Help Tenant Adapt to Market with Flexible Use Clause

As a retail property owner, you know that the success of your strip mall or shopping center largely depends on the mix of tenants you rent space to. Tenant synergy—that is, stores functioning together to draw shoppers that a center normally wouldn't capture without them as a group—can make or break your center's profitability. That's why it's important to have each tenant commit to continue operating the same way—selling the same type of goods or services—that fits your strategy.

As a retail property owner, you know that the success of your strip mall or shopping center largely depends on the mix of tenants you rent space to. Tenant synergy—that is, stores functioning together to draw shoppers that a center normally wouldn't capture without them as a group—can make or break your center's profitability. That's why it's important to have each tenant commit to continue operating the same way—selling the same type of goods or services—that fits your strategy.

However, the economy has forced many struggling tenants to resort to expanding their original permitted use. A narrow use clause could stop a tenant from boosting its sales by selling additional items.

That's why, when negotiating the lease, you should seriously consider giving the tenant a broader range of options to accommodate merchandise expansion or a shifting business model. You can do this by making the use clause—that is, the lease clause that tells the tenant the purpose or purposes for which it can use the space it rents from you—more flexible. That way, you can ensure that the tenant will stick to operating in a way that, although different from its original use, will still be beneficial for your center and not disrupt the mix.

Start with Strong Clause

One of the main reasons you chose your tenants was the type of merchandise, services, or food that they sell. For example, renting adjacent space to a clothing store and a shoe store in your center makes sense because it will become a one-stop-shopping destination for customers who are looking for complementary items but don't want to drive around trying to find them in different locations. Adding a restaurant tenant with menu prices that are affordable to customers at the price point of other stores in the center can capture customers after a long day of shopping.

But after you've gone to a lot of trouble to figure out the best combination of tenants for the type of property you're running, one of these tenants could ask to expand the range of merchandise it offers—merchandise that you did not expressly agree to in its permitted use provisions. This could lead to a dispute if a tenant feels that expanding its inventory is the only way it can stay afloat.

“In the retail setting, agreeing on permitted uses is extremely important because it's in everyone's best interest—the owner's and the tenant's—to have the best possible mix of uses to maximize the number of customers coming to the property and the sales at the property,” says attorney and Insider board member David S. Houston. “Therefore, you don't want to have tenants who could change their use and copy what another tenant is doing in the center, because the performance of both stores would probably decline and there would be less appeal for shoppers to come to the center,” he explains.

“The owner has invested the most financially by buying the property, so from its perspective, it wants to determine where to place certain uses and can see that certain uses are probably going to do better if they're placed near other similar or complementary uses,” Houston observes. “And this works for tenants because most don't necessarily want to be on an island. They don't want to be at the end of the mall with dissimilar tenants,” he says.

“The issue with permitted uses is that the tenant wants the most flexibility as possible so that it can change its use, not operate at all, assign or sublet the space, or terminate the lease and move out. Meanwhile, the owner wants to control everything at the property,” he notes. “That's where lease negotiation comes in. The permitted use clause that ultimately goes in the lease will depend on the leverage of each party.”

A narrow permitted use clause can help you maintain that control and preserve your tenant synergy. Regardless of what leniency you think you might ultimately give a tenant that wants to expand its permitted use, it's important to negotiate a carefully drafted permitted use clause to control what happens at your property. For language you can adapt and use in your lease, see our Model Lease Clause: Carve Out Rights When Agreeing to Use Expansion.

Freedom to Adapt to the Market

Many tenants feel that, to some degree, they own their space during their lease term because they have invested in it by paying rent and completing buildouts or other improvements. They want the ability to make changes to the way they do business that are necessary to adapt to a changing market.

“If the tenant came up with a novel concept to sell a certain product that became obsolete or less popular, it'll want the ability to change course, to avoid going out of business,” Houston points out. “Whereas, the owner may have been looking for the tenant as the final piece of the puzzle, because the product it sells would complement another type of store,” he notes.

If it's clear that holding certain tenants strictly to their permitted uses could hurt sales, and their ability to pay rent, you may be willing to give the tenant some leeway to expand its products or services. Keep in mind that, if you decide to give a tenant use flexibility, you must exclude from the tenant's expanded use any use that would violate a covenant or exclusive you have with another tenant. You may also want to prohibit the tenant from violating an exclusive that you may grant to a future tenant. Failure to have adequate protections in place may inhibit or frustrate future deals. For example, if you're negotiating to bring in a national coffee retailer that typically commands exclusive use protections, it may not be willing to sign a lease if it knows that an existing tenant may be able to change its use to directly compete [Clause, par. a].

If you're concerned that the tenant might take advantage of the expanded use by replacing its whole stock with new types of items rather than adding a few different options for customers, require the tenant to devote a certain percentage of its sales or square footage to its primary use [Clause, par. c].

PRACTICAL POINTER: In addition to considering whether a flexible permitted use for a tenant will violate your leases with other tenants, think about whether the new type of use of the space will disturb neighboring tenants in any other way. And check to make sure that the expanded use complies with parking requirements and government regulations like zoning laws.

Stay in Control of Strategy

Because your strategy for a successful tenant mix is most likely complicated, especially because tenants' exclusive use and co-tenancy rights depend on the permitted use of other tenants, allowing a tenant to change the items it offers can create problems. You'll need time to determine whether you can or should allow the use change, so require the tenant to give adequate notice of its intention to expand its use [Clause, par. b].

And carve out the right to terminate the lease if a tenant wants to expand its use but you don't want it to, or if it changes the way it uses its space without asking for permission [Clause, par. b]. However, if you're otherwise pleased with the tenant, give it the option to withdraw its request and nullify a termination notice from you [Clause, par. d].

Don't Gloss Over Office Building Uses

Permitted use provisions are important, but not as controversial in office building settings as they are in retail settings, notes Houston. That's because, while tenants' businesses may be of different varieties, they generally are performing the same type of function according to their leases: “general office use.”

There may be less negotiation over permitted use clauses in office building leases, but owners should still pay attention to the terms of use and not gloss over the issue. This is especially true for some office building tenants that could have an impact on traditional tenants.

For example, medical clinics have been renting office building or mixed-use space with increasing frequency, and with mixed results. Increased foot traffic from walk-in patients milling around, and the conversion of additional parking spots to handicapped parking stalls might not be disruptive in a large building that already has busy common areas and a huge parking lot. However, a quiet, strictly professional office building could be disrupted by the noise. Likewise, tenants in a building with already-limited parking may be annoyed if their clients can't find spaces.

Consider Allowing Prohibited Uses

Many use clauses include a list of prohibited uses that a tenant must agree to avoid. But what happens if the products that a tenant wants or needs to start selling to increase sales are prohibited? If the reason for banning those uses no longer exists—for example, if a tenant that had an exclusive use that was banned for other tenants has moved out of the center—consider granting the remaining tenant's request to carry that product.

At some point you'll probably encounter a tenant that tries to expand its use without asking to. You could seek whatever remedies are in the default clause of the lease, such as terminating the lease or asking a court to order the tenant to stop the expanded use. But if the tenant isn't interfering with other tenants, think about allowing it to continue selling the items in dispute—especially if the tenant is paying rent on time and you have or anticipate vacancies.

“Even if the owner doesn't like what the tenant is selling, if it depends on that income stream, it should consider leaving the tenant alone,” notes Houston. “The leverage of each party and demand for space at the center can also determine whether the owner pursues remedies against a tenant that's selling prohibited items. If there are tenants waiting in the wings to fill space if it becomes vacant, the owner has more leverage,” he says.

But a large tenant, if it has agreed to a use clause at all, will probably operate how it sees fit, he adds. Anchor and national tenants usually have use clauses that specify the permitted use as “any retail use,” and they will certainly use it that way, whether or not the owner likes it, he says.

Insider Source

David S. Houston, Esq.: Partner, Pillsbury Winthrop Shaw Pittman LLP, 1650 Tysons Blvd., 14th Fl., McLean, VA 22102-4856;


See The Model Tools For This Article

Carve Out Rights When Agreeing to Use Expansion