Co-tenancy Clause
Co-tenancy clauses appear in retail leases and generally grant the tenant reduced rent, lease termination rights, or other privileges if other tenants, typically anchor tenants, vacate in the shared retail center (e.g. a shopping mall or grocery-anchored retail center). These clauses offer some protection to the tenant if another major tenant that is the primary draw for traffic to the center vacates.
Putting “Co-tenancy Clause” in Context
Scenario Overview:
GreenHaven Capital Partners, a real estate investment firm specializing in core-plus acquisition investments, recently acquired Briarwood Plaza, a 110,000-square-foot grocery-anchored retail center located in suburban Atlanta, Georgia. The center is anchored by a well-known regional grocery chain, FreshHarvest, which occupies 70,000 square feet of the space. The remaining 40,000 square feet are leased to a mix of national and local retailers, along with a few service-oriented tenants such as a nail salon, dry cleaner, and a fitness studio.
The Importance of Co-tenancy Clauses:
As GreenHaven Capital evaluated the acquisition of Briarwood Plaza, one critical factor was the presence of co-tenancy clauses in the leases of several smaller tenants. These clauses granted tenants the right to either reduce their rent or even terminate their leases if the anchor tenant, FreshHarvest, were to vacate the property. Given that FreshHarvest draws a significant amount of foot traffic to the plaza, the co-tenancy clauses posed a potential risk to the stability of Briarwood Plaza’s income stream.
For instance, the lease for a popular national clothing retailer occupying 10,000 square feet included a co-tenancy clause that allowed the retailer to reduce its rent by 50% if FreshHarvest were to vacate. Additionally, the retailer could terminate its lease altogether if a replacement anchor tenant was not secured within 12 months. Several other smaller tenants had similar clauses in their leases.
Hypothetical Situation:
Suppose six months after the acquisition, FreshHarvest decides to close several of its stores in the region, including its location at Briarwood Plaza, due to corporate restructuring. This decision triggers the co-tenancy clauses in the leases of multiple tenants. As a result, the national clothing retailer immediately reduces its rent by 50%, while another tenant, a local coffee shop, opts to terminate its lease and vacate the space.
Financial Impact:
The immediate loss of rent from these tenants and the vacancy of the coffee shop space significantly impacts the center’s Net Operating Income (NOI). GreenHaven Capital now faces the dual challenge of finding a new anchor tenant to replace FreshHarvest and filling the newly vacant spaces to restore the property’s income stability.
For example, if the national clothing retailer’s rent was initially $20 per square foot annually, the rent reduction would decrease it to $10 per square foot. With 10,000 square feet of space, this reduction translates into a $100,000 annual loss in rent from just one tenant. If the same situation occurs with other tenants, the impact on NOI could be substantial.
If a suitable anchor tenant is not found within the 12-month period stipulated in the co-tenancy clause, GreenHaven may see additional tenants exercising their rights to terminate leases, further destabilizing the cash flow from Briarwood Plaza.
Strategic Considerations:
Understanding the implications of co-tenancy clauses is vital for GreenHaven’s asset management team. They must proactively engage with tenants, negotiate lease modifications, and aggressively market the center to secure a new anchor tenant. This example highlights how co-tenancy clauses, while protecting tenants, can introduce significant risk to the property’s income if not managed effectively.
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