What Are Landlords Thinking?
[This article was originally published in the National Retail Tenants Association publication “Tenants In-Common” in July 2019.]
Ever wonder just what landlords are thinking? I know I have. Probably most anyone who has negotiated a lease, conducted an audit, or been in a dispute with a landlord has, too.
To help answer this question, at this year’s upcoming NRTA conference we have assembled a diverse panel of in- house finance, leasing and legal executives from developer/landlord companies with years of experience developing, leasing, and operating retail, office, and mixed- use properties of all sorts. This article is a sneak peek into some of the questions we’ll probe with our landlord panel to try to understand the landlord’s perspective. While sometimes the interactions between landlords and tenants seem like a zero-sum game, we need each other for our respective businesses to thrive. A better understanding of the landlord’s concerns can help tenants more successfully navigate and resolve issues in lease administration, audits, disputes, and negotiations.
During the landlord panel session, we will explore some of the following issues.
Getting to Know You
Besides some of the more specific questions and topics outlined below, in order to better understand the landlord perspective, we will ask them to help set the stage for deeper understanding by addressing some foundation questions such as:
- What are some of the key things you think tenants don’t know or misunderstand about landlords and their concerns?
- What do the next five years look like for malls, strip centers, office projects and mixed-use developments?
- How will the changes affect the way you approach relationships with tenants and their lease administrators, lease negotiators, and deal makers?
- How do you expect changes in retail, office, and mixed-use to affect occupancy cost expenses?
- Where are there opportunities for landlords and tenants to work togethermore effectively?
Changing Industry Landscape and the Opportunity to Reinvent-Together
If change is constant (and it is), then smart retailers will be looking ahead for opportunities to evolve. In response to online competition, the closure of a growing number of big box stores, and landscape shifts from direct and indirect competition, landlords and tenants are trying to reinvent malls and other centers, as well as individual store design and operations. Tenants and landlords must approach these issues from two perspectives: (1) how to evolve properties and operations under older existing leases that did not contemplate the current changing environment and (2) how to plan for future centers by drafting and negotiating new leases that address the issues reflected in today’s market, as well as anticipating opportunities for flexibility and potential risks that industry and societal changes have yet to reveal. What are the primary concerns this raises for landlords? How can landlords and tenants approach these changes and challenges in a cooperative and mutually beneficial way? After all, ultimately, the relationship should be a symbiotic one.
Tenants, business operators, employees, and customers want to use centers and projects in new ways. More non-tradi- tional tenants, as well as entertainment tenants, now occupy space in traditional retail centers. For example, fitness clubs, medical offices, educational facilities, game operators, and theme restaurants are growing in popularity in “retail” centers of all kinds.
Many lease forms include antiquated lists of prohibited uses that have not been updated in decades. How can we take a fresh look at traditional use restrictions and better reflect what makes sense in today’s environment? As retailers and others create experiential or hybrid uses (think cafes in banks), how do centers and retailers come to terms on what’s considered a competitive or complementary mix of tenants?
Many new types of users (e.g., medical, financial, and cannabis operations) want to move into established centers.This can raise concerns for existing (more traditional) retail users. How can landlords respect current tenant needs and maintain flexibility as space requirements and users evolve over time?
Are there creative options for addressing the new challenges regarding noise, odor, and hours of operation, to name a few, in a mixed-use environment?
When tenants clash with each other, what role can a landlord offer in resolving conflicts regarding issues such as parking, permitted uses, and hours of operation?
Convenience, Community, or Conundrum?
As retailers search for new approaches to compete with online sellers, they are creating operations that can challenge the historical retail tenant model. Innovations include in-store internet kiosks and interactive digital ordering options, as well as in-store pick up of internet purchases and delivery of merchandise, which can turn rent formulas for “in store sales” on their head. These hybrid models also challenge traditional thinking about customer flow, parking requirements, foot traffic expectation, and many other factors previously taken for granted. Does your landlord see this as a joint opportunity or a source of contention?
Retailers, including fairly traditional retailers, are ramping up excitement for customer engagement with all kinds of community outreach, such as displaying murals by local artists and adding nontraditional services, as well as public engagement activities, including experiential shopping, live and recorded music and videos, game and activity spaces, and even food trucks. What concerns do these activities raise for landlords? Will your great promotional idea be allowed?
Some flagship stores are becoming as much—or more—about branding and promotion as they are about sales from the store. Is this necessarily bad from a landlord’s perspective? How can that be a win-win for the property as a whole?
Retailers are being pinched financially, being asked by landlords or required by market changes to invest in an upgraded shopping experience—refreshing stores, adopting new technology, etc. How can landlords and tenants work together better to respond to these pressures?
With all the changes in the retail and real estate markets, old ways of looking at things may no longer make sense. What data points are landlords capturing regarding foot traffic, demographics, sales trends, effective store operations, and so forth? And how are they analyzing and using that information for more strategic decisions?
Office Use Impacts Also Evolving
Office tenants are shrinking square footage per employee. Both office and retail tenants want buildings with more flexible floor plans that can be configured into more productive spaces and can more easily evolve over time. What concerns does all this raise for landlords? What are they doing to address these changing tenant needs and expectations?
For office space, there are two somewhat competing trends that will affect the demand, use, and value of real estate in ways that are difficult to predict: (1) the movement toward more shared spaces and less square footage per employee and (2) the expected continued increase in employees working remotely. How are landlords planning for these trends?
How Should Occupancy Cost Be Fairly Allocated?
When users have wildly different levels of utilities usage or impact on center services and amenities, how can landlords fairly allocate costs among tenants? It’s becoming more complex. We’ll ask our landlord panelist what they are doing to address these issues, as well as related questions such as:
- What are some particularly difficult things to properly allocate between various retail and office tenants in mixed-use properties?
- How should costs to modernize, repurpose, and reconfigure properties into mixed-use be handled?
- If expenses are being commingled between different types of uses, portions of a project, or ownership entities and passed through, should the tenant have a right to review all applicable expenses?
- Why are administrative fees so high? Why should they apply to things like real property taxes and insurance?
- As a landlord, do you see a continuing trend toward (or away from) fixed CAM? In what ways can fixed CAM be good for landlords or tenants? How can tenants be confident that landlords will apply sufficient resources to properly maintain a center with fixed CAM?
- In a fixed CAM scenario, what’s the justification for a fixed rate of annual bumps that exceeds historic Consumer Price Index increases?
- Are contingency fee auditors necessarily bad for landlords?
Transportation and Parking
Calculations of parking needs may look very different in coming years with the competing forces of (1) higher density users, in both retail and office settings, and (2) increases in ride-sharing, the push for housing near public transit and work centers, and the future impact of driverless cars. How will landlords suggest approaching these changes?
What are landlords doing to balance new demands by some users for parking and pick up lanes, including for online orders, with the parking needs of others in the center?
Can We Live Together? Co-Tenancy and Exclusive Uses
What challenges do landlords face in interpreting and applying co-tenancy and exclusivity provisions as a result of the blurred lines and integration of retail, office and various combinations in mixed- used projects bringing diverse business operations of occupants?
Are landlords approaching co-tenancy and exclusive language differently now in new leases? Are they approaching rent reduction and other remedies differently? Are they more reluctant to give co-tenancy and exclusive use rights?
What trends are landlords tracking related to replacement users for vacated anchor and big box spaces? Do the traditional definitions of an “anchor tenant” and “retailer” still resonate in today’s market?
Why should tenants have to show “damage” to get rehef following a co-tenancy failure or exclusive violation? If required, how should “damage” be measured?
Why should reduced rent have a “sunset” date?
The Decline of Percentage Rent
Is percentage rent still an appropriate economic model? Changes in retail operations and space usage are also raising questions about what ought to be considered a sale from the premises for purposes of percentage rent and even about whether percentage rent makes sense at all in the new retail environment. Consider these examples:
A customer orders merchandise online and selects the option of picking up the purchased item at a particular store or the retailer elects to ship the item from a store rather than a warehouse. Should that sale be counted in determining percentage rent for the store?
What about a purchase made from an instore internet kiosk but shipped directly to the customer from a warehouse in another state?
Should internet sales ever be considered part of “Gross Sales?”
As landlords and tenants look for new ways to use underutilized or vacant spaces, they may well need new approvals from cities and regulatory agencies and may face new regulatory requirements. What are landlords’ experiences navigating zoning, use and code compliance issues for new uses or higher-density uses? Do these evolving uses trigger greater parking requirements or fire and building code upgrades?
What kinds of things are landlords doing in conjunction with tenants to fully investigate, evaluate and address land use restrictions and approval requirements, as well as possible code compliance issues and responsibilities?
Risky Business: Insurance and Casualty Damage
Why do so many landlord lease forms use outdated insurance references that have not been used in the insurance industry for years (e.g., all risk insurance)?
Surely landlords know that national and regional retailers carry coverage under blanket insurance policies and make company-wide insurance coverage decisions. Why do landlord lease forms so often include tenant insurance requirements that are not consistent with the coverage decisions these retailers are likely to make?
Why should a landlord’s repair/restoration obligations following a casualty be limited to insurance proceeds (especially if the landlord is responsible for carrying the insurance)?
Timing is Everything! Terms and Exit Strategies
With uncertainty in the market, many tenants are reluctant to commit to long terms and are seeking early termination rights. What trends are landlords seeing in length of lease terms, options to extend, and early termination rights? What length of term do they prefer? Why do landlords seek to limit extension options and early termination rights to the original tenant?
Changes in business operations and space usage in office buildings, retail centers and, especially, in mixed-use projects present significant challenges for landlords and tenants, but they also present exciting opportunities. And many issues—old and new—in negotiating leases and resolving disputes with landlords will always be with us. Gaining a better understanding of the landlord’s concerns and perspective will help tenants arrive at mutually acceptable and beneficial results in their dealings with landlords. Don’t miss this opportunity to learn what landlords are thinking.