A typical retail shopping center or mall works under a tried and true business plan. The owner and/or developer of the property works first to attract one or more “anchor” tenants and then surrounds them with a variety of smaller tenants who benefit from the traffic they create. Together, the anchor and their supporting tenants form a mutually beneficial “ecosystem” that works to deliver a pleasurable experience for all shoppers. To illustrate how this works, consider two classic retail examples, a shopping mall and a grocery store anchored shopping center.
In a typical shopping mall, the “anchors” are department stores like Macys, Nordstrom, or Neiman Marcus. On their own, these stores can create a big draw so other, smaller stores want to be near them. As a result, the rest of the mall is filled with tenants like clothing stores, electronics shops, and food courts who will benefit from the traffic produced by the department stores. Together, they create a coherent shopping experience for all visitors.
Same idea for the grocery store anchored center. A large, well-known grocer like Publix or Safeway provides the main draw while the tenants that surround them benefit from the foot traffic they generate. These tenants typically include coffee shops, nail salons, bank branches, and quick service restaurants. Together, they allow a shopper to complete many of their daily errands without having to leave the center, a convenient and time-saving value proposition.
But, like any “ecosystem” if one or more tenants choose to leave the shopping center (for whatever reason), it can have a detrimental impact on the whole. For this reason, many tenants attempt to negotiate the inclusion of a “Co-Tenancy Clause” in their lease agreement.
What is a Co-Tenancy Clause?
A Co-Tenancy clause is language in a retail lease agreement that provides rent relief or other remedies for the existing tenants if the “ecosystem” breaks down after multiple tenants leave the property. To illustrate how this works, it is helpful to continue the example from above.
Assume that a grocery store anchored shopping center is arranged so that a Publix is the anchor tenant and there is a coffee shop, nail salon, stationary store, smoothie shop, quick service restaurant, and office supply/shipping store that surround it. In particular, the nail salon and stationary store are heavily dependent on the foot traffic created by the grocery store. If it were to go away, their business could suffer significantly. So, they may attempt to include a co-tenancy clause when negotiating their lease which states that, should the grocery store leave, there will be a significant reduction in their rent to compensate for the loss of business.
Co-Tenancy Clause – Example
By definition, a Co-Tenancy clause contains dense legal language. For example, the following language is taken from a co-tenancy clause in a retail lease. The key points are highlighted in yellow and will be discussed in detail below:
Continuing Co-Tenancy. Notwithstanding anything to the contrary contained herein, in the event less than sixty-five percent (65%) of the tenants in the Shopping Center, excluding the Premises, are open and operating in the Shopping Center, and Landlord fails to cause replacement tenants as the case may be, to reopen in such space (“Co-tenancy Requirement”) within one hundred eighty (180) days after the closing of more than sixty-five percent (65%) of the tenants in the Shopping Center, Tenant’s duty to pay Minimum Rent shall be suspended from the one hundred eighty-first (181st) day after such closing occurs until the Co-Tenancy Requirement is met and Tenant shall pay to Landlord, in lieu of Minimum Rent and additional rent, by the twentieth (20th) day of each month thereafter, an amount equal to four percent (4%) of Tenant’s Gross Sales for the preceding month, but not to exceed the amount due as Minimum Rent under the terms of this Lease for such period, plus ancillaries due under the Lease. If such closed store(s) fail to reopen by the end of the twelfth (12th) month after such store(s) originally closed, Tenant may terminate this Lease upon sixty (60) days written notice delivered to Landlord within the ninety (90) day period following the end of such twelfth (12th) month period, provided, however, Tenant’s termination shall be void in the event of the curing of the Co-Tenancy Requirement prior to the expiration of the Notice Period. If Tenant fails to terminate within such ninety (90) day period (“Notice Period”), the Minimum Rent due hereunder shall once again become due and payable on the first day of the month following the end of the Notice Period. 7.
From the the sample clause, there are three key pieces of information to look for:
- The Co-Tenancy Threshold: Although the specific language can vary from one lease to another, it should always include a threshold for which the tenant has the ability to invoke the co-tenancy clause. The example above states “…the event less than sixty-five percent (65%) of the tenants in the Shopping Center, excluding the Premises, are open and operating…” So, in this case, the threshold is that 65% of the tenant must be open and operating. If they aren’t, the tenant has the ability to invoke the clause. In some instances the calculation of the threshold is also defined. So, it could specify something like it must be 65% of total tenants or 65% of the leasable square footage.
- Cure Period: In some cases, the property owner may have a cure period in which they can bring in new tenants to get back above the co-tenancy threshold. In the example, the cure period is described as “…and Landlord fails to cause replacement tenants as the case may be, to reopen in such space (“Co-tenancy Requirement”) within one hundred eighty (180) days…” In other words, the space could fall below the threshold, but the property owner can bring in replacement tenants or reopen the existing ones up to 180 days after the closing of the tenant that caused the breach of the threshold.
- Relief: Finally, the clause should specify exactly what relief is available to the tenant if the co-tenancy threshold is breached. In the example clause above, there are two types described:
- Rent is reduced to 4% of the tenant’s gross sales, not to exceed the minimum rent due under the lease.
- Or, if the closed stores fail to reopen within 12 months, the tenant has the right to terminate their lease.
Clearly, co-tenancy clauses are very favorable to tenants. But, their ability to negotiate one may depend on how much leverage they bring to the table. For this reason, there are several considerations that the property owner will make with regard to the clause.
Co-Tenancy Clause – The Property Owner Perspective
From the property owner’s perspective, there is a clear risk that the inclusion of a co-tenancy clause in tenant leases could cause a property to “spiral.” If an anchor tenant leaves or the threshold is reached to invoke the clause, multiple tenants could invoke it at once causing a sudden and substantial spike in the vacancy level. Such a situation could cause the property’s Net Operating Income to turn negative and, in a worst case scenario, for the owner to default on their debt.
To protect themselves from this, a property owner may insist that a co-tenancy clause come with a few stipulations:
- Default: The language in the clause may state that the tenant cannot invoke it if they are in default on their lease.
- Evidence: The clause may also require that a tenant provide evidence of harm or a drop in sales as a result of the other vacancies. This evidence may be in the form of tax returns or operating statements that show a clear decline in sales over prior periods.
- Multiple Remedies: Finally, the co-tenancy clause may include limitations on the remedies available to the tenant. In the example above, the tenant can get reduced rent and the ability to terminate their lease. To protect themselves, property owners prefer to limit the number of available remedies.
So, in return for granting the inclusion of a co-tenancy clause, property owners may seek to extract their own set of concessions from the tenant.
Summary & Conclusions
Often, the tenant mix in a retail shopping center revolves around the idea of creating an “ecosystem” where many smaller tenants revolve around one or more “anchor” tenants who drive traffic to the center. If an anchor tenant leaves or the total occupancy of the property dips below a certain level, the remaining tenants could suffer damage to their business. To protect against this, they may negotiate for the inclusion of a co-tenancy clause in their lease.
A co-tenancy clause is one that includes legal language that allows a tenant to request rent relief or other remedies from the property owner if the total occupancy of the center falls below a certain level. Typically, remedies include some type of rent relief and/or the ability to terminate the lease based on certain conditions.
Because the co-tenancy clause is favorable to the tenant, the property owner may try to include a set of stipulations that limit their risk from the inclusion of the clause in a lease.