Gross Leasable Area and Excluded Area

There are as many alternatives to areas excluded from gross leasable area as there are lease forms currently being used at retail facilities. Some of the more common spaces deemed to be “excluded areas” under retail leases include the following: building areas utilized for non-retail purposes, building areas used for recreational purposes, museum space, post offices, military recruitment areas, ice rinks, theaters, kiosk areas, areas occupied by department stores, areas that have an exterior entrance, basement areas, areas used for office purposes, areas used for employees of landlord, free-standing premises that are not attached to the main retail facility, common areas, and areas used for storage. As you can see from the above list, which is illustrative and not exhaustive, there are many areas where landlords will seek to exclude floor area from the denominator used to calculate the tenants' proportionate share. A sophisticated tenant would be mindful to try and alleviate part of the risk associated with the exclusion of these areas. Some of the methods for curbing a tenant's risk associated with the concept of “excluded areas” are discussed below.

Placing a Cap on the Amount of Area That May Be Excluded

Often, the simplest means of limiting the risk to the tenant for the ever-increasing “excluded area” definition is for the tenant to place in its lease a limitation on the amount of area that may be excluded. While this cap or limitation is often the subject of serious debate during the lease negotiation, arriving at some reasonable cap on the amount of area that may be excluded is essential to the tenant's maintaining some degree of protection on increases of its proportionate share of additional costs. By way of example, the parties may agree that in no event shall more than 50,000 square feet be deemed excluded from the calculation of gross leasable area when aggregating all the areas that are included within the definition of “excluded area.”

Another means of placing a cap on the “excluded area” is to specify what the gross leasable area of the retail project is at the commencement of the term of the Lease and stating that notwithstanding the amount of actual “excluded area,” the gross leasable area shall never be deemed to be less than 90% of the gross leasable area at the commencement of the term of the lease. This method of determining the cap on “excluded area” is only effective if the tenant is able to verify how the gross leasable area is calculated at the commencement of the term of the lease. For instance, if there is already 80,000 square feet of gross leasable area excluded from the initial calculation of gross leasable area, the tenant may not be receiving the same protection it had originally envisioned that it would receive.

Limiting Excluded Areas

A tenant's ability to gain control over the definition of “excluded areas” under the lease is particularly important, since in virtually all retail lease forms, the “floor” that the tenant may have negotiated for calculating gross leased area (i.e., as described earlier, that the gross leased area will never be deemed to be less than 80% of the gross leasable area) is calculated based upon the gross leasable area once the “excluded area” is deducted. In other words, the 80% floor, as described, already presumes that the “excluded area” does not exist for purposes of the calculation. As a result, the tenant may be receiving significantly less than it thought it had bargained for in trying to control the tenant's contribution for “vacant” areas of the retail facility, if the “excluded area” definition carries with it a substantial amount of floor area that the tenant thought was included in gross leasable area, but which has been deemed “excluded area.”

A review of a few of the areas addressed as “excluded areas” above reveals some potential exposure to the determination of gross leasable area or gross leased area. For instance, a lease form may exclude the floor area contained in locations that have entrances onto the exterior of the retail facility (often this appears in an enclosed regional mall lease situation). However, while the excluded location may have an entrance onto the exterior of the shopping center, the location may also have an entrance onto the interior of the enclosed mall of the shopping center. Based upon the definition often implemented in retail leases, simply by having an entrance onto the exterior of the shopping center would serve to place that location into the “excluded area” calculation. As a result, a tenant should limit this language so that this type of location would only be excluded if the premises in question only had an entrance onto the exterior of the shopping center (i.e., the location did not have an entrance onto the enclosed mall of the retail facility).

Theaters and ice rinks offer another area for debate. Since these operations are generally run “for profit,” if the landlord chooses to allow these types of tenants not to pay their proportionate share of additional rent items, it is unclear why that obligation should automatically be borne by the other tenants of the retail facility. In addition, it is even less clear why this area that clearly can be occupied for retail purposes, would be considered “excluded area” when calculating a co-tenancy provision, since most leases provide that this area will be excluded, whether or not the premises is vacant or occupied. As a result, if a theater tenant would “go dark” and/or vacate the retail facility, the landlord, under most lease forms, could still exclude the floor area formerly occupied by the theater when determining gross leasable area for purposes of a co-tenancy provision. A tenant should pursue not having theaters or ice rinks considered “excluded area” in their lease documents, or at a minimum, require that these locations are open and operating for business in order to be deemed “excluded area.”

Finally, another area of concern is classifying common areas as “excluded areas.” While in general, there is agreement that common areas of retail facilities should not be considered gross leasable area, it has been increasingly common for landlords to classify areas as “common areas” even though the public is not granted access to these areas and even though these areas have been occupied by retail tenants in the past. Landlords may determine that certain gross leasable areas are going to be “converted” into common areas in the future, and since they are not presently being leased, they are deemed common areas, even though they may be presently boarded up former retail space. Tenants should carefully draft their lease provisions so that “common areas” shall always be deemed to be areas that are open and available to the general public, maintained by the landlord and serve a retail purpose for the retail facility.

Converted Areas

As briefly described in the immediately preceding section, landlords are increasingly re-classifying areas of their retail facilities from gross leasable area to common areas, and then excluding that common area from the definition of gross leasable area. This is especially troubling in situations where the gross leasable area has been closed for several months or longer, formally was used as gross leasable area, and the landlord has not expended any funds in attempting to convert this gross leasable area to common areas. The only action the landlord may have taken is simply re-classifying this area for purposes of its own internal accounting. As a result, a tenant may be very surprised to learn that while a co-tenancy provision was triggered, and the tenant may have paid alternative rent as a result thereof, the co-tenancy condition may have been cured, without any additional space being leased in the retail facility ' simply by square footage being excluded from the denominator of gross leasable area. This reclassification artificially increases the percentage of areas in the retail facility that are open and occupied based on the revised calculation of gross leasable area. Although this concept may not yet have been litigated, it is certainly ripe for litigation in the very near future. However, in order to avoid having to litigate this matter, a tenant would be wise to indicate in its lease that an area will not be deemed “excluded area” due to the area being deemed “common area” unless and until that area is open to the general public, maintained by the landlord, and serves a retail purpose for the retail facility.

Conclusion

As it becomes increasingly difficult to lease space in retail facilities, and as landlords seek to balance their budgets with an ever shrinking tenant pool, the classification of gross leasable area, gross leased area and excluded area will become increasingly more important for tenants to focus on during their lease negotiation. The tenant should read each exclusion carefully, determine what potential uses and abuses can be triggered from that exclusion, and seek to minimize, limit or cap its exposure to the greatest extent possible. The resulting language, which is incorporated into the tenant's lease document, not only serves to save the tenant money that would otherwise be assessed to the tenant by way of additional rent charges, but also serves to assist the tenant in establishing that a co-tenancy condition does exist at the retail facility.

Glenn A. Browne, a member of this newsletter's Board of Editors, is a shareholder in the law firm Braun, Browne & Associates, P.C., Riverwoods, IL. Mr. Browne's law practice is concentrated in the areas of purchase and sale of real estate, commercial leasing and lease related matters.

In an environment where it has become increasingly difficult for landlords to lease space in their retail projects, landlords have employed a new strategy to compensate for the ever increasing vacant space within their retail projects. The newest strategy appears to be excluding space from what otherwise was considered gross leasable area and placing that space in the category of “excluded area” or “non-gross leasable area.” Since many of the terms of the lease are tied to the gross leasable area or gross leased area of the retail project, including, but not limited to, the tenant's proportionate share of operating costs, taxes, insurance and other additional rent items, as well as determining whether a co-tenancy provision has been triggered, it has now become vitally important during lease negotiations to have a complete understanding of what area in the retail project is being used to determine various calculations under the Lease. This article addresses the topic of what is gross leasable area, what is gross leased area, what is deemed to be excluded area, and the concept of “converted” area under present-day leasing situations.

Gross Leasable Area/Gross Leased Area/Excluded Area

While many retail facilities are computing their additional rent charges as “fixed” obligations, with an initial amount due in the first year and mandatory fixed increases of that charge (e.g., 4% per annum) for each succeeding year, many other retail facilities still operate on a proportionate share basis (as described below) in order to determine the tenants' obligations with regard to additional rent costs. These additional rent costs include operating costs, taxes, insurance, trash removal, pest extermination, and other recurring costs. While most retail leases assess the tenants' proportionate share as a fraction, the numerator of which is the floor area of the premises and the denominator of which is the gross leased area (the total floor area of the gross leasable area in a retail project that is leased to rent-paying tenants [often stabilized with a floor, such as not less than 80% of the gross leasable area of the retail project,]) there is still a significant exposure to the tenants, if it is not possible from the individual tenant's lease, to determine exactly what floor area in the retail project is considered gross leasable area and what floor area is determined to be “excluded area.”

There are as many alternatives to areas excluded from gross leasable area as there are lease forms currently being used at retail facilities. Some of the more common spaces deemed to be “excluded areas” under retail leases include the following: building areas utilized for non-retail purposes, building areas used for recreational purposes, museum space, post offices, military recruitment areas, ice rinks, theaters, kiosk areas, areas occupied by department stores, areas that have an exterior entrance, basement areas, areas used for office purposes, areas used for employees of landlord, free-standing premises that are not attached to the main retail facility, common areas, and areas used for storage. As you can see from the above list, which is illustrative and not exhaustive, there are many areas where landlords will seek to exclude floor area from the denominator used to calculate the tenants' proportionate share. A sophisticated tenant would be mindful to try and alleviate part of the risk associated with the exclusion of these areas. Some of the methods for curbing a tenant's risk associated with the concept of “excluded areas” are discussed below.

Placing a Cap on the Amount of Area That May Be Excluded

Often, the simplest means of limiting the risk to the tenant for the ever-increasing “excluded area” definition is for the tenant to place in its lease a limitation on the amount of area that may be excluded. While this cap or limitation is often the subject of serious debate during the lease negotiation, arriving at some reasonable cap on the amount of area that may be excluded is essential to the tenant's maintaining some degree of protection on increases of its proportionate share of additional costs. By way of example, the parties may agree that in no event shall more than 50,000 square feet be deemed excluded from the calculation of gross leasable area when aggregating all the areas that are included within the definition of “excluded area.”

Another means of placing a cap on the “excluded area” is to specify what the gross leasable area of the retail project is at the commencement of the term of the Lease and stating that notwithstanding the amount of actual “excluded area,” the gross leasable area shall never be deemed to be less than 90% of the gross leasable area at the commencement of the term of the lease. This method of determining the cap on “excluded area” is only effective if the tenant is able to verify how the gross leasable area is calculated at the commencement of the term of the lease. For instance, if there is already 80,000 square feet of gross leasable area excluded from the initial calculation of gross leasable area, the tenant may not be receiving the same protection it had originally envisioned that it would receive.

Limiting Excluded Areas

A tenant's ability to gain control over the definition of “excluded areas” under the lease is particularly important, since in virtually all retail lease forms, the “floor” that the tenant may have negotiated for calculating gross leased area (i.e., as described earlier, that the gross leased area will never be deemed to be less than 80% of the gross leasable area) is calculated based upon the gross leasable area once the “excluded area” is deducted. In other words, the 80% floor, as described, already presumes that the “excluded area” does not exist for purposes of the calculation. As a result, the tenant may be receiving significantly less than it thought it had bargained for in trying to control the tenant's contribution for “vacant” areas of the retail facility, if the “excluded area” definition carries with it a substantial amount of floor area that the tenant thought was included in gross leasable area, but which has been deemed “excluded area.”

A review of a few of the areas addressed as “excluded areas” above reveals some potential exposure to the determination of gross leasable area or gross leased area. For instance, a lease form may exclude the floor area contained in locations that have entrances onto the exterior of the retail facility (often this appears in an enclosed regional mall lease situation). However, while the excluded location may have an entrance onto the exterior of the shopping center, the location may also have an entrance onto the interior of the enclosed mall of the shopping center. Based upon the definition often implemented in retail leases, simply by having an entrance onto the exterior of the shopping center would serve to place that location into the “excluded area” calculation. As a result, a tenant should limit this language so that this type of location would only be excluded if the premises in question only had an entrance onto the exterior of the shopping center (i.e., the location did not have an entrance onto the enclosed mall of the retail facility).

Theaters and ice rinks offer another area for debate. Since these operations are generally run “for profit,” if the landlord chooses to allow these types of tenants not to pay their proportionate share of additional rent items, it is unclear why that obligation should automatically be borne by the other tenants of the retail facility. In addition, it is even less clear why this area that clearly can be occupied for retail purposes, would be considered “excluded area” when calculating a co-tenancy provision, since most leases provide that this area will be excluded, whether or not the premises is vacant or occupied. As a result, if a theater tenant would “go dark” and/or vacate the retail facility, the landlord, under most lease forms, could still exclude the floor area formerly occupied by the theater when determining gross leasable area for purposes of a co-tenancy provision. A tenant should pursue not having theaters or ice rinks considered “excluded area” in their lease documents, or at a minimum, require that these locations are open and operating for business in order to be deemed “excluded area.”

Finally, another area of concern is classifying common areas as “excluded areas.” While in general, there is agreement that common areas of retail facilities should not be considered gross leasable area, it has been increasingly common for landlords to classify areas as “common areas” even though the public is not granted access to these areas and even though these areas have been occupied by retail tenants in the past. Landlords may determine that certain gross leasable areas are going to be “converted” into common areas in the future, and since they are not presently being leased, they are deemed common areas, even though they may be presently boarded up former retail space. Tenants should carefully draft their lease provisions so that “common areas” shall always be deemed to be areas that are open and available to the general public, maintained by the landlord and serve a retail purpose for the retail facility.

Converted Areas

As briefly described in the immediately preceding section, landlords are increasingly re-classifying areas of their retail facilities from gross leasable area to common areas, and then excluding that common area from the definition of gross leasable area. This is especially troubling in situations where the gross leasable area has been closed for several months or longer, formally was used as gross leasable area, and the landlord has not expended any funds in attempting to convert this gross leasable area to common areas. The only action the landlord may have taken is simply re-classifying this area for purposes of its own internal accounting. As a result, a tenant may be very surprised to learn that while a co-tenancy provision was triggered, and the tenant may have paid alternative rent as a result thereof, the co-tenancy condition may have been cured, without any additional space being leased in the retail facility ' simply by square footage being excluded from the denominator of gross leasable area. This reclassification artificially increases the percentage of areas in the retail facility that are open and occupied based on the revised calculation of gross leasable area. Although this concept may not yet have been litigated, it is certainly ripe for litigation in the very near future. However, in order to avoid having to litigate this matter, a tenant would be wise to indicate in its lease that an area will not be deemed “excluded area” due to the area being deemed “common area” unless and until that area is open to the general public, maintained by the landlord, and serves a retail purpose for the retail facility.

Conclusion

As it becomes increasingly difficult to lease space in retail facilities, and as landlords seek to balance their budgets with an ever shrinking tenant pool, the classification of gross leasable area, gross leased area and excluded area will become increasingly more important for tenants to focus on during their lease negotiation. The tenant should read each exclusion carefully, determine what potential uses and abuses can be triggered from that exclusion, and seek to minimize, limit or cap its exposure to the greatest extent possible. The resulting language, which is incorporated into the tenant's lease document, not only serves to save the tenant money that would otherwise be assessed to the tenant by way of additional rent charges, but also serves to assist the tenant in establishing that a co-tenancy condition does exist at the retail facility.

Glenn A. Browne, a member of this newsletter's Board of Editors, is a shareholder in the law firm Braun, Browne & Associates, P.C., Riverwoods, IL. Mr. Browne's law practice is concentrated in the areas of purchase and sale of real estate, commercial leasing and lease related matters.