In large shopping centers like strip malls, or even regular malls, there is usually one large, big-name store that draws customers to the area and attracts business to all of the smaller nearby stores. When that large store shuts down, though, it can be a major problem for the smaller stores, who inevitably lose business as a result. For this reason, it’s a good idea for those tenants to request a co-tenancy clause in their leases.
What Is a Co-Tenancy Clause?
A co-tenancy clause is part of a lease agreement and applies to retail leases, allowing co-tenants to pay a reduced rent if a key tenant — also called an anchor tenant — or a certain number of co-tenants leave the retail space. Often, larger tenants draw more customers and traffic, particularly in malls or strip malls, so smaller tenants choose that location specifically for the traffic brought in by those large tenants.
When the large tenant chooses to leave, or a number of retail tenants leave, this vacancy affects business for the other tenants in that location, including tenants with a percentage lease. A co-tenancy clause provides some level of protection through reduced rent as compensation for the loss of business if the landlord is unable to find a replacement tenant.
In a retail shopping center like a mall or strip mall, there are usually one or more anchor tenants. These are the large, popular stores that attract the most foot traffic. For a mall, the anchor tenants would be the large department stores like Macy’s, J.C. Penney or Nordstrom. In a strip mall, whatever the largest or most well-known store is could be the anchor tenant.
“A co-tenancy clause is one that enables a tenant to potentially receive reduced rent in the event that an anchor tenant terminates its lease in the property,” said Matt Kramer, a partner at Weinberg Wheeler Hudgins Gunn & Dial.
How Are Co-Tenancy Clauses Structured?
Co-tenancy clauses are usually written in dense, legal language, but there are three key factors to pay attention to:
- the co-tenancy threshold
- the cure period
- the relief
The Co-Tenancy Threshold
The co-tenancy threshold is the threshold at which the tenant can invoke the co-tenancy clause. Usually, that threshold is given as a percentage that might stipulate that 60% of the co-tenants in the shopping center must be open and operating. Otherwise the co-tenancy clause goes into effect.
The specific language and terms vary from lease to lease. Sometimes, the contract is not based on the percentage of businesses, but rather the leasable square footage, or perhaps a specific anchor tenant.
“Often, back in the days of malls, you’d see clauses where Nike would say, ‘We need to have two of the three anchors open — Nordstrom and Saks. In addition, the mall has to be 70% leased. And if it’s not, we can go on reduced rent or terminate our lease,’” said David D. Wasserman, a Senior Real Estate Advisor at Solomon Partners.
Some co-tenancy clauses include a cure period, a period of time during which the landlord can bring in new tenants to get above the co-tenancy threshold. For instance, a landlord might include a clause stating there’s a 100-day cure period. This stipulation means the landlord has 100 days to find a replacement tenant before the co-tenancy clause comes into play.
The final part of a co-tenancy clause includes the relief a landlord provides. One form of relief could be the reduction of rent. For example, if the co-tenancy threshold is not met, a tenant might have their rent reduced by 5% — or whatever number the landlord and tenant have agreed upon.
Another form of relief could be termination of the lease agreement. The relief clause could state that if the closed stores don’t reopen within an agreed upon period of time, the tenant has the right to terminate their lease.
How to Negotiate Co-Tenancy Clauses
Both landlords and tenants should negotiate the terms that work best for them when it comes to a co-tenancy clause. When requesting co-tenancy, tenants typically have the upper hand, as it’s a clause that benefits them primarily, and not the landlord.
For landlords, co-tenancy clauses aren’t ideal, as they could cause a mass exodus of tenants, or significantly lower rent income.
“Landlords don’t want it,” Wasserman noted.
However, there are a few clauses a landlord can include in the lease to protect themselves from too much financial loss.
“From the landlord perspective, you’ll want the tenant to only be able to exercise the co-tenancy clause if the tenant is not in default,” Kramer said.
A landlord should include a clause that states the tenant cannot invoke co-tenancy if they are in default of their lease.
“Another provision that is often negotiated is the tenant providing proof that sales have been reduced as a result of the anchor tenant terminating its lease,” Kramer said. “So if you’re the landlord, you’ll want to have the tenant show evidence of the drop in sales.”
By including this clause, without a drop in sales, a landlord could then argue that the co-tenancy clause will not go into effect. Landlords can also include limitations on the remedies available to a tenant, meaning a tenant can receive reduced rent or the ability to terminate their lease, but not both.
Tenants should negotiate the terms of the clause as they relate to threshold, cure period and amount of relief, arguing for as much as the landlord is willing to give.
Example of a Co-Tenancy Clause
There are a number of different anchor tenants whose closures would activate a co-tenancy clause. Whole Foods, for instance, often drives foot traffic into a shopping center, helping out the other nearby businesses.
“If you have a shop, and you’re going to open up in a shopping center next to Whole Foods because you’re relying on the traffic from Whole Foods, they’re the anchor,” Wasserman said. “If you have enough influence, and you’re desirable enough to the landlord, you could say to the landlord, ‘I want to have a co-tenancy clause, which would then be such that if Whole Foods leaves or closes, you have the right to cancel your lease.”
Those smaller tenants can then activate the co-tenancy clause if the Whole Foods in that complex closes or terminates its lease.
Co-Tenancy Clauses Protect Small Businesses When the Anchor Tenant Leaves
In the event that an anchor tenant leaves a shopping complex, co-tenancy clauses provide some level of protection to the smaller businesses in the area, who can argue for reduced rent or the termination of their leases. This financial cushion offsets some of the revenue lost and provides tenants with a sense of safety and assurance.