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Spot the difference! – Enclosed mall vs. open air center leases

A few weeks ago, we addressed the major differences between retail and office leases. While retail leases across categories have more similarities than differences, there are distinctions between retail leases in enclosed centers and retail leases in open air centers.

Some may be obvious – there are no enclosed malls to heat and cool in open air centers (though sometimes you may have an outlet center or open air mixed use or festival center that has public restrooms or a food court component that is heated and cooled). However, many of the differences are attributable to the way centers are operated (and can vary greatly based upon market conditions). We’ll address a few of these:

CAM – In the late 90s/early 2000s, mall leases had begun a transition to fixed from prorata. Today, the majority of enclosed mall leases are fixed CAM wit increases. Where they are not fixed CAM, it is typically property specific, where the majority of leases in those centers are prorate. We’ll use a later blog to talk about the pros and cons of fixed vs. prorata. Where there are malls still on prorata CAM, there is one mall distinction in the calculation of prorata CAM – it is much more likely that management fees are included in CAM billed to open air center tenants. Many of the leases for mall tenants define CAM to include the 「costs of managing…」 the common areas (or shopping center), but, while allowed, landlord typically do not bill management fees.

Denominators – When tenants do pay a prorate share of a charge (taxes, CAM, insurance), it is much more likely that inline tenants in regional malls will be billed based upon 「leased」 area, while more likely that open are tenants will pay based upon 「leasable.」 There has been an ongoing shift since the early to mid 90s for open air centers to bill based upon 「leased,」 but it is a slow transition.  (Based upon the 8-10,000 leases we review a year, I would estimate that 85-90% of inline regional mall tenants pay based upon leased, while only 20-25% of open air tenants are billed based upon leased.

Excluded areas – In open air centers, it is fairly common to have a few defined excluded areas – separately assessed premises, supermarkets, outparcels and perhaps premises greater than xx,xxx sf. However, if regional malls, it is not uncommon to have eight or nine different categories – department stores, variety tenants > xx,xxx sf, non-fronting premises, restaurants with exterior entrances, mezzanine areas, theaters – the list can go on with creative landlords.

Percentage rent – While percentage rent may be the single most material distinction between retail and office leases, and almost every retail 「standard」 lease contains a percentage rent and gross sales reporting clause, the requirement is much less likely to remain in open air leases than in regional mall leases. Regional mall leases are 90-95% likely to have the requirements, while open air leases are probably closer to 50-55%. While percentage rent may get deleted, landlord are much less likely to give on the sales reporting requirement as it can be used to determine the health of the tenant and help to establish any renewal rent.

Exclusive uses – While exclusive use clauses exist in almost evert retail property, they are much more prevalent in open air centers. And, where the exclusives do not exist outright, it is not uncommon to see 「springing」 exclusives in open air centers. A springing exclusives would read something to the effect of 「Landlord warrants that no tenants in the shopping center has been granted exclusive rights. However, if the landlord grants an exclusive to another tenant within the shopping center, then tenant shall have the exclusive right to sell…」

Security deposits – In a 125-150 tenant regional mall, there might be a handful of security deposits. However, in strip centers, where there are many more mom-and-pops, it would not be unusual to have a security deposit for every tenant that is not a national or regional tenant.

While these do represent a handful of the differences between enclosed mall leases and open air leases, remember that there are no absolutes. You will find differences and similarities in all categories of commercial real estate leases.

Shopping Centers – 「Bring out your dead!」 「I’m not dead!」

This particular blog in not the Sunday blog addressing lease administration issues. It is an opinion piece. I’ll be back to the regular blog on Sunday.

If you’ve clicked, you probably know the Monty Python reference. If you don’t know it, I’ll try to explain dry (but incredibly funny) British humor. The Dead Collector is collecting dead bodies and hauling them away.  A guy drops a 「body」 on the cart and pays a fee. The 「body」 says 「I’m not dead.」 And then there’s an argument about it being against regulations to take someone who is not dead. The 「body」 argues that he’s getting better. Then a 「No you’re not. You’ll be stone dead in a moment.」 (Here’s think link if you need a quick laugh – https://www.youtube.com/watch?v=fXibX5I0ZBU)

That’s what I feel like we have been seeing for years – no decades – and continue to see today. The media waves its banner that shopping centers are dead, and the industry repeats that it is not.  But, the media continues to argue that it is dead, until finally, one day, the Dead Collector will take out his club and whack the industry over its head one final time.

But, for some perspective, the sky has been falling since I got into the industry in 1987.

This morning, I saw yet another article on The News Funnel – The Death of Shopping Centers. It’s actually a pretty good read and not nearly as negative as it sounds. But, it does present as absolute – 「about 400 of the country’s 1,100 enclosed malls will fail in the upcoming years.」

The number and the timeframe changes from article to article, but the headlines scream:

Dying shopping malls are wreaking havoc on suburban America – Business Insider, March 5, 2017

A Third of American Malls Will Close Soon – Money, May 12, 2016

America’s Shopping Malls Are Dying A Slow, Ugly Death – Business Insider, January 31, 2014

Birth, death and shopping – The rise and fall of the shopping mall – The Economist, December 19, 2007

The earliest article I have listed above is from 2007. This is a blog. I am lazy. I am not going to a library to go back further. However, I can tell you that in the late 1990s, then-ICSC (International Council of Shopping Centers) President John Riordan was already responding to 「death of the mall」 discussions. I wish I had access to those presentations. But, the gist was that the then-universe of online sales was still less than the sales from one regional mall (I think the specific reference may have been Roosevelt Field Mall). But, he presented, matter of factly, that online sales were here to stay and would continue to grow.

Around the same time, there were sessions at ICSC events addressing 「alternative uses for regional malls」 and 「alternative uses for department stores.」 This was 1997/1998. But, the so-called death of the center pre-dates online sales.

I worked on project at Savannah Mall in 1992. It had opened in 1990, about five miles from the then-leading mall in the area, Oglethorpe, and was absolutely beautiful.  It was built where a new perimeter road/bypass was to have been built and was to have been the nail in the coffin for its competition. But, the funny thing is, Oglethorpe dug in its heels, renovated (and succeeded), the bypass didn’t materialize, and within that two year period, Savannah Mall was struggling. I was fairly young and green at the time, so I did not have much of an opinion. However, I believe the general consensus at the time was that Savannah should not have been built.

That was likely the case with hundreds of malls. My numbers are going to be off a bit, but I believe the number quoted around 1995 was somewhere in the neighborhood of 1,800 regional malls in the US. Today, the number quoted is between 1,100 and 1,300. So, in 22 years, we have 「lost」 a third of what may have been our peak number of malls. I put 「lost」 in quotes because many have kept their retail characteristics. It’s not necessarily that they are dead (and, yes, some really are dead), but that they have evolved and continue to evolve.

My entire geography of the country is based upon regional malls. If you can tell me where you shopped growing up, or shop now, I have a pretty good feel for where you are from. But, home to me is Atlanta (Northpoint Mall) and Philadelphia (Neshaminy and Springfield Malls).  Lenox Square and the King of Prussia complex are two of the more successful properties in the Atlanta and Philadelphia markets, respectively. Both of these properties began their existences as open air centers before becoming enclosed. Both had supermarkets when they opened.

As you are probably aware, supermarkets were one of those uses that became 「prohibited uses」 in regional mall leases because they were parking hogs. Along with other uses like health clubs, education and residential, landlords, department stores and inline tenants did not want certain uses in the center. But, look at where we are headed today.

Natick Mall in suburban Boston incorporated residential  a few years back, and now has Wegmans replacing a Penney. Uses that had once been strictly forbidden are being welcomed. Supermarkets are being incorporated into malls around the county. It’s not death, it is evolution.

I go to many ICSC events, either as an attendee or as faculty. The education, advocacy, connections, experiences and opportunities facilitated by organization are invaluable. At ICSC’s Spring Convention (RECon) in 2015, I attended a breakfast roundtable led by Bill Taubman, CEO of Taubman, an owner that owns many of the best malls in the country. My takeaway from that roundtable was that Taubman was working on generating value from retailers because studies continued to show that online sales were much higher in areas where tenants had a bricks and mortar presence than in areas where they had none. And at this year’s University of Shopping Center, I had the benefit of sitting with Dia Lim, a manager in the Philippines. Her company is a leading owner of malls – really mixed use properties – in the Philippines. (As she proudly put it, not 「a」 leading owner, but 「the」 leading owner!) Because the Philippines retail environment developed decades after ours, they had the opportunity to learn from our mistakes and were able to develop more master planned properties (malls, office, residential, education, etc.) rather than focusing exclusively on the tenant mix within the properties. It seems now that we have the opportunity to learn a little from them.

I have rambled. But, in my opinion, just as the television did not signal the death of the theater, online is not the death of bricks and mortar. Pulling a word from my high school biology class, online and bricks and mortar have something of a symbiotic relationship. Each may benefit from the other.

It truly is not the death of malls or shopping centers. It is a continued evolution.

Why should you care about the definition of the 「Shopping Center」 in the lease?

This past week, we were working on a sizable shopping center acquisition in the Southeast. Part of the center had been a mall that was 「de-malled,」 while the balance was developed in two additional phases. The original mall became a series of big boxes, some traditional small shop retail, a few restaurants and a bit of service type retail now often found in shopping centers (dental, doc-in-in-a-box and the like). The second phase added a discount department store and some other big boxes, and the third phase added a supermarket and small shop retail. More recently, some big box space was converted to a nice health club, a theater was added and a group personal training facility lease had been executed.

We knew 「shopping center」 was going to be an issue for this acquisition. We just did not realize how much. Many of the leases defined shopping center as 「(Name) shopping center as reflected on the Exhibit A site plan.」 Others defined the center as Phase II or Phase III, or Phase II and III. Other defined the center as 「(Name) shopping center as described on Exhibit A,」 with Exhibit A being a two page metes and bounds description. There were about 10 different iterations of the term 「shopping center.」

Why would that matter? Because some lease prohibited health clubs or theaters. Others granted exclusives in the shopping center defined in their lease. While yet others extended the exclusives and restrictions to adjacent parcels controlled by the landlord or its affiliates. This mish-mosh of definitions caused our client to wisely have the seller seek waivers on certain existing uses prior to closing, and created the need for an almost Venn diagram type site plan for what can go where. Without the waivers, without a clear picture of restrictions and exclusives, a new owner could have some exposure.

There are other financial implications of the definition of shopping center that we will hit in a future blog, particularly as it relates to whether a particular space is included in the definition of the shopping center and then defined as an excluded area, or whether it is excluded from the definition of the shopping center to begin with. But, be clear about how you define the shopping center in your leases!

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