As you consider the best locations for your stores, nearby businesses are key site selection factors that impact how they may perform. This applies to every facility, but it’s especially important in shopping centers, where neighbors don’t simply bring traffic to your trade area, but right to your door.
The presence or absence of quality co-tenants completely changes a site’s potential. Whether shoppers have to travel through the common area to access stores or each business has exterior entrances and exits, your co-tenants generate foot traffic, some of which spills over to your business. And when a co-tenant is a complementary business, serves the same demographics, or is especially popular, it amplifies the benefits of sharing a facility with them.
Any time a facility you’re leasing has multiple tenants, co-tenancy needs to play a role in your negotiations.
Empty storefronts or an incorrect tenant mix hamper a retailer’s ability to maximize their investments. Retailers who want to attract new customers to increase sales growth and who are mall or strip-center based and rely on heavy foot traffic to attract new clientele are directly affected by a center’s occupancy. As such, it is critically important for these retailers to negotiate advantageous lease language surrounding co-tenancy.
In this article, we’ll discuss:
- What a co-tenancy clause is
- Why co-tenancy is especially crucial for retailers today
- How to get your co-tenancy language right
- Examples of co-tenancy clauses retailers use
Let’s start by looking at what this clause contains and what it does.
What is a co-tenancy clause?
A co-tenancy clause is a section of a commercial lease agreement that defines how the lease will change if specific co-tenants or a predetermined percentage of them leave before the lease term ends. It may provide a path for you to terminate the lease or pay reduced rent.
When you sign a lease, you agree to rent the location for a specific price based on its current condition. Co-tenancy clauses offer a layer of protection to tenants in case that condition changes.
Your co-tenancy clause may name specific co-tenants, or it may simply take effect based on the facility’s vacancy. For example, if you and a popular business like Nike have stores in the same mall, your co-tenancy clause may name Nike since they’ll undoubtedly attract a lot of traffic, and their absence would have a significant impact on the site’s potential. Alternatively, the co-tenancy clause may trigger when 50% or more of the stores are vacant. (The percentage depends on your negotiations.)
Some co-tenancy clauses may be for a specific period, such as an opening co-tenancy clause (for when a tenant leases a location at a brand-new or recently renovated shopping center) or an initial co-tenancy clause (for when the tenant is new to the location).
If a co-tenancy clause is intended to last for the duration of the lease and isn’t connected to an event like an opening, it may be referred to as an ongoing co-tenancy clause or an operating co-tenancy clause.
Why co-tenancy clauses are critical for retailers
Imagine paying full price to be the only store left in a once-bustling strip mall with 10% of the foot traffic it had when you signed the lease. You’d feel duped. However, a good co-tenancy clause ensures you have some lease flexibility if the marketplace sours.
This is especially important right now. In the wake of the COVID-19 pandemic, retailers have been closing far more frequently as they adjust to this new era of consumerism. In other words: you’re a lot more likely to use a co-tenancy clause today.
You want to be in a shopping center that has traffic. If half the shopping center is empty because your co-tenants have moved out, the potential traffic is far lower. There’s less reason for people to be there—and less reason for your business to be there, too.
The presence of a popular co-tenant like Nordstrom may have been one of the factors that led you to select the site in the first place. And in your site selection software, you would’ve based your trade area analysis and sales forecasts on the traffic your co-tenants have been generating. As co-tenants come and go, it could significantly alter your location strategy.
Keys to a favorable co-tenancy clause
Depending on how they’re negotiated, a co-tenancy clause can favor the tenant or the landlord. Your landlord wants to decrease flexibility and increase profits, and you want to increase flexibility and decrease costs.
Unless you have leverage, you may have to sacrifice in other areas to get favorable co-tenancy terms, but if you focus your efforts on the terms that matter most, you can ensure your business has the protection it needs.
Here are four key areas a retailer should focus on.
1. Opening Co-Tenancy
The best way to ensure a strong grand opening in a new center is a mall that is substantially occupied. An Opening Co-Tenancy provision will allow for reduced rent in the event that mall occupancy is below a pre-determined percentage. While most common for new centers under construction, opening co-tenancy provisions can also be found in centers undergoing renovation or repositioning.
2. Operating Co-Tenancy
Once a store is open, an operating (or ongoing) co-tenancy clause ensures full rent is paid only when the center remains substantially occupied. Again based on a negotiated percentage, an operating co-tenancy provision helps protect tenants in the event of a decline in overall mall occupancy.
3. Key “Anchor” Tenants
Certain high-profile tenants are often considered anchor tenants and, in some cases, contribute disproportionally to the success of the center. Commonly a department store in a regional mall or a grocer in a strip center, key tenants drive significant traffic to the center. Lease provisions incorporating named anchor tenants typically invoke an alternative rent structure if an anchor tenant goes dark.
4. Replacement Tenants
While mall occupancy is always changing, it is imperative that the types of tenants (and mix of specialties) occupying a mall remain consistent to draw the appropriate customer base. Without a replacement tenant provision, landlords could choose to replace retail tenants with medical, office or other non-traditional retailers that would not attract the same foot traffic. In this case, conditions on replacement tenants can be agreed upon to ensure appropriate businesses are being selected as replacements.
Identification of a co-tenancy violation is often a difficult undertaking since it is incumbent upon store staff and regional management to note closures and keep the corporate office informed. Once a co-tenancy violation is noted, a landlord will have a defined cure period in which they can provide a replacement tenant to fill the vacancy. It is only upon an unsuccessful cure where a remedy can be invoked.
Remedies typically are one of three categories:
1) Rent Abatement: A reduction in fixed rent or a change to percentage rent are two common rent abatements. In both cases, the tenant’s cost to operate the store is reduced.
2) Lease Termination: While not very common, some co-tenancy provisions allow the tenant (or landlord) to terminate the lease as a result of the co-tenancy violation.
3) Delayed Opening: This violation only applies to opening co-tenancy provisions. It allows the tenant to delay their store opening until a certain occupancy percentage is reached in the center.
A retailer’s ability to insist on one or more co-tenancy elements is largely related to their negotiating leverage as a tenant. While tenants with greater brand recognition and national presence are more likely to achieve positive results, co-tenancy is something all tenants should attempt to negotiate into their leases.
While negotiating a favorable co-tenancy provision is important, equally imperative is having a lease administration system that is able to monitor and take action against co-tenancy violations. Types of co-tenancy, anchor tenants, key dates, and alternative rent terms are all critical elements that need to be captured in the system.
Example of an effective co-tenancy clause
It’s one thing to know what a lease clause should contain and what it’s intended to accomplish, but it’s another to know what it should look like. You have to translate your intentions into real estate legalese. We have two examples to help you prepare your own co-tenancy clause. One is an initial co-tenancy clause for leasing a new location, and the other is an ongoing co-tenancy clause for your established stores.
Initial co-tenancy clause example
As used herein, the “Initial Co-Tenancy Condition” shall mean, collectively, that both (i) [Tenant name] (or a Replacement Tenant, as defined below, for either or both of such named tenants) is open and operating in the Shopping Center and (ii) a national or regional “chain” store tenant typically found in first class shopping centers in the State of Massachusetts and containing at least 23,000 square feet of Floor Area (excluding the Premises) is open and operating (or if not open and operating, then such tenant is actively and continuously fixturing and merchandising its premises in anticipation of opening for business).
For purposes hereof, a “Replacement Tenant” shall mean a national or regional “chain” store tenant typically found in first class shopping centers in the State of Massachusetts and containing substantially the same amount of Floor Area as the tenant whom the Replacement Tenant is replacing.
If, on the Delivery Date, the Initial Co-Tenancy Condition has not been satisfied, Tenant shall have the right, at its sole option, to:
(a) accept delivery of physical possession of the Premises; or
(b) defer its acceptance of delivery of physical possession of the Premises to a later date (but not later than the date on which the Initial Co-Tenancy Condition is satisfied and Tenant receives notice from Landlord thereof), whereupon the Delivery Date shall be deemed to have occurred on the date that Tenant actually accepts physical possession of the; and
in either event, if the Rent Commencement Date occurs before the satisfaction of the Initial Co-Tenancy Condition, Tenant shall be entitled to pay Alternate Rent in lieu of Fixed Rent (but Tenant shall pay its Pro Rata Share of all other Additional Rent) until the Initial Co-Tenancy Condition is satisfied and the Landlord gives Tenant notice thereof.
If the Initial Co- Tenancy Condition has not been satisfied by the first (1st) anniversary of the Delivery Date established pursuant, then Tenant shall have the right, exercisable within one hundred twenty (120) days after such first (1 st ) anniversary of the Delivery Date, to terminate this Lease as of the date specified in said notice, such date not to be later than ninety (90) days after the date of the termination notice. Landlord may negate such termination by causing the Initial Co-Tenancy Condition to be satisfied within thirty (30) days after the date on which said termination notice is given. If this Lease is terminated hereunder, neither party shall have any further liability under this Lease, except for those obligations which survive the expiration or other termination of this Lease pursuant to the express terms of this Lease.
Ongoing co-tenancy clause example
If, at any time during the Term of this Lease, TJ Maxx (or a Suitable Replacement Tenant(s) [as hereinafter defined] in lieu thereof) is not open for business to the general public (such condition being hereinafter referred to as an Excess Vacancy), then in such event, Tenant shall have the right to: (i) pay Alternate Rent in lieu of Fixed Rent during the period of such Excess Vacancy, and/or (ii) if the Excess Vacancy continues for a period in excess of three hundred sixty-five (365) continuous days, to terminate this Lease, exercisable by giving Landlord, within ninety (90) days after the expiration of such 365 day period, at least sixty (60) days prior notice, in which event this Lease shall terminate on the date set forth in Tenant’s notice of termination without further liability on the part of either Landlord or Tenant. If Tenant does not terminate this Lease, then commencing on the expiration of the aforesaid 90-day period, Tenant shall resume paying full Rent, provided, however, that commencing one hundred eighty (180) days after the expiration of the aforesaid ninety (90) day period Tenant shall: (x) again be entitled to exercise its rights each time the then existing condition of Excess Vacancy worsens; and (y) retain all of its original rights with respect to any future condition(s) of Excess Vacancy. As used herein, the term “Suitable Replacement Tenant” shall mean any of the retail businesses set forth in Exhibit O hereto, provided it is operating in the premises currently occupied by [Tenant Name], which Suitable Replacement Tenants shall be subject to the provisions of this Lease. Notwithstanding the provisions of the preceding sentence, a Suitable Replacement Tenant shall not be required to be subject to the provisions of this Lease in the event such Suitable Replacement Tenant is an assignee or subtentant pursuant to an Existing Lease, unless the provisions of such Existing Lease requires Landlords consent (which may be withheld in Landlords sole discretion) to such assignment or subletting.
Take advantage of co-tenancy with Tango Lease
Tango Lease is a comprehensive lease administration and accounting solution used by businesses around the world. This all-in-one lease software includes a suite of more than 40 unique lease reports to help you analyze and organize your real estate portfolio. These reports make it easy to isolate specific information across your portfolio—including co-tenancy clauses.
Tango Lease’s Co-Tenancy Summary provides a list of your co-tenancy obligations organized by lease, and includes key details like your co-tenants for each lease. As you weigh your options and plan your next move, Tango illuminates the possibilities.
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