Is the Future of Retail Leasing in Redevelopment? 4 Considerations for Landlords to Keep in Mind When Restructuring Retail Centers

In 2024, the market is coming to terms with the reality that brick-and-mortar retail will likely not be what it was pre-pandemic. However, where uncertainty and fear regarding the future of retail was prevalent just a couple of years ago, today retail landlords are beginning to embrace this new reality and seize the opportunity to explore new and unique forms of redevelopment of their retail centers.

Earlier this year, Simon Property Group spent $400 million in the construction of luxury apartments, a hotel, and amenities (including a fitness center) as part of the redevelopment of its Southdale Center in suburban Minnesota. This redevelopment of the former retail center also included repurposing big-box retail spaces for commercial space for luxury brands (as opposed to the former lower-end uses).

As retail landlords develop solutions to adjust to a new market, there are several considerations to take into account:

1. Prohibited Uses: Introducing a new tenant mix and residential units results in new uses at properties that were previously 100% retail centers. Most retail centers are bound by Reciprocal Easement Agreements (REAs), which contain several prohibited uses that are often outdated. For example, REAs often contain restrictions on “schools,” “fitness use,” or “medical use,” exposing landlords to the risk of a violation through leasing to tenants such as Kumon (tutoring centers), Code Ninjas, Lifetime (fitness centers), or dental clinics. Additionally, many tenant leases prohibit non-retail-type uses. Retail landlords should review these REAs and leases, familiarize themselves with the prohibited uses, and understand both the risks and consequences of violating the prohibitions in connection with their redevelopment.
2. Zoning: Retail landlords must familiarize themselves with the zoning restrictions affecting their properties when repurposing and redeveloping them. Properties zoned for commercial use are often prohibited from being used for residential use. Apart from understanding current zoning designations and applying for rezoning, retail landlords must familiarize themselves with current building codes and safety and accessibility requirements (including ADA).
3. Rent Structures: In January 2024, the Wall Street Journal reported that retail landlords are moving away from granting rent discounts and concessions like those readily available during the pandemic. However, retail landlords may still consider creative profit sharing to lure new retailers. Percentage rent structures often provide tenants comfort that their landlord shares the risk and reward of a successful tenant business; however, if a lease is structured with a tenant only paying percentage rent and no fixed or base rent, it’s challenging to negotiate the imputed rent if the tenant is closed for business for any reason, including if they are unable to operate due to a force majeure (such as government-mandated closures). Tenants will now likely push back on such imputed rent provisions, especially if the closure is due to circumstances outside of their control. Landlords will benefit from negotiating percentage rent and shared profit structures in detail in the initial letter of intent to be sure they can come to an agreement with the tenant (as opposed to dealing with it later during lease negotiations).
4. Services: Retail landlords may also consider taking on services on behalf of their tenants beyond those that landlords offered pre-pandemic. Security at retail centers, especially in urban locations, has become a concern. When introducing a residential component, landlords may consider offering additional security services. Landlords will want to ensure that risk is appropriately allocated and that, although the security services are provided, tenants cannot hold the landlords liable for security breaches. In addition to security services, retail landlords may also offer more extensive marketing and landscaping services. In connection with such services, landlords should look at their existing leases (and new amendments and new leases) to ensure these costs are reimbursable through operating expense charges.

The list is by no means a comprehensive list of issues. Redevelopment involves financing and loan arrangements, construction, and a host of other considerations. As retail landlords consider redevelopment, a good team of business professionals and legal advisors is essential for growth.