Across the country, big-box retailers are shuttering at a record pace but for landlords, that’s just the tip of the iceberg.
When a Macy’s or Nordstrom goes dark as part of a nationwide cull it continues to pay rent so landlords don’t see an immediate loss of revenue.
However, these departures create ripple effects through co-tenancy agreements, lease clauses that can allow other tenants to pay reduced rent or close completely.
Some co-tenancy agreements are tied to specific anchor tenants while others are contingent on overall occupancy rates, meaning one closure can spark a domino effect.
Meanwhile, some of the best big box replacements in today’s market — gyms and experiential retailers — have historically been barred by these clauses.
“It’s like a lawyer’s dream in the sense that there’s a lot to look at,” Gary Albrecht, a retail attorney with law firm Cole Schotz, said.
Albrecht said his practice has seen an uptick in co-tenancy clause cases as large retailers close down throughout Metro New York and around the country.
So far, 15,000 stores have announced closures this year, accounting for roughly 95 million s/f of retail space, according to data compiled by the CoStar Group, putting 2018 on track to surpass last year’s record-setting total of 105 million s/f.
Large retailers, stores that occupied 100,000 s/f or more, account for 25 million s/f of closures this year, with Macy’s, Sears, J.C. Penny and Nordstrom pulling out of struggling markets and Sam’s Club axing 63 locations. With Toys R Us set close all of its more than 800 locations, stores with 50,000 s/f or less make up 50 million s/f of closures.
“They’re getting hurt at the big end, the middle and the low end,” said Manus Clancy, senior managing director of data and research at the real estate analysis firm, Trepp. “It’s death by a thousand cuts.”
Without these large tenants, foot traffic tends to decline, leading other stores to flex their co-tenant muscles.
In Johnson City, New York, for example, both Sears and Macy’s vacated their spaces at Oakdale Mall, triggering seven co-tenancy clauses, according to Trepp. The contracts are confidential so it’s unclear what the clauses stipulate—Sears and Macy’s, in theory, could have had co-tenancy agreements regarding one another, meaning once one left the other was free to follow—but at the very least it means the remaining parties have to come to the table.
Clancy said the impact of a big box tenant depends on how well the mall or shopping center is doing.
“It’s kind of binary, if you will,” he said. “Either you’re a good mall and a big tenant leaving is not an issue or you’re the older malls, the malls considered Class B and Class C, and the minute you lose one of these guys the screws start to tighten, traffic goes down and you see other tenants start to struggle.“It’s not like these inline guys are doing great to begin with,” Manus said. “You’ve seen 15 to 20 retail bankruptcies in recent years.”
Although co-tenancy agreements are not new, Matthew Harding, Levin Management Company’s chief operating officer, said they were once exclusive to anchor tenants. Within the last five years or so, they’ve become popular requests from tenants of all sizes.
Harding said some retailers could be capitalizing on these agreements to scale down their portfolios without penalty, a reality that could make landlords reconsider co-tenancy guarantees in the future. For now, though, they have to be handled on a case by case basis.
“It’s a business decision,” he said. “At some point in time, if that store’s closure is going to have a ripple effect on the rest of the property, you may be inclined to make a concession.”
While many landlords are filling empty boxes with fitness centers, bowling alleys, movie theaters and the ever-popular Dave & Buster’s franchise, these tenants aren’t necessarily an easy sell to a disgruntled tenant that signed a lease expecting to deal discount jewelry between a Macy’s and a J.C. Penney.
“Experience-type uses were considered to be noxious or not desirable uses in the not so distant past,” Albrecht said.
“Gyms were a big no-no in the earlier part of my career because it was viewed that, on a Saturday, it’s going to take up too much parking, same goes for Dave & Busters and movie theaters.”
Aside from parking issues and the fact that experiential customers aren’t necessarily looking to shop for clothes or homes goods, alternative retailers often have different utility needs, which creates an additional sticking point for co-tenants, particularly those that have to share HVAC systems.
“A lot of times it takes time and money [to solve these problems],” Albrecht said. “You really need both because it’s not a quick process and often to get an agreement on some of these issues you need to give up some kind of allowance when a party’s next door neighbor is going to be an LA Fitness instead of a Macy’s.”