Synergies and Conflicts—Adapting the Retail Environment to New Uses
ICSC Shopping Center Law & Strategy Newsletter
Current State of Shopping Centers
Our legacy shopping centers are often well-located, near transportation routes, population centers and employment hubs. Post-recession enthusiasm for shopping encouraged the expansion of many retail stores and product lines, and rental rates for prime shopping locations continues to grow. Shoppers of every generation still ritualistically experience the “shopping Mall” and the “shopping Center,” with its popularity quickly evidenced by packed parking lots and frenzied back-to-school and holiday shoppers. To the casual shopper or retailer, all looks alive and well.
But is the legacy shopping center industry really that healthy? According to recent studies, visits to shopping malls have been declining for years with the rise of e-commerce and titanic shifts in how shoppers spend their money. Readers of this article might think back to the last time they visited the mall, and be surprised –was it one month ago? Three? Six? Parking frustrations, high traffic locations, and lack of time needed to traverse the mall are all factors that contribute to the shopping center concept decline.
Alongside these changes, retail developers’ appetite for growth in recent years has created a vast amount of retail space. Studies indicate that we are over-stored, with the U.S. having 23.5 square feet of retail space per person, compared with 16.4 square feet in Canada and 11.1 square feet in Australia, the next two countries with the most retail space per capita. This, coupled with declining visits to shopping centers, has resulting in declining sales per square foot. Department stores, along with middle-of-the-mall chains, are among the companies shutting down stores. Other retailers struggle with bankruptcy. Industry sources estimate that retailers need to rationalize nearly 1 billion square feet of U.S. store space to reverse the trend in declining sales per square foot.
Either there will be a “survival of the fittest,” where some centers survive, and others are entirely re-purposed, or we need to replace a substantial part of our existing GLA with other uses within many of our existing centers. If we can accomplish this successfully, the remaining retail will thrive and the new uses will command a premium for being part of the revitalized environment. This article evaluates several steps and missteps developers and other stakeholders can make in effectuating shopping center redevelopment.
Navigating the Path Forward
What does this mean for developers, and how does it affect new initiatives in shopping centers? With advances in technology and the emphasis on creating experiences for the consumer, shopping center owners are encountering new challenges and opportunities in this evolving retail landscape. As developers look to implement new initiatives that convert shopping centers into communities, they must decide if their efforts will rest in a full or partial redevelopment, and be cognizant of restrictions under land use regulations, existing lease agreements, REAs and other encumbrances on the shopping center.
A full scale redevelopment of a shopping center involves a great deal of planning and financing, as many revenue-producing agreements will need to be terminated or suspended while a wholesale reconstruction of the shopping center takes place. Initially, when identifying whether a full-scale redevelopment is feasible, developers will need to review existing lease arrangements for organic termination rights (such as an expiring lease or a defaulted lease), as well as develop strategies that encourage displaced stakeholders to give up existing rights. Further, ancillary documents like REAs or Declarations may contain ongoing access and operations requirements which will be violated when stores close, and large-scale alternate access points may be required as replacements. Financial obligations under these documents will likely continue, without any offsetting rent, so developers need to be prepared to “stay in the game” even when the parcel to be redeveloped is not benefitting from provisions within those documents. Further, local land use regulations may have greatly changed since the property was last developed, and developers will need to determine the cost and effect of new regulatory requirements as well as whether any irreconcilable “grandfathering” status is lost in the redevelopment.
A partial redevelopment focuses on upgrading or modifying certain elements of the shopping center, while keeping some or all existing operations intact. Here, we often see the obvious impediments to redevelopment (e.g., the financial and operational issues identified above) as well as some very nuanced obstacles to redevelopment that we analyze below:
Zoning Codes typically contain use-by-use ratio requirements for parking ratios (e.g. 4:100 or 1 space per 250 square feet for general retail use), but requirements may vary widely between jurisdictions. Zoning Codes sometimes provide for project-wide ratio requirements for mixes of uses, either through generally applicable code requirements or through a planned development (project specific) set of standards. Zoning Codes often allow for variances or for a “Shared Parking” analysis (engineering study) approval process allowing leniency from the general requirements. Due to the legal uncertainties whether requirements will, in application to the circumstances, provide adequate parking, it is common to privately impose specific parking standards.
Many REA forms mandate that each legal parcel “self-park” per code as well as meeting the specified standards, while others rely solely on the legal standards. A typical provision might read as follows:
“Governmental Parking Requirements. There shall be maintained at all times on the Common Area on each Parcel a number of parking spaces at least equal to the number of spaces which would be legally required for the Building sizes and uses on such Parcel if such Parcel were not benefited by any parking rights over any other parcels and no variances or exemptions from legal requirements were applicable.”
Here, any creative parking or alternate transportation incentive used to ameliorate parking difficulties would not be counted towards satisfying parking requirements, which could be a huge burden to redevelopment.
Also, as mentioned previously, the costs of redevelopment may be greatly affected by new regulatory requirements, and loss of “grandfathering” status for any demolished or dormant improvements or parcels could greatly impede redevelopment.
A shopping center developer desiring to implement a functioning greenspace or other special event area will want to consider whether restrictions in national Tenant leases prohibit such common area events. In addition to the general reluctance of developers to over-sign or designate the parking areas for certain retailers, developers may be restricted from granting such rights under the terms of any REA that encumbers an existing shopping center or existing lease agreement. Additionally, a developer needs to know what “dormant” land use requirements apply to the newly proposed use, which could include items all the way from handicap accessibility requirements to newly fashioned “walkability” requirements that might arise.
As it relates to common area promotional events, whether it be Landlord-initiated (such as the common area greenspace used for movies, concerts and other community-oriented activities) or Tenant-initiated (such as a chef-driven restaurant hosting a farmers market or a retailer using a portion of the parking areas for sales and displays), these events are often restricted and developers should refer to the same provisions set forth above and scrutinize Tenant leases accordingly, particularly when a lease has been negotiated on a Tenant’s form. Here is an example of a restriction under a retailer’s lease that would prohibit such Landlord-initiated promotional events:
“The Common Areas of the Shopping Center shall be used for parking and access in connection with business with the tenants leasing space in the Shopping Center, and for no other use or purpose whatsoever.”
Unless the developer creates an exception to the limitation set forth above that gives it the right to host and arrange special events in the common areas, this Tenant-imposed restriction will prohibit such events. In addition to lease restrictions, common area promotional events are often prohibited under any REA that encumbers an existing shopping center.
Use Restrictions and Exclusions
The prohibited use restrictions fall generally into three categories: (a) noxious or distasteful uses; (b) parking hogs; and (c) uses deemed incompatible with retail projects because they don’t generate pedestrian traffic and cross shopping. Obviously, there can be tremendous overlap.
One growing area of diversity in shopping centers is the inclusion of medical interests within the shopping center. Because medical interests are relatively new to shopping centers, medical interests may not be directly prohibited or restricted by Landlords or other Tenants of the shopping center. But herein lies a perfect example of where developers must pay particular attention to the nuances of lease and REA use restrictions and exclusions when redeveloping or inviting new Tenants to breathe life into shopping centers. While medical interests are often good credit Tenants, considering the practical aspects of a niche Tenant’s operations is required to ensure all of the affected lease or REA provisions are identified.
As an example, will the medical interest have a first-come, first-serve admittance policy with a sufficient waiting room, or is it possible that patients will spill over onto sidewalks or other common areas before being seen, thus creating a nuisance? Will the medical interest distribute drug samples or other products that could interfere with a grocery or pharmacy Tenants’ existing exclusive?
Also, when negotiating a medical interest permitted use or exclusive, Landlords and Tenants should think ahead. Will “medical office uses” sufficiently allow a Tenant to provide MRI scans or administer dialysis (now that these services are typically provided outside a physician’s office), or prohibit a Tenant from providing weight loss consulting services? For the granting of an exclusive to a medical Tenant, the same practical analysis should apply. Too broad an exclusive could prevent other specialists (whether of a traditional retail or medical variety) from locating in the shopping center, and too narrow of an exclusive use might prevent the medical Tenant from enjoying its exclusive as the Tenant’s delivery of medical services evolves over time.
How Do We Resolve Regulatory or Contractual Conflicts with Stakeholders?
There are several strategies developers can use to resolve some of the nuanced conflicts presented above, a few of which are identified below.
Pay to Play
There is considerable history in the retail industry of parties using their documented rights to extract economic concessions unrelated to the parking, roadway, circulation, visibility and similar issues initially sought to be protected by restrictive lease and REA provisions. Developers should be prepared to pay Tenants for termination rights, loss of renewal rights, loss of parking, loss of foot traffic and other concessions, as well as fronting review and legal fees for new approvals from Tenants.
Give to Get
One method of bringing stakeholders on board is to give something in order to get what is desired. Developers and Landlords should undertake review of existing agreements to determine what incentives or opportunities might be offered in exchange for a stakeholder’s cooperation. For example, does a Tenant want a designation (which can be granted) for reserved parking? Could the Tenant benefit from additional space or renewal options? Is there an undesirable Tenant next door that can be removed as part of the redevelopment? Does the Tenant want a different location in the new development, with better access to traffic?
Several localities have experimented with condemnation in the name of “public benefit” (versus traditional public use applications) to justify the removal of existing vested stakeholder rights and proceed with private or semi-private redevelopment. Undoubtedly, several of our case studies considered this option, and outcomes and even availability can vary by jurisdiction. A lengthy legal battle could follow, which developers must be prepared to undertake.
White Flint Approach
This theory relates to the recently famous court case concerning White Flint Mall in Maryland. When reviewing agreements, a common risk analysis performed is whether or not the affected party is actually damaged by the contemplated action. As such, a developer might choose to proceed with redevelopment plans despite the known obstacles, and see how far a Tenant will go in defending its rights. As to White Flint verdict, the bet was very costly to the developer, but the same may not be true for smaller Tenants.
As the above article illustrates, navigating the shopping center redevelopment arena can be extremely tricky, with developers and stakeholders often being required to move beyond traditional brick and mortar construction issues and focus upon once sleeper concepts underlying the shopping center structures.
Republished with permission. This article, "Synergies and Conflicts—Adapting the Retail Environment to New Uses," was published in the International Council of Shopping Centers' Shopping Center Law & Strategy Newsletter.