(Bloomberg) -- Mall owners, already squeezed by e-commerce and spending billions on property makeovers to draw shoppers, have a new headache: retailers deducting returns for items bought online from their sales figures.
David Simon, chief executive officer of Simon Property Group Inc., says a “significant number” of tenants are underreporting sales and that the company, the largest U.S. mall owner, is negotiating with them to find a solution.
For America’s beleaguered retail landlords, sales per square foot is a crucial metric, used by investors to gauge their financial health. In addition to the dollars lost themselves, a low number can damage a mall’s reputation on Wall Street.
The issue Simon is flagging arises from rents that are based on how much a retailer sells in its physical store. It’s common for a tenant to pay a base amount and then give the landlord a cut of sales that exceed a set threshold. Occasionally a retailer has no base rent and is obligated to pay only a percentage of sales rung up at the property.
“We are getting dinged by internet returns,” Simon said on a conference call with analysts Friday. “Every retailer is different, and there is not a standard response yet. It needs to be addressed in future leases.” He declined to quantify the problem but said it was “material,” telling the analysts that “we have audit rights, and in our normal procedure we saw some anomalies about sales.”
The tension adds to a growing list of troubles for retail property owners as the rise of internet shopping erodes brick-and-mortar revenues. Landlords are dropping big sums to reconfigure their shopping centers with attractions customers can’t enjoy online, such as restaurants and gyms.
Remaking the mall can mean adding small, local merchants and relatively unknown retailers to the mix as large chains cut back on space, exacerbating the issue of online returns, according to Burt Flickinger, managing director of Strategic Resource Group LLC, a retail-advisory firm. Big, well-known companies, especially publicly traded ones, are likelier to hew to established guidelines when they report sales figures, he said.
“As the big chain tenants close, they’re replaced more often with newer, more entrepreneurial independent owner-operators, who can be more casual in terms of responsibly reporting,” Flickinger said.
And as merchants build out their online operations, returns will pile up and become an even more pressing issue. Online sales will represent 24 percent of total retail sales by 2027, up from 8.9 percent last year, according to estimates in an investment-banking client presentation by RBC Capital Markets LLC obtained by Bloomberg.
Managing returns is a critical issue for both landlords and retailers, and e-commerce has only made it more complicated. Anybody who has bought a pair of shoes or a sweater online can attest that shoppers are far more likely to take back apparel they bought on the internet than picked out in person at a store. The rate of returns for online purchases is estimated to be as much as four times the rate for physical-store sales, according to David Sobie, CEO of Happy Returns Inc., which operates in malls and other shopping venues, taking online returns from consumers for retailers that don’t have a lot of physical stores.
Bad for both store and landlord, right? Not necessarily. When it comes time to seek a refund, people prefer to get it in person instead of printing up a label, making a trip to the post office and waiting weeks for the cash to show up in their bank accounts, Sobie said. That typically works in the landlord’s favor, since anything that triggers a trip to the mall can drive additional purchases.
“Returns from internet purchases as a source of foot traffic are valuable,” Sobie said. “Of course you’re going to browse, and maybe get something to eat.”
It’s hard to parse how the various parties to an internet sale and subsequent return are affected, said Daniel Hurwitz, CEO of retail real-estate consultant Raider Hill Advisors and the lead director of GGP Inc., the second-largest U.S. mall owner. For example, if a consumer trades in an item for one of a different size or color, the inventory at that location is reduced even though no money has changed hands at the cash register, Hurwitz said.
“The mall business has become obsessed with sales per square foot as an absolute measure of success,” Hurwitz said. “The reporting of sales has become less pure because there are so many moving parts with online returns. As an industry, it would be prudent to come up with a way to deal with this.”
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