Retail In Mixed-Use Projects

Many different scenarios are possible. If the retailer itself controls the project, then of course it will have more leverage to assure that its interests are protected (although many of the considerations described in this article will still be relevant). Our discussion focuses, however, on scenarios in which a third-party developer controls the project.

Development priority and timing issues are always a concern. If the project is a completely new development, or if the retailer is new to the project, then priority and timing issues regarding permitting, construction and store opening will be similar to those in traditional locations, although the periods for some or all of those stages of development may be more protracted. However, if the project involves redeveloping an existing project in which the retailer already operates, timing and many other issues take on new meaning, as will be explored in this article.

Common Issues Facing a Major Retailer

The nature of a mixed-use development, including its legal structure, physical arrangement and the co-location of non-retail uses, presents a number of challenges and concerns for a major retailer that chooses to operate in such an environment. First, what will be the legal structure of the development? In some ways, this concern is not unique to mixed-use, but when taken together with other factors, it may assume greater than usual importance. Possible legal structures range from “normal” developer-owned, leased space to subdivision, condominium, air rights leases or a combination of types. The choice of legal structure will be influenced by the physical layout of the project, its location, and local laws and ordinances, among other factors, and of course the chosen legal structure will dictate the nature of the documentation required.

The physical arrangement of a mixed-use project and the co-location of non-retail uses are closely related concerns. Mixed-use projects are often located in urban areas or in suburban “city center” locations that are more dense than traditional strip center or mall developments, and are likely to be more vertical than horizontal in nature. This variation in design presents a number of concerns to a major retailer accustomed to operating in a horizontal environment. The regulatory environment may also add some unfamiliar wrinkles to the process.

Space limitations and the vertical orientation of a development, in conjunction with the combination of dissimilar uses in that limited, vertical space, make it critical for the retailer to examine carefully certain developmental and operational factors that it may otherwise consider to be routine. It may be helpful for the parties to develop a three-dimensional model of the planned multi-level, multi-function structure, either digitally or in physical form, to help visualize how the pieces of the puzzle will fit together.

Parking

Consider, for example, parking. A major retailer, which typically operates in suburban strip centers, may be accustomed to requiring a parking field of several hundred spaces, usually directly in front of its store, with protections against any subsequent changes to the parking field and related driveways and access points. But in a mixed-use development, the retailer may find itself with a street-level, street-front or interior location under or surrounded by a multi-family dwelling, hotel or office project. Parking may be underground or in an interior area, with limited access and visibility.

Care must be taken to assure that the retailer will have the benefit of sufficient parking for its customers, with safeguards in place to prevent, or at least strongly discourage, encroachment by apartment residents or office workers. If the project is located near mass transit facilities, then parking needs may be reduced and the local authorities may even limit parking to encourage the use of public transportation, but the developer and retailer must take steps to discourage transient and commuter parking on-site. If parking is limited, the developer and the local authorities may also resist or limit free parking for the retailer's employees.

Accordingly, the retailer must carefully analyze its parking needs and incorporate into the project's governing documents measures that will assure, to the extent possible, that those parking needs will be met. Solutions may include separate parking areas for major retail, minor retail, residential, hotel and office uses, as well as the installation of controlled access and parking validation systems to manage and control the separate parking areas so that retail parking is not taken up by residents and transients rather than customers and employees.

In a related concern, the retailer should carefully review proposed access to its own store space as well as the other portions of the project. For example, if the project includes a residential component, the retailer must balance the competing interests of maintaining separate parking facilities while providing convenient access for residents to the retailer's store. Retailers (particularly those offering staple items such as groceries) will want to encourage the “captive audience” of residents to be regular customers while still maintaining sufficient parking and easy access for outside customers as well.

Dock Space

Dock space and access for trucks will also present new challenges. Often, the nature of a mixed-use development requires that loading docks be located in interior, underground spaces, and access is likely available only from a specific, limited location or locations. Care must be taken to assure that trucks will be able to reach the access points from adjacent (and often congested) streets, enter the project, reach the loading docks, deliver their goods and depart without incident, all within enclosed spaces. The height and width of accessways, and the available turning radius at critical points, must be carefully determined, examined and legally protected.

Mechanicals

Likewise, the location of mechanical components and other equipment of critical importance to the retailer's operations will assume new importance. In a strip center or stand-alone location, the retailer will likely be accustomed to relatively free rein in locating its HVAC equipment and satellite dishes and antennas on its roof, and running its mechanical connections and utility lines directly within or through walls from the source to the point of need. But in a mixed-use development, the retailer's “roof” may be covered with several stories of an apartment building, office building or hotel, and the retail space may be similarly surrounded horizontally by other uses and users.

Accordingly, the parties may need to provide interior and exterior easements to give the retailer access to other parts of the project. Or in a condominium scenario some portions of the project may need to be made limited common elements benefitting one or more occupants including the retailer. Describing such access rights accurately will require close cooperation of all parties and perhaps the preparation of specialized plans, descriptions and renderings to identify the affected areas with specificity.

Signage

Signage in a mixed-use development will also probably be somewhat different from that in a traditional retail location. The retailer may not have a conventional storefront, or it may be facing an interior area, so typical storefront signage may not be effective. Also, pylon or monument signage may not be present. Accordingly, the retailer must consider carefully the unusual signage characteristics of the project to determine what signage it needs, within the parameters of what the developer plans to provide and what the applicable authorities will allow.

All of the foregoing considerations have an associated cost element, not only in terms of initial cost, but also ongoing maintenance, repair and replacement costs. Again, because of the non-traditional nature of a mixed-use development as compared to a strip center or mall, cost allocations take on a different character. In most mixed-use projects, several different categories of cost items will probably need to be created. Some costs will fairly be attributable to the entire development and should be rightfully shared by all occupants.

Other costs, however, will be attributable only to certain portions of the whole project, so there may need to be separate categories for sharing costs attributable only to the retail portion, or to the residential portion, or to the office portion or to the hotel portion, or in some cases to a combination of users. The proper allocations will depend upon the specific physical configuration of, and mix of uses in, each project.

Redevelopment: Special Concerns

Many additional issues may arise if the project involves redeveloping an existing project in which the retailer already operates. For example, a shopping center whose glory days have passed may be a prime location for a mixed-use project. In most cases, the retailer will have to cease operations and close an existing store for at least part of what could be a lengthy redevelopment period. This will result in a significant loss of revenue for the retailer during the period of closure. So the retailer will want to minimize that period, and its lost revenue from the period of closure will also be a factor in its economic negotiations with the developer, affecting which party will pay for the costs of the retailer's closure, reconstruction, relocation and reopening.

The retailer must also consider how best to protect its legal rights during the period from when it ceases operations in its old premises and its old lease, in effect, terminates, to when it occupies its new premises and a new lease takes effect. The retailer will need to consider, for example, at what point it should, or will be required to, cease operations. Once it ceases operations, although it needs to maintain legal rights with respect to its location in the project, it should not be obligated to pay rent, common area maintenance costs, taxes or other property expenses from the time it closes its old store until it is able to re-commence operations in its new premises.

Of paramount concern to the retailer is how it will maintain control and leverage during the period that it has no physical presence at the project site. Presumably, in a redevelopment scenario, not only will the retailer have been required to close its store, but its store also will most likely have been demolished, so if the developer subsequently fails to perform, the retailer cannot simply move back in and resume operation. The retailer must protect itself from being left in a “no-man's land” with legal rights on paper but no practical solution to the problem.

The underlying documentation for the relocation of the retailer and redevelopment of the project may take various forms, perhaps an agreement to buy out the old lease and enter into a new one, an agreement to enter into an amended and restated lease, which addresses both the termination of the old tenancy and the commencement and duration of the new tenancy, or any number of other formats. But whatever the format or makeup of the documentation, from the retailer's standpoint it must address certain critical issues, including: 1) Closing the existing store, termination of financial obligations of tenant/retailer, and preservation of legal rights to its old and new premises; 2) Entering into a new development agreement and lease for a new store space to be constructed in the new, mixed-use development; and 3) Preserving the retailer's rights during the interim period and assuring that it can re-commence operations in its new store upon delivery.

For the construction period, the retailer must be certain that the documents address additional issues, including: 1) What will be the scope of the developer's work for the new store and the site in general? Will the retailer perform all of its own finish work? What design controls, approval rights and takeover rights will the retailer have? 2) How much of the overall project needs to be completed (both legally and practically) for the retailer to obtain a certificate of occupancy and to open for business? For example, are life safety and other systems project-wide or individual? 3) If the developer defaults and the retailer takes over construction, how much may it take over and how much will it need to take over? Will the retailer have access to the proceeds of the developer's financing? and 4) What if construction is not completed on time? What damages or other remedies will provide practical protection for the retailer?

The master transaction document or documents should include protective provisions to address the foregoing concerns. For example, in addition to typical conditions for permitting, construction, title, and other important elements, the master document may include a provision such as the following (in which “Phase I” refers to that phase of the redevelopment project which must be completed for the retailer to take occupancy of its new premises, perform its own finish work and open for business):

(_) Financing. Developer shall have closed upon financing (which may be provided through a combination of equity, bank financing, and/or other funding (the “Financing”) from a lender of Developer's selection (the Phase I Lender”) including, without limitation, the execution and delivery of a non-disturbance and funding access agreement from the Phase I Lender, in a form substantially similar to the Lender Agreement as provided herein, and otherwise satisfactory to Tenant in its sole discretion as it relates to changes which would increase Tenant's obligations or diminish Tenant's rights, provided, however, Tenant agrees that any other changes will be evaluated and approved based on its commercially reasonable discretion. The Financing, shall, at a minimum, provide sufficient funds for the construction and completion of Phase I of the Project.

The “Lender Agreement” referred to in the above provision will need to include: 1) typical subordination, non-disturbance and attornment protections between the retailer and the developer's construction lender; and 2) agreements among the retailer, its developer and the developer's construction lender establishing and governing the rights of the retailer to take over the construction work if the developer fails to complete that work in accordance with the applicable approvals or the construction schedule, or falls behind in the performance of the work and cannot demonstrate that it will complete the work by the scheduled dates.

If the retailer elects to take over the construction work, it should be required to give the lender written notice, following which the lender should have a stated period to determine whether it will take over such work. If the lender does not take over the work, before the retailer finally commits to assuming the construction responsibilities, the Lender Agreement should provide that the lender must certify to the retailer that the then-remaining available balance of the financing proceeds and all other construction funds (broadly defined, but most likely including equity funds from the developer which the lender would have previously required the developer to place in escrow) will be controlled by the lender in all events and made available to the retailer for completion of construction.

Summary

This article has attempted to highlight areas of major concern to be considered by a major retailer that anticipates locating in a mixed-use development. The solutions to those concerns, and areas of additional concern, are as numerous as the infinite possible configurations of mixed-use projects. The author hopes, however, that the foregoing discussion will serve as a reference guide for identifying, addressing and solving issues and problems that developers and retailers may encounter in this growing category of commercial development.

John H. Lewis is admitted to practice in Florida, Massachusetts, Georgia and North Carolina, and conducts his national commercial real estate practice through The Law Offices of John H. Lewis, PLLC, based in Raleigh, NC.

Before the Great Recession, mixed-use projects involving varying combinations of retail, residential, hotel, office, healthcare and other commercial uses were gaining popularity, both in urban settings and in suburban “city center” locations. Now, as we see signs of renewed development activity, mixed-use projects appear to be among those property types enjoying a resurgence of popularity. This article explores a number of issues that large retailers should consider when anticipating becoming part of a mixed-use project.

A mixed-use project will, by definition, encompass multiple, historically incompatible (or at least inconsistent) uses, often in a congested setting. How may the parties best address the interests of a major retailer in a setting unlike a typical stand-alone location, strip center, life-style center or mall?

Parties, Bargaining Power and Conflicting Priorities

Many different scenarios are possible. If the retailer itself controls the project, then of course it will have more leverage to assure that its interests are protected (although many of the considerations described in this article will still be relevant). Our discussion focuses, however, on scenarios in which a third-party developer controls the project.

Development priority and timing issues are always a concern. If the project is a completely new development, or if the retailer is new to the project, then priority and timing issues regarding permitting, construction and store opening will be similar to those in traditional locations, although the periods for some or all of those stages of development may be more protracted. However, if the project involves redeveloping an existing project in which the retailer already operates, timing and many other issues take on new meaning, as will be explored in this article.

Common Issues Facing a Major Retailer

The nature of a mixed-use development, including its legal structure, physical arrangement and the co-location of non-retail uses, presents a number of challenges and concerns for a major retailer that chooses to operate in such an environment. First, what will be the legal structure of the development? In some ways, this concern is not unique to mixed-use, but when taken together with other factors, it may assume greater than usual importance. Possible legal structures range from “normal” developer-owned, leased space to subdivision, condominium, air rights leases or a combination of types. The choice of legal structure will be influenced by the physical layout of the project, its location, and local laws and ordinances, among other factors, and of course the chosen legal structure will dictate the nature of the documentation required.

The physical arrangement of a mixed-use project and the co-location of non-retail uses are closely related concerns. Mixed-use projects are often located in urban areas or in suburban “city center” locations that are more dense than traditional strip center or mall developments, and are likely to be more vertical than horizontal in nature. This variation in design presents a number of concerns to a major retailer accustomed to operating in a horizontal environment. The regulatory environment may also add some unfamiliar wrinkles to the process.

Space limitations and the vertical orientation of a development, in conjunction with the combination of dissimilar uses in that limited, vertical space, make it critical for the retailer to examine carefully certain developmental and operational factors that it may otherwise consider to be routine. It may be helpful for the parties to develop a three-dimensional model of the planned multi-level, multi-function structure, either digitally or in physical form, to help visualize how the pieces of the puzzle will fit together.

Parking

Consider, for example, parking. A major retailer, which typically operates in suburban strip centers, may be accustomed to requiring a parking field of several hundred spaces, usually directly in front of its store, with protections against any subsequent changes to the parking field and related driveways and access points. But in a mixed-use development, the retailer may find itself with a street-level, street-front or interior location under or surrounded by a multi-family dwelling, hotel or office project. Parking may be underground or in an interior area, with limited access and visibility.

Care must be taken to assure that the retailer will have the benefit of sufficient parking for its customers, with safeguards in place to prevent, or at least strongly discourage, encroachment by apartment residents or office workers. If the project is located near mass transit facilities, then parking needs may be reduced and the local authorities may even limit parking to encourage the use of public transportation, but the developer and retailer must take steps to discourage transient and commuter parking on-site. If parking is limited, the developer and the local authorities may also resist or limit free parking for the retailer's employees.

Accordingly, the retailer must carefully analyze its parking needs and incorporate into the project's governing documents measures that will assure, to the extent possible, that those parking needs will be met. Solutions may include separate parking areas for major retail, minor retail, residential, hotel and office uses, as well as the installation of controlled access and parking validation systems to manage and control the separate parking areas so that retail parking is not taken up by residents and transients rather than customers and employees.

In a related concern, the retailer should carefully review proposed access to its own store space as well as the other portions of the project. For example, if the project includes a residential component, the retailer must balance the competing interests of maintaining separate parking facilities while providing convenient access for residents to the retailer's store. Retailers (particularly those offering staple items such as groceries) will want to encourage the “captive audience” of residents to be regular customers while still maintaining sufficient parking and easy access for outside customers as well.

Dock Space

Dock space and access for trucks will also present new challenges. Often, the nature of a mixed-use development requires that loading docks be located in interior, underground spaces, and access is likely available only from a specific, limited location or locations. Care must be taken to assure that trucks will be able to reach the access points from adjacent (and often congested) streets, enter the project, reach the loading docks, deliver their goods and depart without incident, all within enclosed spaces. The height and width of accessways, and the available turning radius at critical points, must be carefully determined, examined and legally protected.

Mechanicals

Likewise, the location of mechanical components and other equipment of critical importance to the retailer's operations will assume new importance. In a strip center or stand-alone location, the retailer will likely be accustomed to relatively free rein in locating its HVAC equipment and satellite dishes and antennas on its roof, and running its mechanical connections and utility lines directly within or through walls from the source to the point of need. But in a mixed-use development, the retailer's “roof” may be covered with several stories of an apartment building, office building or hotel, and the retail space may be similarly surrounded horizontally by other uses and users.

Accordingly, the parties may need to provide interior and exterior easements to give the retailer access to other parts of the project. Or in a condominium scenario some portions of the project may need to be made limited common elements benefitting one or more occupants including the retailer. Describing such access rights accurately will require close cooperation of all parties and perhaps the preparation of specialized plans, descriptions and renderings to identify the affected areas with specificity.

Signage

Signage in a mixed-use development will also probably be somewhat different from that in a traditional retail location. The retailer may not have a conventional storefront, or it may be facing an interior area, so typical storefront signage may not be effective. Also, pylon or monument signage may not be present. Accordingly, the retailer must consider carefully the unusual signage characteristics of the project to determine what signage it needs, within the parameters of what the developer plans to provide and what the applicable authorities will allow.

All of the foregoing considerations have an associated cost element, not only in terms of initial cost, but also ongoing maintenance, repair and replacement costs. Again, because of the non-traditional nature of a mixed-use development as compared to a strip center or mall, cost allocations take on a different character. In most mixed-use projects, several different categories of cost items will probably need to be created. Some costs will fairly be attributable to the entire development and should be rightfully shared by all occupants.

Other costs, however, will be attributable only to certain portions of the whole project, so there may need to be separate categories for sharing costs attributable only to the retail portion, or to the residential portion, or to the office portion or to the hotel portion, or in some cases to a combination of users. The proper allocations will depend upon the specific physical configuration of, and mix of uses in, each project.

Redevelopment: Special Concerns

Many additional issues may arise if the project involves redeveloping an existing project in which the retailer already operates. For example, a shopping center whose glory days have passed may be a prime location for a mixed-use project. In most cases, the retailer will have to cease operations and close an existing store for at least part of what could be a lengthy redevelopment period. This will result in a significant loss of revenue for the retailer during the period of closure. So the retailer will want to minimize that period, and its lost revenue from the period of closure will also be a factor in its economic negotiations with the developer, affecting which party will pay for the costs of the retailer's closure, reconstruction, relocation and reopening.

The retailer must also consider how best to protect its legal rights during the period from when it ceases operations in its old premises and its old lease, in effect, terminates, to when it occupies its new premises and a new lease takes effect. The retailer will need to consider, for example, at what point it should, or will be required to, cease operations. Once it ceases operations, although it needs to maintain legal rights with respect to its location in the project, it should not be obligated to pay rent, common area maintenance costs, taxes or other property expenses from the time it closes its old store until it is able to re-commence operations in its new premises.

Of paramount concern to the retailer is how it will maintain control and leverage during the period that it has no physical presence at the project site. Presumably, in a redevelopment scenario, not only will the retailer have been required to close its store, but its store also will most likely have been demolished, so if the developer subsequently fails to perform, the retailer cannot simply move back in and resume operation. The retailer must protect itself from being left in a “no-man's land” with legal rights on paper but no practical solution to the problem.

The underlying documentation for the relocation of the retailer and redevelopment of the project may take various forms, perhaps an agreement to buy out the old lease and enter into a new one, an agreement to enter into an amended and restated lease, which addresses both the termination of the old tenancy and the commencement and duration of the new tenancy, or any number of other formats. But whatever the format or makeup of the documentation, from the retailer's standpoint it must address certain critical issues, including: 1) Closing the existing store, termination of financial obligations of tenant/retailer, and preservation of legal rights to its old and new premises; 2) Entering into a new development agreement and lease for a new store space to be constructed in the new, mixed-use development; and 3) Preserving the retailer's rights during the interim period and assuring that it can re-commence operations in its new store upon delivery.

For the construction period, the retailer must be certain that the documents address additional issues, including: 1) What will be the scope of the developer's work for the new store and the site in general? Will the retailer perform all of its own finish work? What design controls, approval rights and takeover rights will the retailer have? 2) How much of the overall project needs to be completed (both legally and practically) for the retailer to obtain a certificate of occupancy and to open for business? For example, are life safety and other systems project-wide or individual? 3) If the developer defaults and the retailer takes over construction, how much may it take over and how much will it need to take over? Will the retailer have access to the proceeds of the developer's financing? and 4) What if construction is not completed on time? What damages or other remedies will provide practical protection for the retailer?

The master transaction document or documents should include protective provisions to address the foregoing concerns. For example, in addition to typical conditions for permitting, construction, title, and other important elements, the master document may include a provision such as the following (in which “Phase I” refers to that phase of the redevelopment project which must be completed for the retailer to take occupancy of its new premises, perform its own finish work and open for business):

(_) Financing. Developer shall have closed upon financing (which may be provided through a combination of equity, bank financing, and/or other funding (the “Financing”) from a lender of Developer's selection (the Phase I Lender”) including, without limitation, the execution and delivery of a non-disturbance and funding access agreement from the Phase I Lender, in a form substantially similar to the Lender Agreement as provided herein, and otherwise satisfactory to Tenant in its sole discretion as it relates to changes which would increase Tenant's obligations or diminish Tenant's rights, provided, however, Tenant agrees that any other changes will be evaluated and approved based on its commercially reasonable discretion. The Financing, shall, at a minimum, provide sufficient funds for the construction and completion of Phase I of the Project.

The “Lender Agreement” referred to in the above provision will need to include: 1) typical subordination, non-disturbance and attornment protections between the retailer and the developer's construction lender; and 2) agreements among the retailer, its developer and the developer's construction lender establishing and governing the rights of the retailer to take over the construction work if the developer fails to complete that work in accordance with the applicable approvals or the construction schedule, or falls behind in the performance of the work and cannot demonstrate that it will complete the work by the scheduled dates.

If the retailer elects to take over the construction work, it should be required to give the lender written notice, following which the lender should have a stated period to determine whether it will take over such work. If the lender does not take over the work, before the retailer finally commits to assuming the construction responsibilities, the Lender Agreement should provide that the lender must certify to the retailer that the then-remaining available balance of the financing proceeds and all other construction funds (broadly defined, but most likely including equity funds from the developer which the lender would have previously required the developer to place in escrow) will be controlled by the lender in all events and made available to the retailer for completion of construction.

Summary

This article has attempted to highlight areas of major concern to be considered by a major retailer that anticipates locating in a mixed-use development. The solutions to those concerns, and areas of additional concern, are as numerous as the infinite possible configurations of mixed-use projects. The author hopes, however, that the foregoing discussion will serve as a reference guide for identifying, addressing and solving issues and problems that developers and retailers may encounter in this growing category of commercial development.

John H. Lewis is admitted to practice in Florida, Massachusetts, Georgia and North Carolina, and conducts his national commercial real estate practice through The Law Offices of John H. Lewis, PLLC, based in Raleigh, NC.