Trends in Leasing Arrangements
What’s new with lease arrangements in 2019? The axiom of real estate lawyers is “nothing is ever really new.” But there are trends that are the focus of negotiations. Here are a few that we are seeing:
Downsizing. While not a specific lease arrangement, there is a definite trend toward a smaller footprint for stores. Clients who used to want 40,000 sq. ft. are finding ways to adjust to 18,000 sq. ft. This has an immediate impact across the board, including store layouts, stock rooms, and the simple ability to negotiate.
When searching for new locations, it has also become common to break up larger spaces. Tenants have a more creative view of taking only a portion of an existing larger space. And landlords seem far more willing to consider installing demising walls, revamping entrances and facades to accommodate smaller spaces. That means the old “big box” might now be three or four small shops. Though it takes imagination, ingenuity and some re-engineering to pull it off. Many of our new deals include an aspect of re-demising an old, larger box.
In-Depth Exclusivity. As stores have grown smaller, there has been a renewed focus on product lines. With limited space, product offerings are necessarily limited. With fewer categories of product on the shelves, there is a need to protect product lines more so than ever. A by-product of these protections is an elevated awareness of potential covenant violations within the center. We see complaints being made by the managers of stores about neighbors far more often than in the past.
Percentage Rent Provisions. While not new in concept, utilizing percentage rent — with lower base rent and higher percentage rent — is on the rise. Arguably in response to entice retailers in space in centers, the cost of entry is lower. With lower rent comes lower breakpoints. But it seems in exchange for lower rent, landlords hope to drive a higher return on their Percentage Rent clauses.
Mutual “Kick-Out” Clauses. Traditionally, it was not unusual to see either a tenant or landlord with a termination provision in a lease. Typically based upon a sales benchmark, and depending on the situation, usually only the tenant had the right to terminate. These clauses have now become more often a mutual right – where both sides have a right to terminate, based upon sales and other factors particular to the situation. However, this is not a continual right. It is usually a specific time – maybe three years into a five-year lease. Also, if the landlord terminates, most tenants will strongly resist a recapture of any tenant improvement allowance.
Fixed CAMs / Gross Rent. In shopping center leases of yore, the CAM was whatever the “pass-throughs” proved to be. More and more, we see a “fixed CAM”, or sometimes a simple gross rent approach is being utilized. It eliminates the need for audits and challenges, and provides certainty to both sides.
Audit Rights / Limitation on CAM Look-Backs. When there is not a Fixed CAM in place, audits of CAMs have become a common expectation. This is at least partially driven by the cottage industry of CAMs-audit firms, often operating on contingency. As a furtherance of the reaction to the often long-range, multi-year CAM audits now seen, many leases now limit audit rights to one or two years. Otherwise, the only limitation is the applicable statute of limitations for written instruments in the state that governs the lease. A few states allow fifteen years or more for recovery of old payments, which has been an unpleasant surprise for certain long term occupants of centers.
Revisiting Lease Terms. In the current era, it is hard to talk about lease provisions without mentioning the current trend of successfully renegotiating current leases with lower rent. A phenomenon, that was largely unheard of before 2010. But given economic realities, it has become far more typical. Though still far from a happy bargain by a landlord. In trade for reduced base rent, some of the typical negotiating chips are extended terms, increased percentage rent, “re-allocation of rent” (lower now, higher escalation “bumps” later) and reduced square footage. Restructuring current leases has for some retailers reached a level of importance equal to that of new store development.
Tenant Improvement Allowances. As the competition for tenants has sometimes become fierce, with too often limited tenant interest for space, concessions have become more typical. Perhaps the most common of these are amounts available for tenant improvement allowances. Although such allowances have increased, the interest factor utilized as a part of the determination of rent has fallen. This was once a “profit center” for landlords — they could pass through an amortized expense plus a 10% – 15% return on the TI allowance given to a tenant. Whether it is the pressure to provide space, or the need to revamp and reconfigure space, this rate factor has come closer to the cost of borrowing over the past several years.
Also, between 2009 and 2011, landlords were asked to somehow secure TI allowances through escrow deposits, guarantieTrends in Leasing Arrangementss or Letters of Credit. But is now rare to win such concessions from a landlord.
Lease Guaranty. Perhaps it is purely anecdotal, but a request for a lease guaranty has seemingly become a more typical requirement. This means a financially solvent backer in each transaction. However, limitations, such as a rolling lease year, or “burn offs” after several years (where the guaranty is released) are often the trade-off given to stronger tenants who perform well.
Self-Branded Merchandise. One area of growth seems to be in self-branded merchandise, or “merch.” T-shirts, hats, almost anything with logos. While it is an additional product line, consideration has to be given to use clauses and restrictive covenants in favor of other tenants.
As the economy continues strong, retail will follow suit. Yet to remain competitive requires ever-changing focus, and staying ahead of the competition. The same as it ever was. Maybe nothing ever is really new.
Steve Kirkham is a partner at the law firm of Waller Lansden Dortch & Davis, which is based in Nashville.
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