Prohibited Uses – Retail Lease Negotiators, Like The Generals, Are Always Fighting The Last War

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This posting precedes a forthcoming July 4 four-day weekend. So, we are surmising that a substantial minority of the 2000+ readers Ruminations attracts each week will be hoping for a short, less than technical topic today. That would be a relief to you and us, given the extraordinary length of last week’s post about how a profit can be made through the use of submetering. If you didn’t see that posting or promised yourself that “you’d get to it,” AND it snows on July 4th, you may want to take that day to revisit the Ruminations blog site.

Only if you’ve been sleeping would you not realize that “times they are a-changin” [a line borrowed from Robert Zimmerman]. It’s not just about the social “culture wars” around us, brought to the forefront last week by some pretty controversial rulings from the SCOTUS. It’s also, in large measure, marked by changes in our “economic” and “recreational” cultures. We seem to be rising from the depths of an economic downturn of the kind last seen by our grandparents and for some readers, their great grandparents. Very few laypeople, pundits, so-called experts, and real experts believe the old days of retail will ever return.

Ruminations thinks the crowd’s wisdom is probably correct. Internet sales can’t fail to cut into sales by traditional brick and mortar stores. That means there will be fewer stores and the remaining ones will be smaller. Circuit City, Linens ‘n Things, and other runner-up retailers won’t be coming back so quickly. The Wal-Marts and other retailers of similar reach have populated the “easy places.” Their size and nature, combined with the high cost of entry to compete against these giant killers, will probably thwart the creation of “look-alikes.” And, at the same time, these dominant retailers’ future expansions will run up against the law of diminishing returns. Vastly improving logistics and inventory control will lead to even smaller store footprints. Yes, there will continue to be a very large retail industry well beyond the life of Ruminations, but it just won’t be the same.

Don’t bail out now just because you’ve heard nothing new yet and because you could list a lot more factors that will result in a sea change in the way the retail real estate industry will look down the road (and perhaps right around the corner). We needed to lay a foundation for today’s posting. Now that we have, we’ll get to the point, but in our customary circuitous manner.

It’s thought that the first indoor shopping center in the United States went up, in Cleveland, in 1890. It is also said that the first regional shopping center with its own parking opened in 1928, also in Ohio. Strip malls were becoming pretty common in the ’20 and ‘30s, and the rest is history.

Who hasn’t heard the adage, “Generals are always prepared to fight the last war?” As we see it, it isn’t only the generals; it is we, the ones who negotiate lease as well. This week, in particular, we’re thinking about the list that sometimes includes items such as “so called gin mills.” Those are the lists on which we also see “massage parlors,” “tattoo parlors,” “arcades,” and the like. Now, before this starts to raise your hackles, calm down, open your mind.

Retailers have traditionally sought a cage where birds of the same feather could flock together. Simply speaking, we call that a “shopping center.” In a limited number of cases, a particular tenant seeks a shopping center populated by a particular other set of tenants, often by trade name; sometimes, by sales category. That requirement is usually captured in the form of a co-tenancy requirement. We can’t think of any landlord that would voluntarily offer co-tenancy protection to a prospective tenant.

On the other hand, when it comes to what “can’t” be operated at a shopping center, as contrasted with what a tenant insists actually be operated there, agreement is often easily obtained, at least as to the concept. That’s not to say that some landlords strenuously resist being bound by any restrictions at all, but it is the rare shopping center where the landlord has not conceded the issue to at least one tenant, usually a major tenant. Often it is to more than one tenant, even if not to all tenants. The effect, on the landlord and the shopping center, however, is the same. If tenants of the larger spaces or tenants with shopper-alluring flags have leases that impose use restrictions on the shopping center, all of the other tenants are likewise protected even if they don’t have a direct remedy.

There are four categories of such use restrictions: (a) those that constitute obnoxious uses; (b) uses that suck up parking or other resources; (c) ones promised exclusively to other tenants; and (d) uses the landlord wants to reserve for potential other tenants.

Here’s an intervening thought. Why does a landlord need to cover (b) or (d), or even (c) in those leases that have narrow and specific use clauses where the landlord has reserved the right to deny consent to a change in use for any reason or no reason at all? Our best guess is that we are afraid of showing individual expression. Be that as it may, there is probably no loss in continuing to follow the belt and suspender approach and when our industry finally concedes that enforceable writings can be entirely electronic, even the damage done to forests and our to our atmosphere (by the paper mills) will be irrelevant.

Now, back to the generals, the last wars, and the changing face of the retail industry. What triggered today’s posting was this headline: “Go-kart raceway brings life back to Cinnaminison mall.” The article described that mall as “long seen as an underperformer.” It quotes officials as saying “it already is a magnet for commerce. … It brings a new set of customers.” The article reminded us that there are a lot of ways to bring customers to a shopping center, and they aren’t all 20th century retail uses. It also described a use usually barred by its inclusion of a list of “prohibited uses.”

Ruminations and many, many others have written about negotiating exclusive use rights. Though there is no end to what can be said about that topic, that won’t happen today. Similarly, we’re not going to comment on landlords who dream of adding a coffee bar style business, insisting that a lease’s list of prohibited uses include coffee bars.

We are, however, going to cover lists that cover high-density parking uses and those that cover uses thought to be “obnoxious.” While there are issues as to whether these lists should bind both landlords and tenants or, if they do, whether the lists should be identical, we think the following principles should inform those lists.

As to high-density parking uses, we’ll use movie theaters as an example. Movie theaters result in a lot of parked cars for two to three hours, often with only a small number of ticket buyers shopping at many of the retail stores at the shopping center. That traditional thought, however, may not be entirely correct. Movie theaters are a destination location. Yes, people come to the property with the principal purpose of seeing a movie, not to spend money elsewhere. So what? The same can be said about sporting goods stores, home improvement centers, and similar retailers. Those examples are almost never found on a list of prohibited uses even though they draw a lot of customers who come only there to buy only what that came for. But, even though those businesses would seem to draw customers who come for that single purpose, they actually advertise the entire shopping center. They bring customers from within a greater radius than would otherwise come to the shopping center. In effect, they bring incremental business. A fair portion of the movie goers or sporting goods store customers who show up would rarely have come anyway. And, some stay for the restaurants, some discover the other retailers at the property, and some plan their shopping based on being at the shopping center “anyway.”

None of this is to deny that these uses, especially ones where parking turnover is in waves and at scheduled times, don’t create a parking problem for stores hoping that their own customers can park “right in front.” Yes, we’re not talking about whether, overall, there are enough parking spaces. We’re concerned as to how that parking is concentrated. So, why don’t we address those issues by agreeing how the parking at the shopping center will be arranged? Why don’t we focus on where the movie theater entrance should be located relative to the retail uses? There are a number of ways to do this. One simple example is to locate the high-density parking uses such that they are end-caps with their entrances perpendicular to, and distant from, other entrances to the shopping center. Another is to bury the high density user inside the shopping center, somewhat distant from the parking so that its customers will disperse their parking throughout available fields.

Let’s face it. Tenants need (and should want) their tenants to be successful. If the shopping center can’t be populated entirely with dry goods stores, why not allow high-density parking users to reside there as well. They bring customers; vacant land, empty stores, and vacant parking fields do not.

Now, what about “obnoxious” uses? Some uses are clearly objectionable to other tenants and are recognized as such by all but the most unreasonable landlord. We looked at a typical list and struggled to find such an example, settling on drug treatment clinics. Look at your own lists and ask the same question in 2013. Ask whether all massage parlors or all tattoo parlors should be on your lists. Those are easy targets because the last war was fought in the 1950’s (which is probably when your list was prepared by you or by the person whose list you copied). Today, 1.65 billion dollars are spent by consumers each year on tattoos; 40% of U.S. adults ages 26 to 40 have at least one tattoo. Those are shoppers in a very important age group, those with growing families. Every reader knows the massage parlor industry has changed and now has a “legitimate” element. It is estimated that in 2010, massage therapy was a $12-17 billion industry with an estimated 280,000 to 320,000 massage therapists and massage school students in the United States. Who hasn’t heard of Massage Envy? Who hasn’t seen a proliferation of “day spas” and physical therapy-focused establishments that offer massage services?

Readers will accurately respond that we’ve adjusted our lists to these new realities. We’ve tweaked them to allow the national and regional chains, but still to keep out the raunchy operators. Tweaking is not the point.

As the relative number of traditional retailers shrinks and as others “skinny down” and where there becomes a limit as to how many frozen desert stores and nail salons can take their place, tenants (mostly, but landlords as well) need to look toward 2025, not back at 2003. Retail shopping centers have absorbed what had previously been thought to be undesirable uses – retail services such as medical offices, retail accounting, real estate brokerages, and the like. That’s because most in this industry agree that an empty space hurts all parties – landlords, their lenders, and their tenants. But, that has been a reactive change. Ruminations believes it’s time to make some predictive changes. After all, today’s leases will affect how our industry adapts to what the world will look like 10, 15, 25 and more years down the road. And, this means not only to think on a micro scale, massage or tattoo parlors, but on a macro scale  ̶  how blocks of space can be designed to be taken out of service as retail space (whatever that might look like down the road), but also to allow, where logically possible, areas of shopping centers to be designed for possible non-retail (e.g., office or residential) use in a way that preserves or even benefits retailers.

If 300,000 square feet of retail space would be a healthy retail environment, why shouldn’t a property owner be able to reserve the right to reduce the existing one from 500,000 square feet by replacing some buildings or part of a building with office uses? That’s not to say that there shouldn’t be some limitation on “how” that would be done, but if the result were no different than having a 300,000 square foot shopping center next door to a 125,000 square foot office building in the first place, doesn’t it make economic sense to keep the property owner economically sound if that’s what the market in 2030 calls for? Everyone loses when a property can’t me mortgaged. Of course, these kinds of arrangements need to be tailored on a location by location basis. We know that’s a lot more difficult that just dragging out the yellow-cornered list with its origins in 1955, but isn’t that why we claim to have a special talent for negotiating retail leases in the first place?

Enjoy the forthcoming holiday weekend.

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Comments

  1. I think we must never underestimate how steadfastly both landlords and tenants will stick to their prohibited use requirements.Also, often the reasons are not entirely clear. Once I was negotiating a lease with one of the 3 major office supply stores, I represented the landlord. As we proceeded to negotiate the tenants prohibited use list we finally got to the item that prohibited office uses. Yes, you have read this right….the office supply store did not want offices in the shopping center.After I raised all the obvious issues and questions and made the obligatory remark that you would think an office supply store would want offices ( direct customers nearby) near it’s store location, we negotiated a satisfactory resolution. The lesson, never underestimate the sanctity of a tenant’s prohibited use list.

  2. Excellent and relevant points; however, you failed to mention an aspect that we’ll be discussing during my upcoming Workshop at ICSC Law Conference: How REA’s/COREA’s drafted for traditional Regional Shopping Centers, and which contain many of the Prohib Uses mentioned in the article, limit Owners from being able to redevelop the SC to meet the needs of the future under the new paradigm.

  3. Jack Levey says:

    Two exclusions that may still be relevant for family-oriented centers: drug oriented stores (long ago known as head shops), and what I will call for brevity’s sake X-rated (excuse me, NC-rated) stores.

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