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Occupancy Protection

April 29th, 2013 by

When the real estate market got hit in 2008, we saw a lot of push and pull in the landlord/tenant relationship. Tenants suddenly had greater bargaining power than they previously did when the market was hot, hot, hot.

In this buyer’s market, we saw an uptick in the amount of occupancy protection clauses, also known as “cotenancies”, included in leases. But what exactly is a cotenancy and why would you want to consider including one in your lease? And if you’re a landlord considering conceding such protection, how can you do it in a way that minimizes risk to you?

The basic premise is that the occupancy of a center, whether described in terms of quantity or its quality, is an intrinsic part of the center’s value. What makes one center more desirable than another, to many tenants (and to potential shoppers), is the co-tenant situation. This, in turn, drives up the rent. Logic tells you that if the co-tenancy situation deteriorates, the value of the real estate drops and the rent should reflect that, too.

A cotenancy can be analyzed, generally in two ways. First, in terms of quantity, i.e., the percentage of the center floor area that is under lease with operating tenants. Tenants leasing shopping center space do so primarily to capitalize on the customer foot traffic generated by the critical mass of other stores operating in the center. Solitude in a multi-tenant project can be deadly to tenant’s business. The landlord’s operating costs, once shared by a group of tenants, now all fall on the shoulders on the one. Customers develop a negative perception of the near empty center and of the remaining tenants, even though tenants may well be strong retailers in their own right. Foot traffic dies. Tenants who are aware of this possibility, and that would be any retailer who lived through the recession, are now regularly insisting on protection against this cruel fate.

“Quality” of cotenancy refers to the identities of particular tenants in a given center – usually marquee-name anchor stores. A smaller retail tenant leases space in a center that features the Latest Trendy Store because the smaller tenant believes that it shares a customer base with the Latest Trendy Store. If the Latest Trendy Store closes its doors for good, the smaller tenant will feel that its business is also at risk. The center may still have a high occupancy rate but a center that is fully leased with the wrong kind of tenant mix is as deadly to certain tenants as the empty center.

The simplest form of cotenancy protection provides two steps of relief – first a rent reduction, often converting fixed rent to a percentage of the tenant’s sales, and later, a right to terminate.

But do landlords have to grant tenants this type of protection? Maybe, maybe not. More on that side of the argument in our next blog post.

Build Out 101

April 19th, 2013 by

The last two blogs have detailed the many factors that contribute to the value of a retail space as reflected in the rent. But, as you consider my input on each of these elements, from location to convenience to price, to determine whether a space is right for your business, it is hard not to notice that the physical condition of the store itself has yet to be discussed.

Shouldn’t you be concerned with what your future store looks like? Yes and no. Is the square footage and general shape/layout important? Yes. Should you be turned off because you despise the coral-colored carpet? No, not any more than such an easily modified thing would keep you from purchasing a home. The majority of shopping center landlords assume that each new tenant will need modifications made to a space, which we refer to as the build out. If you’re not yet a seasoned and confident negotiator of this issue, it is imperative to use a savvy commercial real estate agent to get you the best deal possible for your needs and to hire a lawyer, experienced in retail property matters, to make sure that the agreement is properly documented in the lease.

While it is safe to assume that the build out details will outline the improvements to be made—whether it’s an all-out overhaul or simply new paint and fixtures—the lease should also clearly indicate who will be responsible for the costs incurred, as well as hiring contractors and overall project management. I have seen build out costs handled myriad ways, and it is not safe to assume there is a standard practice. Just because your friend’s build out was covered by the landlord does not mean yours will be too. And do not assume that if the landlord agrees to pay for the build-out, it is not actually being amortized in your rent. Again, that is where a good agent and lawyer can make sure you are getting the full story and a fair deal. One additional caveat is to beware of the landlord trying to roll additional costs into the build out to bring the building up to code. Even if the landlord is not willing to pay for the build out, capital improvements made to the building required for code-compliance should be the responsibility of the building owner who is in it for the long haul, not tenants whose interest is over within a term of years.

Also, if you are going to operate a specialty business that might necessitate unusual fixtures or built-in elements (perhaps elaborate dog washing stations for a pet groomer, kitchen equipment for a restaurant, etc.), the contract could stipulate that you can remove those items at the end of the term. In addition, you may need to finance them and your lender will not go for any lease that requires you to leave them in the space at the end of the term, or makes the lender’s interest in them secondary to the landlord’s. Make sure you are aware of those requirements, too.

By the time you get to the build out, you should be having some fun (finding furnishings, fixtures and finishes), so rely on your professional resources, lean on your agent, your lawyer, even your architect, engineer and interior designer. Let your team help you define and state clearly in the lease your build out needs, wants and expectations.

Cotenants, Convenience and Comfort

April 10th, 2013 by

In my last blog, I detailed how your business’s location and cotenants can affect price. But they aren’t the only factors.

Another element of the analysis is customer convenience and comfort – this means access, amenities and ample parking. All three drive price. The chances of maximizing your sales from a shopping center location are increased if the mall is situated near major cross streets, highly visible to motorists, easily accessible from adjoining roads, features abundant parking and provides amenities, like restaurants, comfortable seating, free Wi-Fi, ATMs, daycare centers. Realize, however, that these conveniences and the amenities that make shopping more of a fun activity than a mundane task require more real estate, and the cost of additional real estate factors into the rental rate. There are costs for taxes and on-going management and maintenance. All will be factored into the rent. The more the shopping center property is enhanced, the higher its value and, therefore, the higher the rent.

While the nature of the development and the landlord’s investment in it will dictate the “pro forma” rent, the individual deal that you make can also affect your rental rate. Negotiate a longer lease term and your rental rate will typically be lower. There are costs to the landlord in leasing space, including broker’s commissions, fit-out costs and, most significant, interruption in the rent stream. The landlord is usually willing to pay for a longer-term commitment by lowering the rent. And, where rent comprises fixed rent and a percentage of sales, you might lower the fixed rent by agreeing to pay a greater percentage of sales.

On the other hand, if you need the landlord to grant you an “exclusive” on an item you sell, you will pay for that in your rent. The more risk you shift to the landlord, the higher the rent will be. If you negotiate occupancy protections (e.g., rent reduction if the mall is empty, a right to terminate if your sales don’t hit a certain minimum), or the right to terminate the lease early if your sales don’t meet a certain target level, your landlord will hedge those risks in the rent. Also, if your landlord gives you an allowance to build your store, that’s not “free money,” and your rent will be increased over what it would have been in the absence of the allowance. Stay tuned: more info on occupancy protection and build-out allowances in future blog posts.

Numerous other factors play a role. Optimize your chances of making the best deal for yourself in the best property by working with experienced retail property professionals like brokers and other licensed representatives. And when it comes time to work through the legal issues, bring in a lawyer, preferably a specialist in shopping center law. Assembling the right team now will save you dollars down the line.

Location, Location, Location

April 4th, 2013 by

Navigating the search for a retail location comes with plenty of twists and turns. My clients wonder why certain spaces are exponentially more expensive than others, when they appear on paper to be comparable.

When it comes to commercial real estate, the old adage holds true: location, location, location. Prime location drives up the cost every time. But location, in the retail property context, is more than just where the drop pin falls.

The value of retail space depends on its sale-generating potential. It’s more than just a place to live. It’s also a key component of the success of a retail business. What sort of community does your business need to thrive?

Your primary goal is to reach consumers and maximize sales. So the most basic element of the value analysis is to identify where your market lives, works, plays. The lifespan of your business will be short unless you find and follow your customers.

Second, ask yourself which businesses you will want as your neighbors. A well-balanced, well-merchandised center will command a higher rental rate. No retailer wants to think of its business as commonplace. So a retailer’s first instinct may be to run from competition and try to find a project in which its use will be unique. But it’s wise to temper this concern by considering the concept of synergy that is created when retailers of similar goods operate within a single center. Customers like convenience, choice and comparison shopping. The per foot sales of a shopping center that boasts all three will be higher, and the rental rate, a reflection of per foot sales, will also be higher.

Then, consider who you want as your neighbors. Who are the “anchor” store co-tenants that attract your customer base? Nearly all shopping centers, large and small, are anchored by big-name retailers, supermarkets, movie theaters, businesses that are large space users and are known to bring customers to the center. To attract the big names to the center, the landlord will make sweeter deals with the anchors than are made with the smaller retailers. And the cost of the sweet deal to the landlord is passed through to the smaller tenants in the form of higher rent. But it’s a cost that is often well worth the pain. Depending on how large the big-name tenants are, their drawing power can be significant. If you are a small retailer, a relative unknown, without your own following, or you have limited advertising dollars to spend, piggybacking on the reputation and name recognition of the anchor store can be an effective way to bring customers to your door.

In my next post, I will detail a few additional elements that will increase a space’s price. In the meantime, if you have questions regarding retail real estate law, you may always contact me at eminns@eminnslaw.com.