This Space for Rent

A retailer that rents out space within its business to another company may sound like a friend who’s fallen on hard times and starts accepting boarders.

But subletting to another business can help a company grow, conserve resources or even stave off disaster, according to industry experts. “The classic challenge presented to operations executives is balancing demand and capacity,” says Dave Greisler, head of the MBA program at York College of Pennsylvania. “When demand is down, capacity is idle” and space changes from an asset to a liability. Subletting is a way to fix that, he says.

The term “store in a store” has been used as far back at least as the 1920s, ever since New York retailers leased space to businesses that sold products that complemented their own. In more recent years, grocery stores have begun renting space to banks and other small businesses.

The practice has been on the upswing for the past two decades among large enterprises and mid-sized companies. In recent years, Walmart opened Walmart Realty to bring small businesses into its properties. This year, Target installed Radio Shack-owned and operated mobile phone shops in 1,450 of its stores. Best Buy is searching for tenants to sublease in many of its stores.

Driven by the Recession, Online Shopping and More
The recession helped make subleasing attractive. As demand and inventory declined during the downturn, many businesses didn’t need as much floor space. Online shopping also has reduced foot traffic. As technology got smaller, it reduced the need for shelf space. After all, music players and tablets don’t take up nearly as much space as stereo systems or PCs.

For the tenants, sublets are a way to reach new customers without going to the trouble and expense of building new stores.

World of Floors is subletting to put itself on the expansion fast track. The $33 million flooring retailer based in Rochester Hills, Michigan, operates two brick and mortar stores in Michigan and one each in Florida and California. But the ink is drying on a contract that will put the company inside 33 Art Van Furniture stores throughout Michigan, according to World of Floors president Emil Pedick.

Art Van, a $430 million chain out of Warren, Michigan, was inspired to approach World of Floors after striking a similar deal with Paul's TV, an Irvine, California, electronics retailer, according to Pedick. Paul’s TV has also moved into stores run by Living Spaces, a Rancho Cucamonga, California, furniture retailer, and Jordan's Furniture in Boston.

From the time Art Van came to Pedick with the idea, it took 10 months to hash out a contract and develop a concept. But the positive effects of signing on with Art Van Furniture were almost immediate, Pedick says. “They spend a boatload of money on advertising, which will bring in a lot of foot traffic,” he says, “and they're very respected. They've been around for 50 years.”

Taking the Plunge
Subletting isn't for everyone. But for companies considering it, industry experts recommend doing adequate due diligence, including asking the following questions:

1. Does the landlord have a landlord? Some businesses own the property they occupy, but many don't. “Almost every lease favors the building owner, and most have a very restrictive sublease clause,” says Marisa Manley, president of Commercial Tenant Real Estate Representation. That often gives the landlord the final say over whether a company can sublet from the tenant.

2. Does the contract have a non-disturbance agreement? Such a clause ensures that should a main tenant be forced to leave a property, a sublessor can elect to stay. Regardless, agreements need to have some sort of exit clause, advises Tracy Plott, partner with the law firm Schiff Hardin's Real Estate Practice Group. “Companies should always look at the long-term horizon,” Plott says.

3. Does it make sense for customers? World of Floors CEO Pedick says he wouldn’t have considered subletting from a store like Best Buy because a customer shopping for electronics isn’t necessarily in the market for flooring. But locating inside a furniture store made sense. “Sometimes customers don't want to buy furniture until they know how it's going to go with the rest of the room,” Pedick says. “They may leave the store, intending not to purchase the set until they put it all together, and of course, they may not come back. We believe that with our store in there, they're going to close more sales.”

To hit the subletting sweet spot, both the landlord and tenant must benefit. For that to occur, the customer needs to feel the arrangement works. That, says Pedick, is what he was aiming for: “It was very important that it is a win-win-win situation.”