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Not All Retail Leases Are Created Equal
There are important distinctions between in-line leases, ground leases and leases of stand-alone buildings for retail uses.
Understanding the complexities of retail leases is essential for landlords and tenants alike. Retail leases include provisions for issues related to allocation of operating costs and taxes, as well as maintenance and repair obligations, common area rights, and obligations following fire or another casualty.
These agreements establish the financial, operational and legal framework that safeguards each party’s interests, so it is important to recognize that a lease for one type of retail space likely carries far different considerations than a lease in another type of retail space. For example, leases for in-line premises located in a shopping center call for different obligations on both the landlord and the tenant when compared with leases for freestanding buildings or ground leases. This article highlights some of the distinct considerations that go into negotiating and drafting leases for different kinds of spaces.
Accounting for Costs
Typically, the tenant maintains and repairs the leased premises and is responsible for those costs, while the landlord is responsible for the exterior and structural portions of the building and the common areas. In this arrangement, the tenant pays its proportionate share of the landlord’s operating costs.
Though that may be true for in-line leases, it is not always the case for ground leases and leases for freestanding buildings. Ground tenants are often obligated (and prefer) to maintain, repair and replace every improvement on the leased premises at their sole cost and expense. Similarly, in leases for freestanding buildings, tenants may want to operate their space (including adjacent common areas, such as drive-throughs, patios and reserved parking areas) independently, so landlords may be required to maintain and repair only those common areas outside of the areas the tenant intends to maintain. In this case, freestanding tenants usually pay all operating costs associated with the building and their exclusive-use common areas.
Considering Common Areas
Aside from the maintenance and costs associated with common areas, the actual use of those areas has various implications within the variety of retail leases. Ground leases of a single parcel that is not part of a larger shopping center are usually free of these considerations. Ground tenants have exclusive possession of the entire leased space. However, ground leases within a larger shopping center, as well as tenants in freestanding buildings in a shopping center, often have exclusive use of adjacent common areas, especially when it comes to parking. They also have the right to use those common areas shared with other tenants of the shopping center. In-line tenants are usually subject to the shared use of walkways, parking lots, trash areas, utilities lines and the like.
It is important to note that all three types of shopping center tenants may push for no-build provisions to be included in their leases — the goal of which is to preserve parking, foot traffic and storefront visibility. Landlords must be diligent in negotiating these provisions, ensuring they are not so restrictive as to prevent the development of the common areas in furtherance of the utility and prosperity of their property.
Before granting any exclusive rights over common areas in a shopping center, it is imperative that the landlord review all other leases to ensure this action does not violate the rights of existing tenants.
Factoring in Taxes
Allocation of real estate taxes is handled differently among the various categories of retail leases. Ground leases of separately assessed tax parcels often entitle tenants to act as if they own the leased premises during the term. Accordingly, ground tenants are liable for all taxes assessed on the leased premises, but they are also allowed to depreciate the building that they construct and appeal tax assessments.
Freestanding tenants sometimes pay 100% of taxes assessed on the building they occupy and a pro rata share of taxes assessed against the land comprising the shopping center. So, if the freestanding building is located on a parcel with other improvements or tenanted buildings, the freestanding tenant might pay 100% of taxes assessed on its building and a pro rata share of other improvements from which it reaps a benefit (e.g., a shared parking lot). Freestanding tenants generally will not wish to contribute toward taxes assessed to other tenanted buildings. If the freestanding building is located on a separate out-lot or parcel, the tenant likely pays all taxes assessed to that lot, similar to a ground lease.
In-line tenants generally pay their proportionate share of taxes assessed to the building of which the leased premises are a part as well as on the common areas. Savvy in-line tenants will exclude from their share of taxes those taxes assessed on stand-alone premises and paid by such ground tenants or stand-alone tenants.
Evaluating Casualty Considerations
Ground tenants often must face the brunt of casualties, such as fire or natural disaster, on their own. It is typical for ground tenants to remain liable for the full amount of base rent following such casualty and to repair or restore its improvements without assistance from the landlord. This may seem odd, but in a ground lease, the landlord is leasing the dirt (undeveloped land) to the tenant. Presumably, this land is not impacted by a casualty to the building that the ground tenant constructed.
Freestanding leases bring more variety to this issue. The provisions are often heavily negotiated and depend on whether the lease of a freestanding building is more akin to a ground lease or an in-line lease. For in-line buildings with multiple tenants, landlords will want to insure the building (and pass the premiums along as an operating expense) and perform the repair and restoration (often excluding tenant leasehold improvements).
In-line tenants are often entitled to rental abatement until the landlord completes its repair or restoration. Additionally, if a landlord’s repair or restoration is estimated to take too long (often a negotiated point), or if too large a portion of the leased premises is destroyed (the proportion of which is usually negotiated), in-line tenants frequently have the right to terminate the lease without further recourse to the landlord or tenant.
Going Beyond Generic
Neither landlords nor tenants should assume that any generic lease form will adequately govern use of the premises and the relationship of the parties. Each retail lease should be precisely tailored to the pertinent property, and the context of the tenant’s occupancy should play a key role in determining the rights and obligations of the parties.
This article is intended to raise only some of the differences between in-line leases, ground leases and leases of freestanding buildings. Depending on the type of space being leased, there are many other differences, nuances and considerations for landlords and tenants to bear in mind when negotiating retail leases.
Shain P. Roche is an associate at Hinckley Allen.
