From a landlord’s perspective, the retail anchor tenant lease (the primary tenant/largest tenant in a shopping center) is the catalyst for a successful or unsuccessful shopping center.  With a great anchor, the surrounding spaces are more valuable as the adjacent tenants will have more foot traffic to draw from; thus, leading to more sales for the entirety of the shopping center.  On the flip side, anchor tenants understand this fact and will use it to negotiate advantageous lease terms to the tenant’s advantage.

Over time, the amount of negotiating leverage of a landlord vs. a tenant in an anchor leasing situation has ebbed and flowed, but generally, the age-old adage of “location, location, location” holds true, especially concerning anchor leasing.  A landlord with a property boasting significant traffic counts, synergistic co-tenancy, retail concentration in the immediate vicinity, and high average household incomes (among other things) can take more risks and can take rigid positions more frequently than an owner with inferior real estate. 

This leverage usually initially appears in the preliminary stage of negotiations prior to the drafting of a retail anchor tenant lease.  In the LOI stage, landlords, correctly, are focused on the fundamentals of the deal including rent, term, options, relative construction obligations, guaranty, maintenance requirements and other threshold issues that allow a landlord to underwrite a lease deal.  However, there are other concepts that are frequently included in anchor leases that landlords must understand in order to reserve rights to operate the property as the landlord sees fit.  

Here, we will briefly discuss the following provisions: 

  1. Co-Tenancy
  2. Exclusive Use 
  3. Operating Expenses 
  4. Continuous Operation 

While our discussion touches on these various issues and certain strategies landlords can use in negotiating, there are countless ways to address these particular issues within a lease agreement that are different from those included here.  Our goal is to give a flavor of the positions that landlord’s take on concepts that anchor tenants (and smaller tenants as well) frequently require in leases. 

Note from Spencer: This is another post in a growing section we call ‘A.CRE Legal‘. One of Texas’ top real estate attorneys, Ronald Rohde, has graciously offered to share his time, expertise, and open his library of real estate legal templates for the A.CRE audience. Click here to learn more about Ron or to contact him directly. This article is co-authored by Tim Donovan from Nelson Mullins.

Video Walkthrough of the Agreement of Lease Template

In the following video, Ron Rohde discusses anchor leasing and shares details about his Lease Template.

Co-Tenancy in a Retail Anchor Lease

In recessions, corrections and market downturns, the co-tenancy clause is a provision that many tenants turn to in order to justify paying less rent than would otherwise be due.  Generally speaking, a co-tenancy clause provides an anchor tenant with a right to reduce rent if after a certain number of months a pre-negotiated occupancy percentage is not achieved in the shopping center.  While this general comment has many variations, the purpose of this provision from the tenant’s perspective is that a tenant is entering into a lease based on a myriad of different variables, one of which is the tenant-mix in the shopping center and occupancy level.  In order to protect itself from the decrease in the occupancy or the loss of a particular tenant, tenants will negotiate a co-tenancy provision to provide a remedy in the event the landlord is unable to comply with such requirement. 

In order for a co-tenancy clause to be triggered, two main prerequisites must be present in the shopping center: (1) the occupancy percentage must be below a certain threshold (i.e. 50% of the shopping center is occupied by national tenants) and (2) the occupancy percentage breach must have occurred for a certain period of time (i.e. (1) is violated for a period of at least 6/12/24 months).  While the prerequisites seem rather simple, there is quite a bit of grey area in those two threshold questions, along with many different options when negotiating the details of the above co-tenancy requirement in the retail anchor tenant lease.

COVID-19 UPDATE

The COVID-19 pandemic provides a timely backdrop to discuss co-tenancy: Let’s assume we have a 100,000-square-foot shopping center and we are negotiating with a 40,000 sf anchor tenant, who is requiring that the landlord agree to the following provision: “In the event more than 30,000 square feet (50% of the remaining square footage of the Center) of the shopping center is not comprised of nationally recognized tenants open and operating within their respective premises for a period exceeding 6 months, Tenant shall have the right to pay to Landlord 4% of Gross Sales in lieu of Rent until such time as such co-tenancy violation is cured by the Landlord”.  While this provision, again, seems fairly straightforward when reading through it, a few questions should come to mind: 

  1. what does “open and operating” mean, does that mean during normal business hours, does that mean 7 days a week, what if the particular tenant closes for a couple days a week; 
  2. what is a nationally recognized tenant, what is the threshold between “nationally recognized” and “regional”, is it a number of locations that would push a tenant from regional to national?, is it a certain number of states in which the tenant is operating locations; 
  3. what if the tenant provides notice to the landlord that the co-tenancy requirement has been violated and begins to pay 4% of gross sales as their “rent” under the lease, how does a landlord push back on this type of allegation? 

With respect to whether or not a tenant is “open and operating”, if we just had the language provided above in our lease, it could be argued that the first prong has been satisfied when tenants were forced to close because of a government mandate due to the COVID-19 pandemic.  The second question is a real grey area.  While there are some tenants that are clearly nationally recognized (think…Giant, McDonald’s, Subway, Chick-fil-A, etc…) there are countless other regional retailers that are very well known in the Southeast, Northeast or some other area of the US, but would that constitute a “nationally recognized” tenant?  Finally, if a tenant believes that the co-tenancy requirement has been violated and begins to pay lower rent, then the landlord has a couple choices, none of which are ideal, (a) continue to accept significantly less rent until the landlord cures the co-tenancy violation by requiring the violating tenant(s) to reopen or leasing other vacant space, (b) deliver a default notice to the tenant and potentially litigate, which generally landlords are not eager to do, or (c) default tenant with the intention of negotiating a settlement between the two parties, which would most likely require some kind of concession from the landlord and/or tenant to continue moving forward with the lease.  

A carefully drafted co-tenancy provision is critical to avoid the above options for an anchor tenant. With a carefully drafted co-tenancy provision, the questions that landlords and tenants have to ask when a potential violation has occurred can be discussed and agreed upon ahead of time; thus, potentially eliminating confusion between the parties. 

Exclusive Use Clause

There are many ways to negotiate an exclusive use clause in our retail anchor lease.  At the outset, the exclusive use clause is solely a tenant-requested provision, as generally, landlords do not want to limit their ability to lease their own shopping centers, mixed-use projects or office buildings.  Practically speaking, tenant-mix is always on a landlord’s mind as leasing space to two similar tenants in the shopping center will inhibit the ability for both tenants to capture foot traffic and flourish symbiotically.  That being said, landlords do not want to have contractual obligations restraining their ability to lease their shopping center.

From a tenant’s perspective, entering a shopping center with a use substantially similar does not make sense.  As an anchor tenant, prospective tenants will require that a landlord’s ability to lease their respective properties to certain similar uses is constrained to protect the anchor tenant’s leasehold interest.  There is a broad spectrum of clauses that provide such protection but in concept a tenant wants a broadly drafted provision and landlords advocate for provisions that are specifically tailored to the anchor tenant’s primary business.  

What types of tenant use violate “exclusive use” clause?

As an example, to illustrate the nuances of this type of lease provision, let’s assume that a landlord wants to sign a new lease with a quick service sandwich operator (while this would not be an anchor tenant, for illustrative purposes we will consider this use).  As a condition to signing the lease, the sandwich shop would undoubtedly require an exclusive use clause limiting a landlord’s ability to lease to other similar sandwich shop concepts.  From the landlord’s perspective, the goal here is simply to make the exclusive use provision as narrow as possible. What does this mean?  Ideally, we would want to limit the exclusive to a specific list of tenants so the landlord is crystal clear on what concepts cannot be tenants in the respective shopping center.  So, if a landlord wants to lease to Subway, the landlord would want the exclusive to provide that the landlord “shall not lease any portion of the Shopping Center to Firehouse Subs, Jimmy Johns, Jersey Mike’s, etc…”.  On the other hand, the tenant will want their exclusive use clause to read something like: “Landlord shall not lease to any tenant or occupant whose business is primarily the sale of sandwiches for take-out or indoor dining”.  

While the Tenant’s request may seem simple enough, a problem occurs if a Panera Bread (or similar restaurant) wants to enter the shopping center, would Panera Bread constitute a tenant whose “primary” business is the same of sandwiches for take-out or indoor dining”?  This becomes a negotiated point and could cause an issue down the road if the landlord is leasing spaces in the shopping center but has to negotiate and risk triggering an exclusive use clause violation by leasing to certain tenants. 

Operating Expenses

The retail anchor tenant lease will be a form of triple net, therefore allocating operating expenses is critical. Depending on the occupancy level, management capabilities and physical layout of a shopping center, there could be various differences between owners when it comes to the collection, payment and reconciliation of operating expenses.  However, one aspect remains true: landlords desire to charge tenants for the cost of operating a property; provided such costs are consistent with the market in which the property is located.  This is especially true when it comes to anchor tenants as these large occupants require significant time and money on the part of the landlord.  

Customarily, the anchor tenant desires to pay its proportionate share (determined by dividing the total amount of gross leasable square footage of the shopping center vs. the square footage of the anchor space) of the operating expenses of the shopping center.  To limit potential exposure to high operating expenses, anchor tenants will try to limit the increases in the proportionate share of the operating expenses which the anchor tenant is required to pay.  The main way of doing this is by creating a cap on increases year over year (usually somewhere in the 3%-5% range).  From a landlord’s perspective, the goal then becomes to exclude as many costs as possible from such cap.  In general, the exclusions from this cap on increases would exclude items that are completely out of the landlord’s control such as real estate taxes and insurance; however, many times landlords are successful including further line items in an operating budget, including security and snow and ice removal. This exception from the cap can be very meaningful in a given operating year in which the costs of those certain amounts exceed the prior year; thus, helping landlords collect more pass-through expenses for the benefit of the landlord’s management of the property. Landlords when negotiating these types of provisions need to be acutely aware of the costs in which they are passing through and the line items that are generally flat on a year to year basis and/or the line items that vary greatly, so the landlord can be prepared. 

Anchor Tenant Control of CAM Charges

Alternatively, anchor tenants may require that all maintenance of the premises and the parking lot servicing the anchor tenant is under the control of the anchor tenant.  In this situation, the anchor tenant would control the maintenance, schedule all repairs and pay for any and all costs associated therewith. Consequently, landlords would need to audit all operating expenses and determine where cuts can be made from the landlord’s perspective and if there are any services that need to be shared between the anchor tenant and landlord (common area utilities being a good example of this).  

CONTINUOUS OPERATION IN RETAIL ANCHOR LEASE

The continuous operation provision is frequently negotiated in favor of the anchor tenant because of the relative leverage between the parties.  However, there are certain ways that landlords can tighten such language to make a continuous operation provision more beneficial.  

Customarily, anchor tenants will limit any express requirement to open for business and obligate themselves only to open “fully stocked, staffed and merchandised” for one (1) day.  Certainly, the tenant has a vested interest in opening at the premises and operating within the premises for normal business hours, as the tenant needs to generate sales in order to pay the landlord the necessary rent.  However, only being obligated to open for “one (1) day” allows the tenant maximum flexibility with respect to their day-to-day operations along with providing the tenant the ability to “go dark” (i.e. to close the store to the public).  

The alternative of the above-referenced provision is a strict continuous operation clause, which would read similar to the following: “Tenant shall open fully stocked, staffed and merchandised within [thirty (30)] days after the [Commencement Date] and each and every day thereafter”.  This is very rarely agreed to by anchor tenants as it provides no flexibility to close for renovation (although this would usually be covered somewhere else in the lease) or to close due to the fact that the tenant is losing money in the location by continuing to operate (among other things).  

Go Dark Provisions

Thankfully for landlords with “go dark” provisions in anchor leases, these provisions do not generally excuse the payment of rent. That said, landlords do not want dark storefronts in a shopping center as occupancy drives traffic and a shuttered anchor will inevitably hurt the other smaller tenants. To combat this concern at the lease negotiation, the main option is a “recapture” right in favor of the landlord following a tenant closure.  This recapture provision would essentially provide that in the event a tenant is not open for business for a finite amount of time, the landlord will have the right to take over the space (i.e. recapture) the space using any applicable legal rights or using certain highly negotiated provisions associated therewith, which may include a monetary payment by Tenant to Landlord.  

Conclusion

Landlords negotiating a retail anchor lease should understand how and why the Anchor Lease varies from a typical retail lease. The division of negotiating leverage is the main difference and savvy landlords should carefully review the lease before entering into any agreements. Be sure to comply with all terms to avoid a costly landlord default. We’ve discussed the 4 biggest areas for concern and ways to produce creative solutions for each.

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Version Notes

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About the A.CRE Legal Contibutor: Ronald Rohde has over ten years of legal experience with real estate transactions, leasing, and investment. He received his undergraduate degree from Cornell University and his juris doctor from the University of Miami.