A typical retail shopping center or mall operates based on a well-established business model. The owner or developer of the property first attracts one or more “anchor” tenants and then surrounds them with various smaller tenants who benefit from the traffic these anchor stores create. Together, the anchor tenants and supporting businesses create a mutually beneficial ecosystem that aims to deliver a pleasurable shopping experience for all visitors.
The Anchor-Tenant Ecosystem
To illustrate how this ecosystem works, consider two classic retail examples: a shopping mall and a grocery store-anchored shopping center.
In a typical shopping mall, the anchors are department stores like Macy’s, Nordstrom, or Neiman Marcus. These stores possess a significant draw on their own, attracting foot traffic that can benefit surrounding smaller stores. Consequently, the rest of the mall is filled with tenants like clothing stores, electronics shops, and food courts that capitalize on the traffic generated by the department stores. This synergy creates a coherent shopping experience that entices visitors.
The same principle applies to a grocery store-anchored center. A notable grocer like Publix or Safeway provides the primary draw, while nearby tenants gain from the foot traffic generated therein. These surrounding businesses may include coffee shops, nail salons, bank branches, and fast-casual restaurants. Together, they enable shoppers to quickly complete their daily errands without leaving the center, presenting a convenient and time-saving value proposition.
The Risks of Tenant Departure
However, like any ecosystem, the departure of one or more tenants can negatively impact the entire retail center. Thus, many tenants seek to negotiate the incorporation of a “Co-Tenancy Clause” in their lease agreements.
What is a Co-Tenancy Clause?
A Co-Tenancy Clause is language in a retail lease that offers rent relief or other remedies to existing tenants if the “ecosystem” deteriorates after several tenants vacate the property. To continue our previous example, consider a grocery store-anchored center featuring Publix as the anchor tenant, with various supporting businesses like a coffee shop, nail salon, stationary store, smoothie shop, quick-service restaurant, and shipping supply store. The nail salon and stationary store rely heavily on the foot traffic generated by the grocery store. Therefore, they may wish to include a co-tenancy clause in their lease, stating that if the grocery store were to leave, they would receive a significant rent reduction to offset the loss of business.
Understanding the Co-Tenancy Clause
By its very nature, a Co-Tenancy Clause contains complex legal language. Consider the following excerpt from a co-tenancy clause in a retail lease:
“Continuing Co-Tenancy. Notwithstanding anything to the contrary contained herein, in the event less than sixty-five percent (65%) of the tenants in the Shopping Center, excluding the Premises, are open and operating… Tenant’s duty to pay Minimum Rent shall be suspended from the one hundred eighty-first (181st) day after such closing occurs until the Co-Tenancy Requirement is met.”
This contains several key components:
- Co-Tenancy Threshold: This threshold dictates the conditions under which the tenant can invoke the co-tenancy clause. In the example above, the threshold is set at 65% of tenants being open and operating.
- Cure Period: Often, property owners may be granted a cure period during which they can attract new tenants to meet the co-tenancy threshold. Here, the cure period is defined as 180 days.
- Relief: The co-tenancy clause specifies what relief is available if the threshold is breached. In this case, tenants may receive reduced rent and the option to terminate their lease if the issue persists beyond a year.
Co-tenancy clauses are generally favorable to tenants, but their negotiation can depend on the leverage they possess during negotiations.
Considerations for Property Owners
From a property owner’s perspective, there are inherent risks associated with allowing co-tenancy clauses in tenant leases. The potential for a “spiral effect” exists when an anchor tenant departs or the occupancy level drops below the threshold, which may prompt multiple tenants to seek relief at once, driving the vacancy rate higher. This situation could threaten the property’s Net Operating Income and, in a worst-case scenario, lead to default on loans.
To mitigate these risks, property owners often insist upon several stipulations:
- Default Clause: The co-tenancy clause may specify that a tenant cannot invoke it if they are in default on their lease.
- Proof of Harm: Property owners may require tenants to substantiate claims of loss or diminished sales related to the vacancies, potentially demanding documentation like tax returns or operating statements.
- Limitations on Remedies: Owners may wish to restrict the number of remedies available under co-tenancy clauses to limit exposure. For example, a tenant’s remedies could be reduced to just a rent concession without lease termination rights.
In exchange for permitting a co-tenancy clause, property owners might seek concessions from tenants such as increased fees or restrictions on types of businesses that can occupy empty spaces.
Summary and Conclusions
In summary, the mix of tenants within a retail shopping center typically revolves around creating an ecosystem that enables smaller tenants to thrive alongside one or more anchor tenants. Should an anchor tenant depart or the overall occupancy dip, the remaining tenants may face significant business challenges. To shield against these risks, tenants often negotiate for co-tenancy clauses in their leases.
A co-tenancy clause allows tenants to seek rent relief or other remedies if occupancy falls below an established level. While these clauses benefit tenants, property owners may include stipulations to mitigate their exposure.
