Navigating Co-Tenancy Clauses in Retail

Co-tenancy clauses, which allow tenants to reduce rent or terminate leases if certain occupancy conditions aren’t met, are under renewed scrutiny. The California Supreme Court recently upheld such a clause, affirming its enforceability as an alternative rent structure rather than a penalty. This decision underscores the importance of carefully negotiated co-tenancy provisions in retail leases. However, landlords are increasingly cautious, as these clauses can significantly impact revenue if anchor tenants vacate. The balance between protecting tenant interests and ensuring landlord revenue stability is becoming more complex in today’s volatile retail environment.

Renewed Focus on Enforceability and Clarity

In late 2024, a development from the California Supreme Court upheld a co-tenancy provision that allowed for reduced rent when a shopping center’s occupancy or anchor tenant presence fell short. The ruling emphasizes that such provisions, when clearly defined and reflecting the parties’ intentions, are generally enforceable, especially between sophisticated parties who have negotiated the terms. This means both landlords and tenants are re-evaluating and potentially revising their lease agreements to ensure co-tenancy provisions are structured in a manner consistent with these judicial interpretations.

Impacts of E-Commerce on Co-Tenancy Clauses

The continued rise of e-commerce has fundamentally altered how physical retail spaces generate traffic. Landlords and tenants are recognizing that a diverse tenant mix is crucial to drawing in customers, which has impacted co-tenancy clauses. 

While traditional anchor names remain important, some co-tenancy clauses are becoming more flexible. Now, they allow for a wider range of businesses to qualify as key tenants, provided they demonstrate strong traffic-driving potential. Additionally, landlords are increasingly negotiating carve-outs in co-tenancy clauses, which allows for a greater variety of non-traditional retail uses. This further demonstrates that shopping centers are relying more on a variety of offerings. 

Flexible Lease Structures

With low vacancy rates in many retail markets and a highly competitive landscape, landlords are becoming more adaptive in their leasing strategies. Co-tenancy clauses are seeing a push towards more flexible options beyond just fixed rent reductions or termination rights. One example is percentage rent adjustments. By shifting to a percentage rent model where rent is a percentage of the tenant’s gross sales, this can align the landlord’s income more closely with the tenant’s actual performance during a period of reduced foot traffic.

A co-tenancy clause may also offer temporary rent reductions with cure periods. This allows the landlord a set time to replace a vacating tenant or restore occupancy before remedies are triggered. Landlords may also add other incentives, such as tenant improvement allowances or lease term extensions at a lower rate, to retain tenants during a co-tenancy breach. 

Key Takeaways for Retailers and Landlords

Co-tenancy clauses remain critical for mitigating risk in retail real estate. For tenants, it’s essential to negotiate clear, comprehensive clauses that reflect their business’s reliance on specific co-tenants or overall center vitality. For landlords, understanding the evolving landscape means embracing a more diverse tenant mix, offering flexible solutions, and proactively managing their properties to maintain high occupancy and desirable co-tenancy conditions. The future of retail real estate will undoubtedly see continued innovation in these crucial lease provisions as both parties strive for stability and success in an ever-changing market.