Changing Face of Retail and Office Real Estate – Let’s Talk About It

Forum hosts industry leaders to discuss legal, real estate, development, leasing, lease administration and auditing trends on commercial real estate.

NRTA Expanding Knowledge 2018 conference logoGregg Ankenman, Esq., Forum Moderator

As the U.S. economy changes so does the commercial real estate market including the retail and office sectors. In response to online competition and the closure of a growing number of big box stores and other retailers, landlords and tenants are trying to reinvent malls and other centers as well as store design and operations. More non-traditional tenants, as well as entertainment tenants, now occupy space in traditional retail centers. For example, fitness clubs, medical offices, educational facilities, game operators and theme restaurants are becoming common. At the same time, office tenants are using less space per employee and requiring more flexible space. Mixed-use developments and conversion of existing projects to mixed-use are on the rise, combining retail, office, residential, hotel, and other uses.

At this year’s NRTA conference, we wanted to provide a forum where attendees can hear from industry leaders on ways to adapt and thrive in the changing real estate and retail landscape. To this end, we have put together a diverse panel of legal, real estate, development, leasing, lease administration and auditing experts to discuss the significant business and legal impacts of these trends on commercial real estate, including those discussed below.

Occupancy Cost Allocation: One of the key areas of concern these changes in commercial real estate are raising is proper allocation of costs. The issues include how to fairly allocate costs among different types of users that often have widely different levels of need and usage of utilities, services, and amenities. Cost allocation considerations are addressed in detail in a separate article by Rick Burke.

Transportation and Parking: Transportation and parking considerations are evolving and complicated. Higher density users, in both retail and office settings, will have greater transportation needs and, under current models, parking demands. On the other hand, calculations of parking needs may look very different in coming years with increases in ride-sharing, the push for housing near work and the future impact of driverless cars. To ensure adequate parking, tenants should consider designating protected parking areas, specifying minimum numbers of available spaces and/or requiring parking management programs.

Character of Center; Compatibility of Uses: As various types of non-traditional tenants are increasingly occupying shopping center spaces, landlords and more traditional retail tenants need to work together to deal with existing and future “prohibited” uses. Of course, many retail tenants already include provisions in the leases to prohibit various immoral, obnoxious or otherwise objectionable uses, and some tenants may now want to add other use restrictions in the face of evolving trends. On the other hand, landlords will want to preserve flexibility as space requirements and users evolve over time. These considerations come into play as a number of long-time retailers (including certain big box tenants) have closed or reduced the size of stores in recent years and as retailers and shopping centers seek to attract shoppers in the face of online competition.

Co-Tenancy; Exclusive Uses: Many national and regional retailers have negotiated co-tenancy protections and exclusive use rights in their leases. Changes in the nature of retail and mixed-use projects and in the business operations of occupants also present challenges in interpreting and enforcing the co-tenancy and exclusivity provisions. Furthermore, these changes are causing landlords and tenants to reexamine how to approach these issues in negotiating new leases. For example, the traditional definitions of an “anchor tenant” and even of a “retailer” are losing relevance in the evolving retail and real estate landscapes.

Operational Changes for Retailers: Many retailers are looking to new approaches to how they operate and use their stores in an effort to attract customers and compete with online sellers. Innovations include in-store internet kiosks and interactive digital ordering options as well as in-store pick up of internet purchases and delivery of merchandise. Retailers, including fairly traditional retailers, are also adding all kinds of community outreach and public engagement activities and even entertainment with things like murals by local artists, music and videos, and food trucks. For certain retailers, some flagship stores are becoming as much–or more–about branding and promotion as they are about sales from the store. This all raises many issues as retailers seek greater flexibility in their own use and permitted activities and at the same time seek to have some restrictions on what other tenants can do.

Percentage Rent: Changes in retail operations and space usage are also raising questions about what ought to be considered a sale from the premises for purposes of percentage rent and even about whether percentage rent makes sense at all in the new retail environment. For example, if a customer orders merchandise online and selects the option of picking up the purchased item at a particular store, should that sale be counted in determining percentage rent for the store? What about a purchase made from an in-store internet kiosk?
User Density and Building Configurations: Both office and retail tenants are seeking out-buildings with more flexible floor plans that can be configured into more productive spaces and can evolve over time. In the office world, there are also two other somewhat competing trends that will affect the demand, use, and value of real estate in ways that are difficult to predict: (1) the movement for more shared spaces and less space per employee and (2) the expected continued increase in employees working remotely.

Zoning, Use and Code Compliance: As landlords and tenants look for new ways to use underutilized or vacant spaces, they may well need new approvals from cities and regulatory agencies and may face new regulatory requirements. New uses or higher-density uses may trigger greater parking requirements or fire and building code upgrades. Both landlords and tenants should take care to fully investigate, evaluate and address land use restrictions and approval requirements as well as possible code compliance issues and responsibilities.

It is clear that changes in business operations and space usage in office buildings and shopping centers present significant challenges for landlords and tenants, but they also present exciting opportunities. Those who educate themselves and anticipate these evolving trends will be better positioned to address concerns and liabilities in lease documents and thus will be better prepared to handle the challenges and take advantage of the opportunities.