What Tenants Are Asking of Their Landlords in Challenging Economic Times

The current economic slowdown has been particularly hard on the retail industry. Operating retail stores in times of economic uncertainty has placed most real estate professionals in uncharted waters. Tenants are looking to their landlords for economic relief to meet the challenges of operating their stores without incurring unacceptable losses during these turbulent times. This special issue of Commercial Leasing Law & Strategy discusses difficulties arising in the context of retail leasing.

No matter how strong a retailer's business, all tenants are concerned about the state of the economy and the considerable decline in retail sales in almost every sector of the industry. Tenants are asking their landlords for assistance so they can weather the storm. Many tenants need immediate relief and are frequently finding that their landlords are willing to work with them on various rent concession proposals and other lease modifications.

This article provides an overview of what tenants are asking for from their landlords, including base rent and additional rent reductions and other lease modifications relating to operating covenants, use restrictions, exclusives and transferability. Many of these issues are relevant to lease renewal negotiations as well as new lease negotiations. Rosie Rees' article  examines the strategies that retail landlords and tenants can utilize to keep the tenant in the premises and the rent coming in. Mark Morfopoulos' “In the Spotlight” (discusses how to utilize a lease audit to add value, and Ira Fierstein's article  outlines some procedures landlords should make certain they follow so that they are protected in case replacement tenants follow the footsteps of their predecessors, shut down operations and bail out before expiration of the lease terms.

Existing Leases and Rent Reductions

Base rent relief to help tenants weather current economic conditions is the most sought-after lease modification in today's economy. Many strong tenants are preparing for a two- to three-year cycle with stagnant retail activity and are trying to protect their cash and risk of continued high base rent obligations during this period of reduced sales. Armed with gross sales results, as well as comparable figures for prior years, tenants can provide persuasive evidence to landlords that a base rent adjustment is necessary in light of current sales volume. Many landlords are receptive to reducing base rent and tying this rent into a certain percentage of gross sales until the tenant's gross sales exceed a certain minimum threshold. Tenants are agreeing to return to full base rent, or some other fixed amount, when their gross sales return to a certain agreed-upon minimum. Where a tenant leases several stores from the same landlord, most discussions relate to the entire portfolio, not just the under-performing stores. Tenants who are open and operating are important assets to their landlords and create value for their landlords' lending relationships. Thus, healthy tenants can make a persuasive case that they warrant some relief in light of changed market conditions. Many landlords are lowering base rents, albeit for widely varying periods of time. Many tenants are seeking two- to three years of base rent relief, and are prepared to renegotiate percentage rent breakpoints to reflect recent sales. When sales return, in addition to base rent returning to prior amounts, many landlords require the tenant to pay some percentage of the increase in gross sales over existing percentage rent levels to help make the landlord whole for the rent concessions the tenant received because of current operating conditions.

Get Control of Pass-Through Expenses

Tenants are looking for certainty in their operating expenses. Renegotiating additional rent provisions in leases is in high demand; tenants want to convert their pro rata exposure for common area maintenance, tax and insurance obligations to fixed amounts.

In light of the inordinate amount of time spent negotiating and enforcing inclusions, exclusions and amortizations of common area expenses, many parties are agreeing to fix pass-through amounts for common area, insurance and tax expenses. Typically, these include an automatic annual percentage increase in such expense. Other landlords are agreeing to caps on increases in certain pass-through expenses. Tenants are revisiting the definition of pro rata share, the inclusions and exclusions in common area expenses, and any other lease provisions where costs are passed through to the tenant as additional rent.

Almost every lease has something unique to it. There is no substitute for a thorough review of each lease in a tenant's portfolio with an eye toward the need for revisions to reflect a changing industry and the evolving economic climate.

Operating Covenants, Restrictions and Other Common Issues

High on the wish list of many tenants is revisiting and revising their opening and operating covenants in leases. Few clauses in the lease offer more opportunities and challenges than the co-tenancy provisions. Any thorough lease review should include due consideration to possession, opening and operating co-tenancies, and penalties and remedies upon breach thereof.

Many non-anchor tenants are more and more focused on comparable tenants as co-tenants rather than anchor stores are. For example, a 10,000 sq.-ft. men's clothing store is more interested in being located near comparably sized clothing retailers that are open and operating than anchor tenants in a shopping center. Tenants are focusing more on being located near industry-specific trade groups, like men's and women's clothing stores, than being tied into big box stores, bookstores, restaurants and service stores.

Tenants that make capital improvements to their premises will want to make sure they can get some remuneration in the event the co-tenancy provisions are not met, so that if the tenant elects to terminate its lease because of the landlord's failure to satisfy the co-tenancy provisions, the tenant can also offset all rent and remain in its premises until it can offset such improvement costs against rent.

Landlords and tenants are revisiting use definitions, exclusive use rights, use restrictions and durations, and the exceptions and exclusions therefrom. As the tenant mix of centers changes, and centers evolve over time, tenants need to review, reconsider and renegotiate the rights, obligations and restrictions regarding use and operating provisions, including exclusives, restrictions and covenants.

Tenants also want to eliminate radius restrictions. They want maximum flexibility to open new stores in the best locations possible. Radius restrictions are viewed as unreasonably restrictive against a tenant's best interests in picking new locations.

Tenants are also asking for more leniency in assignment and subletting rights and for more definitive standards with respect to what transfers are permissible without the landlord's consent, and otherwise requiring landlord to act reasonably. Landlords are also keenly interested in issues of transferability.

Give and Take

Tenants should be prepared to accommodate the major concerns of the landlord in exchange for some of the things they request. Many of the issues discussed above are also of concern to landlords, including operating covenants, exclusives, transferability rights, lease guarantors and issues of credit worthiness. One rarely gets something for nothing, and negotiating rent relief and other concessions from a landlord is certainly no exception.

Lease Renewals

Tenants with lease renewal rights, and those without who are interested in renewing a lease are frequently preferring shorter extension terms. Tenants have considerable anxiety regarding current market conditions, projected market conditions over the next several years, and their ability to meet their rental obligations in light of current gross sales volume. Tenants are reviewing all of the issues addressed above and negotiating many of those issues in their lease renewal procedures. Fewer tenants are taking the automatic lease extension rights in their leases and many are negotiating with their landlords more acceptable terms and conditions under which the tenant extends its lease for a renewal term.

In addition to revising base rent, requesting base rent reductions over the next two or three years, and trying to fix or better manage pass-through expenses, tenants interested in renewing or extending their lease term frequently have improvement and refurbishment needs. Many would like the landlord to kick in a generous improvement allowance or advance tenant money for the upgrading, remodeling and/or refurbishing of the leased premises. Tenants must also consider whether their landlord has access to the capital they need, which they could typically negotiate with their landlord in exchange for extending an existing lease term. Tenants must appreciate that landlords are also challenged in these economic times to make typical concessions, and landlords may not have access to improvement allowance monies.

New Deals

While the numbers are certainly down, there still are considerable numbers of new lease transactions taking place throughout our economy. Many of those leases provide for generous rent reductions and abatements over the short term. Some tenants are getting possession without any obligation to pay base rent and additional rent for months, and some for years.

Tenants want certainty in their rental obligations. Given current economic conditions, many tenants want their rent tied to gross sales. Tenants also want fixed additional rent obligations, with annual percentage increase provisions. Tenants are interested in shorter terms, with operating requirements tightly tied into co-tenancy provisions. In the event the existing tenant mix at a center does not satisfy the opening co-tenancy requirements, many tenants are being careful not to be obligated to take possession until such time as certain other tenants have taken possession and/or are open in the center.

Through the Looking Glass

There is no crystal ball in understanding exactly where we are or where we are going in this economy. Inevitably, new needs, ideas and solutions will evolve in light of evolving market conditions. Creativity and thinking outside the box are tremendous assets. Tenants have faced such exceptional changes and challenges over the last year and are eager to adapt to the changing dynamics of the retail economy. Landlords and tenants are working together to create better conditions for tenant stability and opportunity for success. There is considerable common ground between tenants and landlords and current market conditions provide good opportunities for revisiting lease provisions to enhance competitiveness and survivability in today's challenging economic times.

Randall S. Arndt is Practice Coordinator of Schottenstein Zox & Dunn's Real Estate and Land Use Practice Area. He oversees all aspects of the firm's real property practice as well as the growth of the associates in the department. Arndt's practice includes representation of national, regional, and local landlords and tenants, developers, buyers, sellers and others in the commercial real estate arena.

The current economic slowdown has been particularly hard on the retail industry. Operating retail stores in times of economic uncertainty has placed most real estate professionals in uncharted waters. Tenants are looking to their landlords for economic relief to meet the challenges of operating their stores without incurring unacceptable losses during these turbulent times. This special issue of Commercial Leasing Law & Strategy discusses difficulties arising in the context of retail leasing.

No matter how strong a retailer's business, all tenants are concerned about the state of the economy and the considerable decline in retail sales in almost every sector of the industry. Tenants are asking their landlords for assistance so they can weather the storm. Many tenants need immediate relief and are frequently finding that their landlords are willing to work with them on various rent concession proposals and other lease modifications.

This article provides an overview of what tenants are asking for from their landlords, including base rent and additional rent reductions and other lease modifications relating to operating covenants, use restrictions, exclusives and transferability. Many of these issues are relevant to lease renewal negotiations as well as new lease negotiations. Rosie Rees' article  examines the strategies that retail landlords and tenants can utilize to keep the tenant in the premises and the rent coming in. Mark Morfopoulos' “In the Spotlight” (discusses how to utilize a lease audit to add value, and Ira Fierstein's article  outlines some procedures landlords should make certain they follow so that they are protected in case replacement tenants follow the footsteps of their predecessors, shut down operations and bail out before expiration of the lease terms.

Existing Leases and Rent Reductions

Base rent relief to help tenants weather current economic conditions is the most sought-after lease modification in today's economy. Many strong tenants are preparing for a two- to three-year cycle with stagnant retail activity and are trying to protect their cash and risk of continued high base rent obligations during this period of reduced sales. Armed with gross sales results, as well as comparable figures for prior years, tenants can provide persuasive evidence to landlords that a base rent adjustment is necessary in light of current sales volume. Many landlords are receptive to reducing base rent and tying this rent into a certain percentage of gross sales until the tenant's gross sales exceed a certain minimum threshold. Tenants are agreeing to return to full base rent, or some other fixed amount, when their gross sales return to a certain agreed-upon minimum. Where a tenant leases several stores from the same landlord, most discussions relate to the entire portfolio, not just the under-performing stores. Tenants who are open and operating are important assets to their landlords and create value for their landlords' lending relationships. Thus, healthy tenants can make a persuasive case that they warrant some relief in light of changed market conditions. Many landlords are lowering base rents, albeit for widely varying periods of time. Many tenants are seeking two- to three years of base rent relief, and are prepared to renegotiate percentage rent breakpoints to reflect recent sales. When sales return, in addition to base rent returning to prior amounts, many landlords require the tenant to pay some percentage of the increase in gross sales over existing percentage rent levels to help make the landlord whole for the rent concessions the tenant received because of current operating conditions.

Get Control of Pass-Through Expenses

Tenants are looking for certainty in their operating expenses. Renegotiating additional rent provisions in leases is in high demand; tenants want to convert their pro rata exposure for common area maintenance, tax and insurance obligations to fixed amounts.

In light of the inordinate amount of time spent negotiating and enforcing inclusions, exclusions and amortizations of common area expenses, many parties are agreeing to fix pass-through amounts for common area, insurance and tax expenses. Typically, these include an automatic annual percentage increase in such expense. Other landlords are agreeing to caps on increases in certain pass-through expenses. Tenants are revisiting the definition of pro rata share, the inclusions and exclusions in common area expenses, and any other lease provisions where costs are passed through to the tenant as additional rent.

Almost every lease has something unique to it. There is no substitute for a thorough review of each lease in a tenant's portfolio with an eye toward the need for revisions to reflect a changing industry and the evolving economic climate.

Operating Covenants, Restrictions and Other Common Issues

High on the wish list of many tenants is revisiting and revising their opening and operating covenants in leases. Few clauses in the lease offer more opportunities and challenges than the co-tenancy provisions. Any thorough lease review should include due consideration to possession, opening and operating co-tenancies, and penalties and remedies upon breach thereof.

Many non-anchor tenants are more and more focused on comparable tenants as co-tenants rather than anchor stores are. For example, a 10,000 sq.-ft. men's clothing store is more interested in being located near comparably sized clothing retailers that are open and operating than anchor tenants in a shopping center. Tenants are focusing more on being located near industry-specific trade groups, like men's and women's clothing stores, than being tied into big box stores, bookstores, restaurants and service stores.

Tenants that make capital improvements to their premises will want to make sure they can get some remuneration in the event the co-tenancy provisions are not met, so that if the tenant elects to terminate its lease because of the landlord's failure to satisfy the co-tenancy provisions, the tenant can also offset all rent and remain in its premises until it can offset such improvement costs against rent.

Landlords and tenants are revisiting use definitions, exclusive use rights, use restrictions and durations, and the exceptions and exclusions therefrom. As the tenant mix of centers changes, and centers evolve over time, tenants need to review, reconsider and renegotiate the rights, obligations and restrictions regarding use and operating provisions, including exclusives, restrictions and covenants.

Tenants also want to eliminate radius restrictions. They want maximum flexibility to open new stores in the best locations possible. Radius restrictions are viewed as unreasonably restrictive against a tenant's best interests in picking new locations.

Tenants are also asking for more leniency in assignment and subletting rights and for more definitive standards with respect to what transfers are permissible without the landlord's consent, and otherwise requiring landlord to act reasonably. Landlords are also keenly interested in issues of transferability.

Give and Take

Tenants should be prepared to accommodate the major concerns of the landlord in exchange for some of the things they request. Many of the issues discussed above are also of concern to landlords, including operating covenants, exclusives, transferability rights, lease guarantors and issues of credit worthiness. One rarely gets something for nothing, and negotiating rent relief and other concessions from a landlord is certainly no exception.

Lease Renewals

Tenants with lease renewal rights, and those without who are interested in renewing a lease are frequently preferring shorter extension terms. Tenants have considerable anxiety regarding current market conditions, projected market conditions over the next several years, and their ability to meet their rental obligations in light of current gross sales volume. Tenants are reviewing all of the issues addressed above and negotiating many of those issues in their lease renewal procedures. Fewer tenants are taking the automatic lease extension rights in their leases and many are negotiating with their landlords more acceptable terms and conditions under which the tenant extends its lease for a renewal term.

In addition to revising base rent, requesting base rent reductions over the next two or three years, and trying to fix or better manage pass-through expenses, tenants interested in renewing or extending their lease term frequently have improvement and refurbishment needs. Many would like the landlord to kick in a generous improvement allowance or advance tenant money for the upgrading, remodeling and/or refurbishing of the leased premises. Tenants must also consider whether their landlord has access to the capital they need, which they could typically negotiate with their landlord in exchange for extending an existing lease term. Tenants must appreciate that landlords are also challenged in these economic times to make typical concessions, and landlords may not have access to improvement allowance monies.

New Deals

While the numbers are certainly down, there still are considerable numbers of new lease transactions taking place throughout our economy. Many of those leases provide for generous rent reductions and abatements over the short term. Some tenants are getting possession without any obligation to pay base rent and additional rent for months, and some for years.

Tenants want certainty in their rental obligations. Given current economic conditions, many tenants want their rent tied to gross sales. Tenants also want fixed additional rent obligations, with annual percentage increase provisions. Tenants are interested in shorter terms, with operating requirements tightly tied into co-tenancy provisions. In the event the existing tenant mix at a center does not satisfy the opening co-tenancy requirements, many tenants are being careful not to be obligated to take possession until such time as certain other tenants have taken possession and/or are open in the center.

Through the Looking Glass

There is no crystal ball in understanding exactly where we are or where we are going in this economy. Inevitably, new needs, ideas and solutions will evolve in light of evolving market conditions. Creativity and thinking outside the box are tremendous assets. Tenants have faced such exceptional changes and challenges over the last year and are eager to adapt to the changing dynamics of the retail economy. Landlords and tenants are working together to create better conditions for tenant stability and opportunity for success. There is considerable common ground between tenants and landlords and current market conditions provide good opportunities for revisiting lease provisions to enhance competitiveness and survivability in today's challenging economic times.

Randall S. Arndt is Practice Coordinator of Schottenstein Zox & Dunn's Real Estate and Land Use Practice Area. He oversees all aspects of the firm's real property practice as well as the growth of the associates in the department. Arndt's practice includes representation of national, regional, and local landlords and tenants, developers, buyers, sellers and others in the commercial real estate arena.