The Tangled Web of Retail Centers

My what a tangled web we weave. In real estate there is no more tangled web than the shopping center. Built on the concept of symbiotic relationships, the shopping center is a carefully choreographed mix of anchors, in-line tenants and outlots. For the center to operate, anchors such as department stores and grocery stores drive the traffic that feeds the junior tenants. Junior tenants cluster around certain anchors and other traffic-generating in-line tenants to benefit from their traffic. In the past several decades, big-box retailers have been joined by “junior-boxes,” each of which could stand alone, but buttress each other in what is commonly referred to as a “power center.” No matter the name or the size of the box, this marriage of interests is critical to the overall success of the center as a place for people to gather and engage in commerce.

While the shopping center’s success is carefully choreographed at the outset of its occupancy, its failure is similarly orchestrated in the lease, in anticipation of the fall of one or more key tenants. While anchors have leverage in occupancy, such as reduced rental rates (in some instances, virtual giveaways highly visible locations, signage rights and other financial incentives, they also have leverage in vacancy by virtue of “go-dark” clauses that provide them a right to close for business while continuing to pay rent. In this scenario, the tenants also have a weapon called the “co-tenancy” clause. This places the shopping center owner and/or lender(s) in an unenviable middle position.

This must-have lease provision for retail tenants often provides a lease termination right if the anchor or other key tenant goes dark or terminates their lease. In other instances, the in-line tenants may be able to maintain possession of their space at drastically reduced rents. Considering that the junior tenants pay the vast majority of the rent in a center, and that the anchor typically pays the least, the anchor-less center can quickly become an excuse for the junior tenants to follow the anchor out of the center or to maintain possession with drastically reduced rent, which may be just as bad. The co-tenancy clause is a bargained-for excuse for a tenant’s non-performance of their lease obligations (i.e. namely the obligations to pay rent and operate). With recent news of an ever-decreasing demand for retail space (some estimates of as much as a billion square feet going dark over the next decade), shopping center landlords across the country are facing the very real possibility that the co-tenancy clauses in their leases could provide their tenants with an excuse to turn off the rent spigot.

While many may argue this doomsday scenario is just that and nothing more than media hysteria around evolving on-line retail trends, this very scenario is written in black and white in shopping center leases. Lawyers on both sides of the transaction are hired to play out these nightmare scenarios and mitigate the risks for their clients. The parties likely contemplated this scenario the very day they signed the lease. In the current retail anchor climate, this scenario may not be as far-fetched as it was the day the lease was signed. The time is now for owners and lenders to plan for economic resilience so that the shopping centers of yesterday can quickly rebound as tomorrow’s centers of activity.

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