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Occupancy Protection single

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.

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