June 11, 2017
This week, we were working on a mall in the Rocky Mountain States. One of the food court tenants had a precipitous drop in sales – from north of $2m to under $1m from 2014 to 2016. I looked at the monthly sales, and sales had been running about $200k per month almost regardless of time of year. Then in May 2015, sales dropped to under $100k and never recovered. I did a search for the tenant name and the town and May 2015. Lo and behold, less than a mile down the road, the tenant opened a freestanding location on April 30.
It’s not often that obvious. But in this case, a tenant that was well in to percentage rent, had a sales drop of $1m due to opening another location. The landlord lost all of its percentage rent. And, to make matters worse, the tenant had a cap on CAM based upon a percentage of sales.
A real life example of the value of a radius restriction! A radius restriction specifically prohibits a tenant from opening another location within a certain radius of a property. The radius can be down in terms an 「as the bird flies」 distance, or a driving distance, or often even specifically prohibiting a certain competing location (「Shall have no other operations within 5 miles or at Maggie Mall…」). The negotiated distances can range from as little as a half mile to as much as a full 100 miles. With strip centers, 1-3 miles is typical. With regional malls, 3-5 miles is typical. With outlet centers, 25 to 50 miles is fairly typical. (There may be exceptions to outlet center or regional mall leases allowing the operation of the other category within the radius – Something like an outlet center lease stating that 「the tenant shall have no other outlet locations within 25 miles. However, this restriction shall not prohibit tenant from operating its regular, non-outlet operation provided the location is more than 3 miles …」
It may seem odd to think a tenant would agree to a hundred mile radius restriction, but, in cases where a landlord is providing significant financial incentives to a tenant (perhaps bringing a new anchor not currently in the region and fully building out a space, requiring little to no rent, and perhaps even offering something like the first round of inventory), the landlord must know that its investment is protected – at least for a while.
That 「for a while」 means that tenants will sometimes negotiate an expiration of the radius restriction – essentially enough time for a landlord to recoup its investment.
Radius restrictions will often exclude 「then-existing」 locations (i.e. already operating within the radius at the execution of the lease) or those locations a tenant subsequently acquires via something like a merger. And, the clause will typically address remedies other than just default – most typically a requirement that the sales from the violating location be included in the reported gross sales for the landlord’s premises (but in cases where there is no percentage rent requirement, it may address an increase in minimum rent).
Not to be one sided, radius restrictions are not always just limited to tenants. It is not unusual for a supermarket or theater lease to restrict a landlord from allowing another supermarket or theater on property controlled by the landlord within some negotiated distance.
Believe it or not, we worked on one trophy regional mall where the operating agreement between the partners actually restricted one partner from developing or acquiring another property within a 25 mile radius of the property.
A radius restriction can be a very powerful tool to protect a retail investment.
(Unfortunately, the lease in the Rocky Mountain States Mall did not have a radius restriction!)