Five Items a Retailer Should Have in its Lease

With long-time anchors leaving malls, urgent care clinics moving into neighborhood centers, and online sellers applying pressure from all sides, retailers should take a new approach in structuring their lease agreements with property owners, say experts from both sides of the negotiations table.

“In today’s environment, it’s very interesting. Both retailers and landlords are under a lot of pressure, most of it coming from online competitors,” said Rick Burke, president of Lease Administration Solutions, an auditing firm for tenants. “It’s a scary situation for both sides.”

Anchors such as Sears and Macy’s leaving enclosed malls set in motion a range of scenarios that affect owners and tenants. In-line retailers pay high square-footage rates and shoulder all the common area costs in order to be next to those anchors. If one of them leaves, that high-rent traffic is bound to fall off.

But anchor churn could also be good for them. Say an owner replaces an anchor with three mid-box stores paying full rent and contributing to common area maintenance costs. CAM costs would then decrease for all in-line tenants, and perhaps square-footage rate for new tenants, too. And should traffic fall off, new lessees could negotiate percentage-of-sales rents based on the traffic-building merits of the anchor replacements.

Owners are all too aware of these contingencies, and the good ones are having little trouble dealing with them, according to Ami Ziff, director of national retail at Time Equities Inc.

“We bought a mall with a Sports Authority from GGP and GGP had a new anchor store ready to take the space in case Sports Authority didn’t emerge from bankruptcy — which it, of course, didn’t,” he said. “There was just a few months’ downtime. Also, a lot of these anchor leases are very old, and the property often sees a 200% to 400% rent increase with a new tenant.”

Dick Spinell, a partner in Mid-America Asset Management Inc., reports that the worst is over in the Midwestern region, and that rents are trending upward. “The stuff hit the fan back in 2007. We had 300 mid-box vacancies. But rental rates in 2016 are close to where we were at the peak,” he said.

That said, brick-and-mortar retailers find themselves rethinking their retail footprints. Here are five areas of concern that wise retail leasing managers will be paying extra special attention to in lease negotiations.

1. Co-tenancy clauses

When the anchor you’ve paid dearly to be in the path of leaves, you need to have a clause in your lease that ensures you’re paying the right rent for what you are getting with a new anchor or anchors.

When Paul Kinney was the leasing manager for Friendly’s Restaurants some years ago, the chain had a store in a mall that lost a department store and replaced it with a Dick’s Sporting Goods. Friendly’s depended on a steady stream of female shoppers with longer dwell times than men, but Dick’s customers skewed male. To make matters worse, the mall closed an entrance in the reconfiguration and the restaurant’s sales dropped by 15%.

“There’s more to think about in co-tenancy clauses than replacement time for the lost anchor. In our case, the question ended up being, ‘Will the new anchor bring in the right people?’” said Kinney, now the executive director of the National Retail Tenants Association. “If I’m going into a lease like that today, I’m going to use stronger language. I’d ask for a consideration if my sales dropped 30% or more. It was normal to give owners a year to replace an anchor. Nowadays, I would not give them a year.”

Tenants can also ask for a percentage rent clause, in which their rent reverts to a percentage of sales should a change in the mall mix adversely affect traffic. Kick-out clauses that allow retailers to back out of their leases under such conditions should also be explored.

“This keeps the landlord incented to keep the center as viable as possible. We’re seeing a lot of new co-tenancy clauses,” Burke said.

2. Shorter-term leases

This is a trend gaining favor among property owners as well as tenants. Look no further than the local neighborhood center, where new restaurant concepts and boutique fitness centers have replaced traditional retailers in an effort to build traffic. New formats trend quickly in these segments, and owners are starting to move to shorter lease terms to give them the ability to react to new needs in local marketplaces.

Retailers, too, need to allow themselves the nimbleness to react to changing customer mixes and many are re-considering the wisdom of signing 10- or 20-year leases. “Ten years is probably the average now, but we’re seeing more five-year terms and additions of a right of first refusal,” Burke said.

3. Permitted-use clauses

Retailers can pursue this route to make leasing arrangements more flexible and adapt their businesses to the changing nature of malls and shopping centers.

Most retail leases are explicit in the nature of the business and selection of merchandise lessees can sell within their four walls.

But retailers can seek to insert clauses allowing them to sell categories that once were the sole domain of a department store or big-box category killer. A gift shop at a mall with a Sears store, for instance, might fashion a lease that would allow it to sell small appliances should Sears depart.

4. Assignment clauses

Often the fail-safe for modern retail times, assignment clauses give tenants another escape route with the awarding of the right to sublet its space or re-assign its lease.

5. Occupancy costs and caps

The rise of mixed-use developments that blend office and residential space with retail raises plenty of questions about which tenants should be paying for what attendant costs.

“I deal with many mixed-use properties, and there’s always the question of how we’re going to work this out for the retailers,” said Nancy Erickson, executive managing director of retail services for Colliers International. “If they’re in ground-floor spaces in an office or residential tower, they don’t use the elevators, so why should they pay for them?”

This is a complicated issue to resolve, because office tenants commonly pay rent, which includes taxes, plus electric while retail tenants are on triple-net leases that break out taxes, insurance and CAM costs. Erickson said that, in the case of one New Jersey mixed-use complex she represented, elevator costs were eliminated from retailers’ leases, though they continued to be responsible for CAM costs.

“What a lot of retailers are attempting in mixed-use situations is to put a cap on their insurance, real estate tax and CAM costs,” Burke said.

More new configurations and new kinds of tenants are surely in retail’s near future. Online sellers are beginning to migrate into centers. Urgent care facilities and even hospital clinics are squeezing in between PetSmarts and Sam’s Clubs. It’s imperative that lease arrangements evolve with the landscape.

“Who knows what’s ultimately going to happen with Sears and Macy’s? There’s a lot of repositioning to be done,” Spinell said. “The strong are getting stronger, and the weak are getting weaker.”