Critical Issues for Retailers in Vertical Mixed-Use Projects
Introduction. Retailers leasing space in mixed-use projects encounter critical issues that might be of little or no concern in traditional shopping centers. Vertical mixed-use projects (multi-story buildings with subterranean parking or attached parking structures, one or more floors of retail at the base, and offices, apartments or condominiums above) present even greater challenges. This article addresses some of these issues and offers practical suggestions for their resolution.
Background. The complexity inherent in vertical mixed-use project leasing reflects both the manner in which such projects are subdivided (separate legal parcels created by horizontal planes are stacked upon each other like layers of a wedding cake) and the competing concerns of the different users of the project (e.g., retailers may prefer early-morning or late-evening deliveries, but residents may be disturbed by the noise generated by large trucks). Horizontal subdivision gives developers the flexibility to sell or lease parking areas to third-party operators in order to help finance the project or to form joint ventures with well-known residential builders for development and marketing of luxury apartments or condominiums. As a result, the project will be subject to one or more sets of covenants, conditions and restrictions designed to allow the project to operate as a fully-integrated community despite the separation of ownership interests and competing expectations and demands of occupants. Additional restrictions may be contained in a development agreement between the developer and a redevelopment agency or other governmental authority exercising control over the project, or in a conditional use permit issued in connection with a zoning variance.
Site Plan. Unlike the single-page site plan attached to most shopping center leases, the site plan for a vertical mixed-use project consists of multiple pages showing parking levels, retail levels, and other relevant areas; paths of travel between the retail stores and the office and residential components; shared facilities such as loading docks, trash areas, and delivery storage areas; access and visibility corridors, no-build areas, and restricted-use zones; sign areas reserved to tenant or to landlord; reserved and restricted parking areas; valet drop-off points; and any other areas that are difficult to describe by narrative. A thorough review of the lease and the site plan should be made to confirm that all lease references to the site plan are reflected on the site plan, and that all areas outlined on the site plan are referenced in the lease. Subsequent to lease execution, changes to the site plan may be required in order to reflect the needs of new tenants or demands of governmental agencies. Although material changes should be subject to the reasonable approval of any tenant with a signed lease, the tenant should understand that the mixed-use project is a work in process until final permits are issued and that the price of being unwilling to include some flexibility in its lease for future site plan modifications may be that its lease gets put on the back-burner, resulting in loss of negotiating leverage and raising the possibility that it may be replaced by a more cooperative tenant.
Parking. One of the most difficult aspects of developing and managing a mixed-use project is the allocation of parking spaces in a manner that satisfies the needs of retail customers and employees, office workers and visitors, and residents and guests. The need to satisfy increased parking demands of holiday shoppers during November and December provides a further complication. A retailer expects its customers to find parking near a mall or store entrance without delay and to be directed to its store by appropriate signage. An adequate number of spaces in defined areas must be reserved for the exclusive use of retail customers. Nights and weekends, retail customers should have access to unreserved office parking spaces. Restaurants will want spaces reserved for customers picking up take-out orders.
Retailers of all sizes will demand that landlords provide free or reduced-rate for customers or provide a system for point-of-sale validation either with or without a purchase; the success of these demands will be determined by prevailing market forces, but retailers should understand that developers view the parking areas as a profit center, and projected revenues may be relied upon by lenders. If valet parking is provided, a conveniently located drop-off area should be identified and a specified area of the garage or parking structure should be reserved for valet-parked cars. Employee parking may be limited or subject to monthly charges; this issue should be addressed as early as possible because most retailers are accustomed to unlimited free parking for employees in traditional shopping centers.
Tenants should be cautious of provisions that allow access to parking areas to be restricted or for parking areas to be closed for “special events” or “periodic street fairs.” A “special event” may not benefit all or even a majority of tenants; parking structures may be closed and tented for movie premieres or corporate charity events. “Periodic” street fairs and farmers’ markets may occur weekly. Each tenant will have to balance the benefit conferred by the increase in foot traffic against the detriment caused by the loss of parking and the street closure. If the project is near a stadium, arena, theater, convention center or other venue, the landlord may attempt to set aside parking that it or its third-party operator can sell to patrons of those venues at premium rates; again, each tenant will have to evaluate the net benefit of such an arrangement.
Marketing. Retail tenants in mixed-use projects have a large pool of potential customers on the office and residential floors above them. This is especially beneficial for restaurants. But it may be difficult to market to office workers and residential occupants because retail leases for mixed-use projects often prohibit distribution of flyers, coupons and other advertising media within the project. More acceptable methods of building a customer base may include sponsoring social gatherings within the project, offering incentives to customers who refer other staff or residents of the building, providing delivery and catering services within the project, and being included on any project directories, signs, electronic displays or other joint advertising media.
Phased Construction. The retail floors of a high-rise mixed use project are often completed before the office and residential floors. If construction on the exterior of the building is complete, the garage is finished and accessible from adjacent public streets, and there are no impediments to customers’ use of common areas to access the retail areas, then the construction of interior tenant improvements is unlikely to disrupt retail operations. However, to the extent a retailer is counting on the patronage of residents and office workers in order to meet sales goals, it may be prudent to delay rent commencement until occupancy rates in the office and residential components have reached specified levels. If a retailer must open while work is being completed, then staging areas for storing equipment and materials and for performing finish work should be limited to areas delineated on a site plan attached to the lease. Any construction immediately above, below or adjacent to a retail tenant that creates noise or vibration should be performed outside of Tenant’s business hours.
Signs. The urban location and large footprint of vertical mixed-use projects allow for many signs to be placed around the exterior of the building, including blade signs outside each shop, large signs on the facades identifying anchor tenants, Landlord’s signs offering office and residential space for lease, and, if permitted by local regulations, video screens and electronic billboards capable of displaying multiple advertisements. The retail tenants in the project should have the right to be represented on such signs, and the landlord should not be allowed to show ads of competitors of such tenants. In addition, there should be a prohibition on placement of signs that would obscure a retail tenant’s signs; this requires a protected area that is three-dimensional to account for hanging signs and signs that draw attention away from the protected signs.
Common Area Maintenance Costs. Allocating CAM expenses in a vertical mixed-use project is a challenge for a landlord, and determining if the allocation is reasonable is an even bigger challenge for a tenant. The retail lease should provide for an initial allocation to be made among the retail, office and residential components of the project, and then for the amount allocated to the retail component to be sub-allocated among the stores and restaurants on either a pro-rata basis or pursuant to a formula designed to separate different levels of use. Given the discretion afforded to landlords in these situations, it is important for the tenant to secure the right to perform annual audits of landlord’s books and records as they relate to CAM expenses for the entire project. The landlord may attempt to limit the audit to expenses concerning only the retail component, but a determination of the appropriateness of the allocation to the retail component cannot be made in a vacuum. However, in fairness to the landlord, the retail tenant has no reason to examine costs that were not included in its CAM expenses for the year in question. It is important to remember that retailers pay a straight pass-through of CAM expenses, whereas office tenants typically pay only increases over a base year, and apartment tenants pay a gross rent with actual expenses absorbed by landlords. Landlords have an incentive to place as much of the CAM expense as possible onto the retail component due to the complete pass-through of those expenses to the retailers. Parking fees collected by landlord should be applied against parking garage and structure operating, repair and maintenance costs, with only the balance of unrecovered costs included in CAM expenses.
Delivery Issues. Retail tenants in vertical mixed-use projects may be required to share loading docks with other retailers as well as with moving vans and office supply trucks. Demand for dock space may require that trucks be unloaded more quickly than in traditional shopping centers. The retailer may want to negotiate for secure storage space in the dock area; this allows for merchandise to be removed from trucks immediately and then protected until employees can safely transfer items from the dock to the store. If the only path of travel from the loading area to the store is through common areas, retailers may consider requiring the landlord to provide a security guard escort in order to clear a path. Restrictions on hours of deliveries should be carefully reviewed; these restrictions may prove particularly problematic for restaurants receiving perishable foods such as fish or produce from a supplier distributing to multiple customers. The delivery restrictions should not apply to FedEx, UPS or other carriers whose hours are beyond tenant’s control.
Summary. As suburban sprawl reaches its limits in many areas, and as so-called “affordable” housing requires the homeowner to commute an hour or more to work, vertical mixed-use projects concentrated in urban areas are providing people with the opportunity to live, work and shop without getting anywhere near a crowded freeway. The concept is nothing new for New York City or Chicago, but for many areas such as Southern California where the solution to increased housing demand for the last hundred years has been to extend the freeway another mile and turn more farms into tract homes, the shift in thinking about quality of life issues has raised new challenges for retailers planning growth strategies. City planners are revising plan approval criteria to force multi-unit residential projects to include retail components. While the suburban shopping centers seem safe bets as they are repositioned as “lifestyle centers,” everyone on the retailer’s team must be prepared for the increasing importance of urban mixed-use locations in the retailer’s portfolio.
