With a few notable exceptions, you have one bunch of guys all in snazzy suits and walking with a swagger, dripping with luxury accessories and wearing constantly smug expressions of guys (and gals) who have met all their targets and are assured of great bonuses in a couple of months. You will find another bunch of men and women usually ‘dressed down’ (intentionally) and exuding the air of folks who know it all and despite never having done anything like putting their own money at stake, will never tire of telling you what you’ve been doing wrong all these years, a third group of very busy and professional looking folk who seem to exude an air of ‘what am I doing here? I could’ve been elsewhere spending my time more profitably’, and finally you have a ragged group of ‘all-sorts’, some in suits (minus of course, the luxury accessories) and some in humbler rags looking around with an air of the hunted about them, lost and seeming like they’ve been beaten senseless by the politics and the challenges of the industry. The first group are the Real Estate and Mall Developer Types, the second are the Consultants, the third are the Vendors and of course, the last sad bunch are the Retailers themselves.

While reserving my comments on the Consultants and the Vendors for another article, I would like to dwell in some detail on the other two protagonists in this real life stage – the Developers and the Retailers. While most Retailers, particularly those in the field of the vending of FMCG merchandise, are yet to record a clean profit at Enterprise level, despite a constant struggle for the past almost 20 years of organized retail in India, the Developers have been garnering huge profits from the retail industry by controlling the supply and the purvey of the so called ‘quality retail spaces’ being offered at prices that are sometimes downright obnoxious to say the least. Mall Developers in the main Urban Centres of the country have been asking for astronomical rentals, without any assurance of traffic or footfall, which has been putting most retailers’ business models into a severe tailspin when probed for profitability. Even the most hardworking FMCG Retailer struggles to achieve a 20% Gross Margin, and are expected to show profit at enterprise level when they are hardly left with a Nett Margin of 1.5~2% after costs. While the rest of the input costs like Manpower, Technology, Asset Creation and Merchandise, are pretty competitive and driven largely by market forces, the only one cost that seems to be a mugs’ game in retail is that of Rentals. Only large space consumers like Hypermarkets seem to have any chance of getting concessional rentals by bagging sweet Anchor Tenancy deals. While the rest are literally thrown to the wolves.

Why are we encountering such high realty prices? Perhaps the whole problem is one of structure – of the entire Realty market itself, which is ruled by extreme short supply, high demand, poor quality workmanship and un-professionalism as it is largely geared to cater to the middle income housing segment. While that is true, it is also true that some of the parcels of land that have recently been released into the market, especially by way of Governmental auctions have been acquired by developers at absurd prices of upwards of Rs. 11,000 Per SFt. Thus, based on such inputs costs and the forever rising cost of quality construction, the developers of some premium mall properties have priced their rentals at simply unaffordable levels of Rs. 250 to Rs. 350 Per SFt. bracket. While I am willing to concede that Developers too face their own set of problems like archaic Zoning Laws, corruption in the Government Departments and Local Bodies and a very low FSI allowance - considering their investment. It is also true that in some zones, the Building Height restrictions add to the pressure on a projects’ viability.  But, this is only one side of the coin.

The other aspect that makes the asking rentals even more unaffordable are the methods adopted by the developers for fixing the Rental Area, and the worst offender amongst these is the so called ‘Plinth’ to ‘Super Built’ or Rental Area conversion. Retailers face problems in even accurately establishing the so-called Plinth area, as it is based on the whims and fancies of every individual developer and variously includes or excludes external wall thicknesses, half of internal wall thicknesses, peripheral columns, internal columns with unlimited confusion on the inclusion of staircases, lift shafts and other such grey areas, etc. This is unbelievably non-standard, and procedures for arriving at the Plinth Area vary from developer to developer and is often a point of negotiation! Thus, we see that once the Plinth Area is negotiated on and established, it can be close to 10% higher than the actual useful Carpet Area. The conversion of this Plinth Area to Super Built or Rental Area is again by multiplying the Plinth Area by an unexplained factor, which may range from 35% to 50%!

So why does the developer need to apply such a high conversion? Typically, in a Mall when all the Tenantable Areas are added up, they do not equal the total Construction Area, for which the builder needs to spend for construction. This includes areas that are required for common use like corridors, aisles, stairs, lobbies, ramps and engineering or service areas – all of which should not exceed 20% in a well designed building. The difference usually comes from poor architectural design that creates negative spaces, excessive common areas and poor utilization of space due to some very fanciful designs being adopted for Malls. In effect, it seems like the poor design standards and pre-occupation with Form by most Architects, which normally result in such inefficiencies in space utilization, has to be borne by the hapless retailer in the form of inflated rentals. I sincerely believe that retail space design needs to be approached purely on a very scientific basis and with an end use approach of providing very affordable high quality retail spaces. It is a myth that people will flock to Malls designed to look like Palaces, Space Research Centres from Star Wars, or gaudy Hallucinations in Glass and Light. Customers will come to clean and orderly designed spaces that offer ease of shopping in a comfortable and safe environment that houses happy and contented retailers!

When most of the contemporary malls are studied closely and their design efficiencies mapped out, we see quite a depressing picture. Especially when the final design efficiency is reckoned based on the actual True Carpet Area (actual area of Carpet you will order for that space), which is the measure of a property’s true physical potential or the Useable Area efficiency, that one actually ‘trades’ out of, can be as low as 40 – 45% of the Rental Area, or area for which rent is paid. This just not tenable. Thus, a small Health & Beauty Retailer who needs 1000 SFt. Carpet Area, ends up having to take about 1100 SFt. Plinth Area and 2200 SFt. of Rental Area. Further, as they are most often treated as small consumers of mall space, they will get almost no preferential treatment and may end up forking out Rs. 250 Per Sft. on Rent, Plus Service Tax and Rs. 50 Per Sft. on Amenities or CAM (Common Area Maintenance). Even after ignoring the Taxes component, the Occupancy Cost works out to Rs. 6,60,000 Per Month or Rs. 660 Per Sft. on Carpet Area. You name one FMCG Retailer that can make a profitable business venture while bearing such rentals. I cannot think of any.

One must also note that despite adding the Lobbies and the Concourses as ‘Common Area’ and asking tenants to pay support rent for them, these areas are used as Revenue Models by letting out the space for Temporary Promotions and Brand Building, maximizing the profits for the Mall Managements. In the ideal world, any common floor area that can be used to generate revenue must be excluded from the Common Area rental calculations. In addition to the above rent quantum, as explained earlier, most Mall Managements levy unjustifiably high charges for CAM. Compounded with these high costs, are poor Mall design criteria, resulting in odd shaped lots, lots with poor connectivity / visibility, large central columns, deep beams, low ceiling height etc., all impediments that make adoption of standardized modern retail store formats a nightmare in the Indian context.

The final nail in the coffin of many a struggling retailer would be the very long gestation period that most new Malls face in the country. For a Mall to attract and retain sufficient footfalls, many things will need to be just right, not the least being absence of competing Malls, location, accessibility, catchment, tenant mix, scale and parking facilities. Due to one or several of these factors not having been addressed properly, the mall can be simply doomed to failure, or at best, be relegated to an ‘also ran’. It is also sometimes observed that in a hurry to fill the Mall, even the Managements’ mandated tenancy mix is given the go-by and many small ‘me-too’ retailers take the spaces and offer little synergy to the other tenants. This is particularly true in ‘Sold’ Malls, where the developer has no control over who the tenant of the investor would be. We must also be sobered by the fact that Indian Mall environments are yet quite of recent vintage, and it will be a few more years of hit-and-miss research before a suitable Tenant Mix model can be reliably developed and consistently applied.

Thus, in conclusion, it is quite evident that Malls need to be built on reasonably priced land parcels, which are large enough to provide sufficient scales of operation. The Mall Managements also need to change their ‘profit-at-all-costs’ approach and prescribe their asking rentals based on more justifiable methods and formulae. I would love to someday see a Mall advertise that they will be charging only 20% over Measured Carpet Area, and then put the onus on the Architects to deliver Design Efficiencies that would make that viable. I would also love to see the day when the internal Marketing teams of Malls are given targets to recover the ‘notional rent possibilities’ of Common Areas by leasing for events, and not burdening the tenants with rentals for the same.

India will take some time yet, to achieve the standards that good Malls in similar environments like Southeast Asia offer. The property conditions are quite comparable in the two regions, but asking rentals in very successful malls in South East Asia are about half of those in India, without all the attendant opaque area measurement parameters, while on the other hand, the market potential offered by those markets is at the very least, twice that in India. Let me also hasten to add that the above story is true only at the few professionally managed malls, and the picture in the majority of the smaller developments and ‘sold’ Malls is even scarier to contemplate.

I do hope that Mall Developers in India study in greater depth the business, management and design models of Malls at similar market countries such as Malaysia or even Indonesia, and soon move in the right direction - To a saner and hopefully brighter future. A high tenant turnover due to failed retail business models helps no one - not the Mall, not the other tenants and definitely not the displaced tenant. Thus, it is absolutely no surprise, that currently, all the strutting around at the retail seminars and meetings is done by developers, and the retailers, particularly the small and medium sized ones look like a hunted lot… they are truly lambs to the slaughter.   Malls need to be built simply and efficiently and rentals charged on justifiable basis for retail to survive in India. Until that happens, we can continue to expect to see a lot of broken-hearted retailers, rueing their trust in the ‘so called’ Indian Retail revolution.


  1. Dear sir.

    The post is quite interesting. Specially , when coming from retail industry.The post is from a perspective of an retailer . I want to add to the same from a student and consumer's point of view as well.

    1.Organized retail is promoted by Big business houses, having deep pockets.

    2.The obsession of presence across , leads to inorganic growth.

    3.Investments made with mind set "investment are for the future ". while the present itself keeps evolving in terms of technology to taste of products to preference of shopping.

    4.If retail wants to thrive in India , then it has to be based on "logic" of water and not rock.Specially ,products like apparel, accessories , cosmetics and QSRs, make a kill out it.I think the retailers go for POP up stores , extensively and pass on the benefits to consumers in terms of " new prices " then old prices ( buying from malls).If at all malls needs to be there , then be them seamless ( just an thought).what implications you tell us ?How I see malls are, like expensive catalogue ,while looking for a better deal else where.

  2. Hi Lodha, thanks for your comment.

    I think your views on retailers based in malls choosing to overcharge are quite well placed, but that may be true largely for apparel and luxury goods and others who enjoy high margins. For food and FMCG retailers who work with margins of sub-20% the effort to break-even is very strenuous.

    Consider this, rent as a portion of a retailers cost should not be higher than 5~7.5% of the monthly top line. Thus with a rental outflow of 3 lakh for a property that offers 50% efficiency, the impact of the rent is 6 lakh. You can imagine what kind of turnovers will be required to ensure that the rental outflow is within the required parameters.

    In large cities where traffic and weather play a very big role in attracting sufficient numbers of customers to your store as convenience and comfort are now the basic requirements for an evening of shopping and not always the price, the ideal retail environments are quickly pointing towards malls. Thus, mall developers need to have a more retail environment centric outlook and help build industry as partners instead of just looking at retailers as moneybags. If the developers charge reasonable rentals, the retailers will perhaps price their products more dynamically and ultimately, the customer benefits and tends to shop more often setting off a positive feedback and impetus to retailers to expand and ultimately benefiting the developer in the long term. That is what I'm advocating in my article.