Co-tenancies and Mixed-Use Madness

Mixed-use development is defined as ” ' a real estate project with planned integration of some combination of retail, office, residential, hotel, recreation or other functions. It is pedestrian-oriented and contains elements of a live-work-play environment. It maximizes space usage, has amenities and architectural expression and tends to mitigate traffic and sprawl” (Niemira, Michael P., The Concept of Drivers of Mixed-Use Development: Insights from a Cross-Organizational Membership Survey. Research Review, Vol. 4 No. 1, 2007, 54). And it seems to be the wave of the future. Admittedly, my perception may be a little skewed because I live in an area where everywhere I look there is an existing mixed-use development or a mixed-use development is under construction (for example, Crown Farm in Gaithersburg, MD, Pike & Rose in Bethesda, MD, and Market Square at Frederick in Frederick, MD). My office is even located in a mixed-use development.

There are myriad issues that must be addressed when leasing space within a mixed-use development that differ from the standard issues that are of concern when leasing space within retail centers such as enclosed mall shopping centers. For example, the allocation of common-area maintenance costs is vastly different, as you need to allocate costs among the retail, office and residential components of the mixed-use development and/or the different ownership interests that may exist between the retail, office and residential components of the mixed-use development. This article focuses only on one difference.

One such issue that has not garnered much attention is whether or not the residential component of mixed-use developments should somehow be made a part of what would otherwise be a traditional co-tenancy requirement for which retailers often bargain. I would argue, and I do not think many retailers would disagree, that the lure of being a retailer in a mixed-use development is the built-in foot traffic that the residents of the residential component offer the retailers. A recent study found that office workers who both live and work in a mixed-use development spent an average of $793.90 on typical purchases around the office during the workweek (including transportation costs, online purchases, full-service restaurant and fast food purchases, and purchases for goods and services).

Moreover, if you exclude transportation costs and online purchases from that amount, the office workers spent an average of $763.30 during the workweek (ICSC Research, Retail Real Estate Business Conditions Vol. 9 No. 11, May 11, 2012). Another study found that all office workers spent an average of $206.31 on typical purchases around the office building during the workweek; if you exclude transportation costs and online purchases from that amount, all office workers spent an average of $170.88 during the workweek (Niemira, Michael P. and Connolly, John, Office-Worker Retail Spending in a Digital Age. ICSC Research, 2012).

In other words, office workers who both live and work in a mixed-use development spent almost 4.5 times the amount spent by all office workers on average on a weekly basis (excluding transportation costs and online purchases). Because these studies focused on office workers only and not residents, they are not entirely on point; however, it is logical to infer that if office workers who live and work in a mixed-use development spend more than office workers in general, then residents of mixed-use developments likely spend more than individuals who do not live in mixed-use developments. Assuming this inference is correct, landlords who have leased up the residential portions of their mixed-used developments should be able to take that into consideration when trying to satisfy co-tenancy requirements.

Alternatively, retailers of mixed-use developments should be able to add an extra layer of co-tenancy protection that takes the residential component of the mixed-use development into account. The same may also be applicable to the office component of mixed-use properties, but the focus of this article is on the residential aspect; however, the proposed model clauses below can be easily modified to incorporate the office aspect into a co-tenancy clause. Two model co-tenancy clauses that account for the residential component of the mixed-use development are set forth herein.

Landlord's Perspective

The following clause is drafted from a Landlord's perspective. The residential portions of the shopping center are used as an aid in satisfying co-tenancy requirements:

Landlord agrees that if at anytime during the Term, the Continuing Occupancy Requirements (as hereinafter defined) are not satisfied for a period of one hundred eighty (180) days (“Reduced Occupancy Period”) after Landlord's receipt of Tenant's written notice (“Measurement Commencement Date”), then, so long as Tenant is not in default of the terms, covenants or conditions of this Lease and Tenant has remained open during the entire Reduced Occupancy Period and conducts its business in the Premises in accordance with the terms, covenants and conditions of this Lease, commencing at the end of said Reduced Occupancy Period, Tenant shall have the right to pay to Landlord, in lieu of Minimum Rent, an amount equal to fifty percent (50%) of the Minimum Rent otherwise due and payable by Tenant to Landlord under this Lease (hereinafter referred to as “Alternative Rent”), until such time as the Continuing Occupancy Requirements have again been satisfied. It is expressly agreed that Tenant shall continue to pay for all other charges payable by Tenant under this Lease during the time that Tenant pays the Alternative Rent. As used herein, “Continuing Occupancy Requirements,” means that (i) tenants occupying at least sixty percent (60%) of the gross leasable area in the Shopping Center (including the Premises) are open to the general public or (ii) a majority of the units comprising the Residential Portion of the Shopping Center (as said Residential Portion is identified on the Site Plan attached hereto) are leased and occupied by residents. Notwithstanding anything to the contrary contained herein, any tenant closure or unoccupied residential unit caused due to casualty, condemnation, force majeure , or other causes beyond such tenants' or residents' reasonable control shall not be used in determining whether or not the Continuing Occupancy Requirements have been satisfied.

Notwithstanding the foregoing, if Tenant has paid or is entitled to pay Alternative Rent for three hundred sixty-five (365) days (“Last Day of the Measuring Period”), Tenant's right to pay Alternative Rent shall thereafter automatically cease and Tenant shall immediately commence paying full Minimum Rent in accordance with the terms of this Lease unless Tenant terminates this Lease as provided for herein. Tenant shall have the right to terminate this Lease if all of the following conditions have been satisfied: (A) Tenant has not been in default of the terms, covenants, or conditions of this Lease, (B) Tenant has remained open and conducted its business within the Premises in accordance with the terms, covenants and conditions of this Lease from the date of the Measurement Commencement Date through the Last Day of the Measuring Period, and (C) Tenant notifies Landlord in writing of its election to terminate this Lease no later than ten (10) days prior to the Last Day of the Measuring Period. If Tenant has the right to terminate and Tenant elects to terminate this Lease as set forth in the immediately preceding sentence, this Lease shall terminate thirty (30) days after Landlord's receipt of Tenant's notice to terminate. The parties acknowledge and agree that Tenant shall continue to pay Alternative Rent and all other charges payable by Tenant to Landlord under this Lease from the date of Tenant's notice to terminate through the last day of the Term.

Notwithstanding anything herein to the contrary, if Tenant exercises an option to extend this Lease and there is a failure of the Continuing Occupancy Requirements at the time Tenant exercises an option to extend this Lease, then this Section of this Lease shall be deemed to be null and void and of no further force or effect.

If Tenant is permitted to terminate this Lease as provided for above and Tenant elects not to terminate this Lease then, in such event, this Section of this Lease shall be deemed to be null and void and of no further force or effect. Additionally, the remedies set forth herein are Tenant's sole and exclusive remedies for a failure of the Continuing Occupancy Requirements and Landlord's failure to satisfy the Continuing Occupancy Requirements shall not be deemed to be a default of this Lease.

Tenant's Perspective

The following clause is drafted from a Tenant's perspective. The residential portion of the shopping center is an additional layer of co-tenancy protection afforded to Tenant:

If at any time during the Term (i) less than sixty percent (60%) of the leasable area of the Shopping Center (excluding the square footage of the Premises) is open for business or (ii) less than a majority of the units comprising the Residential Portion of the Shopping Center (as said Residential Portion is identified on the Site Plan attached hereto) are leased and occupied by residents, [parts (i) and (ii) are collectively and each separately referred to herein as a "Shortfall")], Tenant's sole obligation for payment of Minimum Rent during the period in which a Shortfall exists, shall be the payment of an amount equal to the fifty percent (50%) of Minimum Rent. If the Shortfall continues for twelve (12) consecutive months following the month in which Tenant commences payment of reduced Minimum Rent (the “Shortfall Measuring Period”), Tenant shall have the option to terminate this Lease at anytime thereafter upon thirty (30) days' notice to Landlord. If the Shortfall ends prior to Tenant's surrender of the Premises, Tenant shall have the right to rescind Tenant's termination upon notice to Landlord. Should the termination date fall within the months of September through the end of December, Tenant shall have the right, but not the obligation, to extend the termination date to the next succeeding January 31, which decision is to be stated in Tenant's termination notice. Within five (5) business days after receipt of a request from Tenant, Landlord shall provide Tenant with a detailed written summary of the current occupancy level of the Shopping Center and the Residential Portion of the Shopping Center.

Conclusion

Please note, with respect to the model tenant clause, this concept should only be included if the landlord owns or has the ability to control the residential component of the mixed-use development. If the landlord has the ability to sell the residential component of the mixed-use development, it must take into consideration any and all co-tenancy provisions tied to the residential component of the mixed-use development. Additionally, if the residential component of the mixed-use development is slated to be completed after the retail component of the mixed-use development, the model tenant clause would need to be modified accordingly.

Although the discussion above may have made an already complicated and heavily negotiated provision more complicated, the tie-in of the residential component to the co-tenancy provision in mixed-use centers will become a part of co-tenancy provision negotiations in the letter of intents for mixed-use centers.

Matthew Davis is an associate with Hirschel, Savitz, Parker & Hollman, P.A., in Gaithersburg, MD.

Mixed-use development is defined as ” ' a real estate project with planned integration of some combination of retail, office, residential, hotel, recreation or other functions. It is pedestrian-oriented and contains elements of a live-work-play environment. It maximizes space usage, has amenities and architectural expression and tends to mitigate traffic and sprawl” (Niemira, Michael P., The Concept of Drivers of Mixed-Use Development: Insights from a Cross-Organizational Membership Survey. Research Review, Vol. 4 No. 1, 2007, 54). And it seems to be the wave of the future. Admittedly, my perception may be a little skewed because I live in an area where everywhere I look there is an existing mixed-use development or a mixed-use development is under construction (for example, Crown Farm in Gaithersburg, MD, Pike & Rose in Bethesda, MD, and Market Square at Frederick in Frederick, MD). My office is even located in a mixed-use development.

There are myriad issues that must be addressed when leasing space within a mixed-use development that differ from the standard issues that are of concern when leasing space within retail centers such as enclosed mall shopping centers. For example, the allocation of common-area maintenance costs is vastly different, as you need to allocate costs among the retail, office and residential components of the mixed-use development and/or the different ownership interests that may exist between the retail, office and residential components of the mixed-use development. This article focuses only on one difference.

One such issue that has not garnered much attention is whether or not the residential component of mixed-use developments should somehow be made a part of what would otherwise be a traditional co-tenancy requirement for which retailers often bargain. I would argue, and I do not think many retailers would disagree, that the lure of being a retailer in a mixed-use development is the built-in foot traffic that the residents of the residential component offer the retailers. A recent study found that office workers who both live and work in a mixed-use development spent an average of $793.90 on typical purchases around the office during the workweek (including transportation costs, online purchases, full-service restaurant and fast food purchases, and purchases for goods and services).

Moreover, if you exclude transportation costs and online purchases from that amount, the office workers spent an average of $763.30 during the workweek (ICSC Research, Retail Real Estate Business Conditions Vol. 9 No. 11, May 11, 2012). Another study found that all office workers spent an average of $206.31 on typical purchases around the office building during the workweek; if you exclude transportation costs and online purchases from that amount, all office workers spent an average of $170.88 during the workweek (Niemira, Michael P. and Connolly, John, Office-Worker Retail Spending in a Digital Age. ICSC Research, 2012).

In other words, office workers who both live and work in a mixed-use development spent almost 4.5 times the amount spent by all office workers on average on a weekly basis (excluding transportation costs and online purchases). Because these studies focused on office workers only and not residents, they are not entirely on point; however, it is logical to infer that if office workers who live and work in a mixed-use development spend more than office workers in general, then residents of mixed-use developments likely spend more than individuals who do not live in mixed-use developments. Assuming this inference is correct, landlords who have leased up the residential portions of their mixed-used developments should be able to take that into consideration when trying to satisfy co-tenancy requirements.

Alternatively, retailers of mixed-use developments should be able to add an extra layer of co-tenancy protection that takes the residential component of the mixed-use development into account. The same may also be applicable to the office component of mixed-use properties, but the focus of this article is on the residential aspect; however, the proposed model clauses below can be easily modified to incorporate the office aspect into a co-tenancy clause. Two model co-tenancy clauses that account for the residential component of the mixed-use development are set forth herein.

Landlord's Perspective

The following clause is drafted from a Landlord's perspective. The residential portions of the shopping center are used as an aid in satisfying co-tenancy requirements:

Landlord agrees that if at anytime during the Term, the Continuing Occupancy Requirements (as hereinafter defined) are not satisfied for a period of one hundred eighty (180) days (“Reduced Occupancy Period”) after Landlord's receipt of Tenant's written notice (“Measurement Commencement Date”), then, so long as Tenant is not in default of the terms, covenants or conditions of this Lease and Tenant has remained open during the entire Reduced Occupancy Period and conducts its business in the Premises in accordance with the terms, covenants and conditions of this Lease, commencing at the end of said Reduced Occupancy Period, Tenant shall have the right to pay to Landlord, in lieu of Minimum Rent, an amount equal to fifty percent (50%) of the Minimum Rent otherwise due and payable by Tenant to Landlord under this Lease (hereinafter referred to as “Alternative Rent”), until such time as the Continuing Occupancy Requirements have again been satisfied. It is expressly agreed that Tenant shall continue to pay for all other charges payable by Tenant under this Lease during the time that Tenant pays the Alternative Rent. As used herein, “Continuing Occupancy Requirements,” means that (i) tenants occupying at least sixty percent (60%) of the gross leasable area in the Shopping Center (including the Premises) are open to the general public or (ii) a majority of the units comprising the Residential Portion of the Shopping Center (as said Residential Portion is identified on the Site Plan attached hereto) are leased and occupied by residents. Notwithstanding anything to the contrary contained herein, any tenant closure or unoccupied residential unit caused due to casualty, condemnation, force majeure , or other causes beyond such tenants' or residents' reasonable control shall not be used in determining whether or not the Continuing Occupancy Requirements have been satisfied.

Notwithstanding the foregoing, if Tenant has paid or is entitled to pay Alternative Rent for three hundred sixty-five (365) days (“Last Day of the Measuring Period”), Tenant's right to pay Alternative Rent shall thereafter automatically cease and Tenant shall immediately commence paying full Minimum Rent in accordance with the terms of this Lease unless Tenant terminates this Lease as provided for herein. Tenant shall have the right to terminate this Lease if all of the following conditions have been satisfied: (A) Tenant has not been in default of the terms, covenants, or conditions of this Lease, (B) Tenant has remained open and conducted its business within the Premises in accordance with the terms, covenants and conditions of this Lease from the date of the Measurement Commencement Date through the Last Day of the Measuring Period, and (C) Tenant notifies Landlord in writing of its election to terminate this Lease no later than ten (10) days prior to the Last Day of the Measuring Period. If Tenant has the right to terminate and Tenant elects to terminate this Lease as set forth in the immediately preceding sentence, this Lease shall terminate thirty (30) days after Landlord's receipt of Tenant's notice to terminate. The parties acknowledge and agree that Tenant shall continue to pay Alternative Rent and all other charges payable by Tenant to Landlord under this Lease from the date of Tenant's notice to terminate through the last day of the Term.

Notwithstanding anything herein to the contrary, if Tenant exercises an option to extend this Lease and there is a failure of the Continuing Occupancy Requirements at the time Tenant exercises an option to extend this Lease, then this Section of this Lease shall be deemed to be null and void and of no further force or effect.

If Tenant is permitted to terminate this Lease as provided for above and Tenant elects not to terminate this Lease then, in such event, this Section of this Lease shall be deemed to be null and void and of no further force or effect. Additionally, the remedies set forth herein are Tenant's sole and exclusive remedies for a failure of the Continuing Occupancy Requirements and Landlord's failure to satisfy the Continuing Occupancy Requirements shall not be deemed to be a default of this Lease.

Tenant's Perspective

The following clause is drafted from a Tenant's perspective. The residential portion of the shopping center is an additional layer of co-tenancy protection afforded to Tenant:

If at any time during the Term (i) less than sixty percent (60%) of the leasable area of the Shopping Center (excluding the square footage of the Premises) is open for business or (ii) less than a majority of the units comprising the Residential Portion of the Shopping Center (as said Residential Portion is identified on the Site Plan attached hereto) are leased and occupied by residents, [parts (i) and (ii) are collectively and each separately referred to herein as a "Shortfall")], Tenant's sole obligation for payment of Minimum Rent during the period in which a Shortfall exists, shall be the payment of an amount equal to the fifty percent (50%) of Minimum Rent. If the Shortfall continues for twelve (12) consecutive months following the month in which Tenant commences payment of reduced Minimum Rent (the “Shortfall Measuring Period”), Tenant shall have the option to terminate this Lease at anytime thereafter upon thirty (30) days' notice to Landlord. If the Shortfall ends prior to Tenant's surrender of the Premises, Tenant shall have the right to rescind Tenant's termination upon notice to Landlord. Should the termination date fall within the months of September through the end of December, Tenant shall have the right, but not the obligation, to extend the termination date to the next succeeding January 31, which decision is to be stated in Tenant's termination notice. Within five (5) business days after receipt of a request from Tenant, Landlord shall provide Tenant with a detailed written summary of the current occupancy level of the Shopping Center and the Residential Portion of the Shopping Center.

Conclusion

Please note, with respect to the model tenant clause, this concept should only be included if the landlord owns or has the ability to control the residential component of the mixed-use development. If the landlord has the ability to sell the residential component of the mixed-use development, it must take into consideration any and all co-tenancy provisions tied to the residential component of the mixed-use development. Additionally, if the residential component of the mixed-use development is slated to be completed after the retail component of the mixed-use development, the model tenant clause would need to be modified accordingly.

Although the discussion above may have made an already complicated and heavily negotiated provision more complicated, the tie-in of the residential component to the co-tenancy provision in mixed-use centers will become a part of co-tenancy provision negotiations in the letter of intents for mixed-use centers.

Matthew Davis is an associate with Hirschel, Savitz, Parker & Hollman, P.A., in Gaithersburg, MD.