What to Watch Out for when Leasing Retail

Over the years I have had the privilege of negotiating and executing hundreds of retail leases. In earlier days I primarily represented building owners or tenants searching for lease space. In recent years, my perspective in negotiating leases is largely as a landlord of neighborhood retail centers.

This article will highlight a few leasing issues which I believe are important to be aware of when negotiating a retail lease agreement.

Tenant Entity

Research and underwrite the tenant entity thoroughly before signing the lease. It is always preferable to obtain a personal guarantee from one or more parties executing the lease. If a personal guarantee is unable to be obtained, underwrite the corporation, partnership or signing entity for its financial strength and longevity. Frequently a tenant will attempt to execute a lease with a “shell corporation,” or in other words, a corporation which has very few assets. Such corporations are easily put into bankruptcy by the tenant with minimal impact on the primary business or operations of the tenant.

Triple Net Expenses

Triple net expenses are composed of the property taxes, insurance and common area maintenance (CAM) expenses associated with a retail property. Read the lease carefully to thoroughly understand what is included in the definition of CAM. Many national retailers will exclude management fees and other typical operational expense items in the definition, and therefore, these expense items will not be reimbursed to the landlord by the tenant. It is somewhat typical for tenants to place a cap on the CAM reimbursement increases from year to year. However, resist efforts by tenants to cap either property taxes or insurance as these expenses are not controllable by the landlord. Capping taxes and insurance may well have a substantial negative impact on the cash flow and yield of a retail center in subsequent years.

Be aware that most leases require the landlord to invoice tenants within a specified time frame at year end for operating expense “billbacks.” Failure to invoice timely will cause the landlord to forfeit his right to collect these dollars owed to him by the tenant per the lease. I have heard of one horror story in which a landlord forfeited the right to collect tens of thousands of dollars from a national retailer on a reimbursement do to the invoice not being issued timely.

Exclusivity Clauses

Be precise in the wording of any required exclusivity clauses. Vague or broadly defined exclusivity clauses can hamstring the leasing efforts of your shopping center and prevent you from leasing to quality prospects at your center.

Subleasing/Assignment Language

It is important that you understand the rights of the tenant and the landlord relative to subleasing/assignment. It is essential as a landlord that you maintain strict approval rights in the lease. I like to add language which requires the subtenant or assignee to have equal or greater creditworthiness and financial strength than that of the primary tenant in order to gain approval.

Protect your investment by preventing the tenant from subleasing or assigning to a lease prospect which will detract from your center or be in competition with other tenants.

Go Dark Provisions

A go dark provision allows a tenant to close down their business in a center even though they continue to pay rent. In the case of anchor retailers, the impact on a center can be devastating when the anchor closes down. Try to limit the ability of the retailer to go dark by offering other incentives to the retailer.

Early Termination Clauses

Many times a tenant will require the right to terminate his lease early for a particular reason. The landlord should obligate the tenant to pay a penalty for such right. A frequently used formula is to have the tenant reimburse the landlord for any un-amortized tenant improvements and commissions expended in leasing to the tenant.

Leases dictate the value of your shopping center. Before executing any lease, read it thoroughly and understand it. Failure to pay attention to the details may have substantial impact on the value of your investment.

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