US mall landlords push to cut escape clauses for smaller tenants

New York

THE only thing more dangerous for America's malls than a string of apparel-chain bankruptcies is when the trouble hits department stores.

Retailers like JC Penney Co and Macy's Inc are considered "anchors" that keep malls humming and foot traffic flowing. They're so important to the ecosystem that smaller tenants may refuse to set up shop without a promise that the anchors will stick around: many leases include so-called co-tenancy clauses that let them cut and run or pay less if those key tenants depart.

Now, many landlords are pushing to eliminate or narrow the escape clauses in the wake of mass department-store closings. That means less flexibility for the remaining tenants.

"Most retailers based in a mall do live or die based on an anchor," said Andy Graiser, co-president of A&G Realty Partners, a commercial real-estate adviser. "Certain retailers are going to have a risk if certain anchors go away."

The past couple of years have brought hundreds of department-store closings. This is the result of of liquidations (Gordmans and Bon-Ton Stores Inc), restructuring by struggling chains (Sears Holdings Corp and JC Penney) and pullback by relatively healthy operators seeking to downsize their store presence (Macy's, which is closing underperforming stores).

While retailers are still flocking to the high-income "A" malls that make up about a third of enclosed centres, lower-tier properties are often struggling to replace lost merchants, sometimes turning to non-traditional tenants such as urgent-care centres.

Landlords are now routinely pushing to chisel away co-tenancy provisions when leases come up for renewal, said Ivan Friedman, head of RCS Real Estate Advisors, a New York consulting firm. That wasn't the case even a couple of years ago.

That will have consequences, such as leading to fewer lease renewals, said Kent Percy, a managing director at consulting firm AlixPartners. "They could lose the whole inside of the mall."

Mr Percy and others did note that even robust co-tenancy clauses offered limited protection for tenants; landlords are inclined to push back on any legal lease-breaking, and the cost of battling them can be prohibitive.

Many of those interior tenants have already suffered mightily, leading to bankruptcies like Gymboree Holding Corp and Rue21 Inc, which reorganised with fewer stores. Other merchants like Coldwater Creek Inc didn't survive.

Ron Marshall, chief executive officer of Claire's Stores Inc, specifically cited co-tenancy clauses as an issue during a June 2017 conference call. The chain filed for bankruptcy last March.

Tenants do have other options. They are negotiating for shorter leases and reduced rents. As a last resort, they can file for bankruptcy, allowing them to exit from leases without penalty.

They may also sign contracts stipulating an exit only if certain anchors leave, Mr Graiser said. "The retailer may say, yeah, I'm OK if Bon-Ton leaves, I'm OK if Sears left, but I'm not OK if Macy's, Dillard's, Neiman Marcus or Nordstrom left."

The definition of what constitutes a key tenant has changed, too. In some cases, it may be a dominant retailer, such as a big-box store, or a high-performing speciality chain.

Even so, landlords are going to remain under pressure, RCS's Mr Friedman said. "Everybody is closing stores, everybody is getting lower rents when they do their renewals," he noted. And with the US retail excess estimated at 25 per cent, even after earlier shakeouts, "it's going to continue". WP