Retail Out-Parcel Leases 

publication 

April 2006 - (Lang Michener LLP Real Estate Brief April 2006)

Lang Michener LLP Real Estate Brief April 2006

Introduction

More and more retail developments are including freestanding retail buildings that are leased to one or more retail tenants. This is commonly known as an out-parcel or pad site. Tenants of pad sites include restaurants, banks and big box users. The shopping centre containing the pad site may be a retail strip centre, a neighbourhood or regional centre with an interior mall or a power centre or other collection of freestanding buildings. Typically a pad site is attractive to tenants due to the increased visibility, easier access and the opportunity for the premises to meet that Tenant's specific branding and other requirements (such as standard colours, signage and even building design). Further, the use of a pad site provides some flexibility for increased rights not typically found with in-line stores, such as drive-thru facilities, exclusive parking areas and outside patios.

The lease document used for a pad tenancy will need to recognize and deal with the unique features of the pad tenancy. Of course, any other issues generally relevant for a retail lease will be equally relevant in a pad site lease and some will have greater relevance in a pad situation. This article will identify and discuss a number of the special issues (in both of these categories) that arise in a lease of a pad site.
Access

One driving factor for a Tenant to negotiate for a pad lease is to get the benefits of better access for its customers. As most Landlord forms of leases will allow the Landlord to make changes to the common areas (including the access) as it sees fit, this benefit will require special protection by the Tenant.
Some Tenants will bargain for specific easements or rights in favour of the pad premises. These easements would be shown on a site plan attached to the document and run for the duration of the term and any renewal or extension. In these situations a Landlord may want to negotiate at least a right of relocation for the specific easements.

If specific easements are not granted, then the Tenant will at least look for some general covenants from the Landlord that the access will not be materially adversely changed (or not so changed without the consent of the Tenant). To state the obvious, a drive-thru only works where vehicles can drive to it. The Landlord needs to balance the granting of any such rights against the desire to be able to control future redevelopment and other changes to the shopping centre.

When negotiating access rights, the Tenant needs to determine whether all of the access to its premises is in fact through the shopping centre or whether there are abutting developments where the Landlord has negotiated reciprocal rights. It is not uncommon to see some major retailers purchase their property from the developer of the remainder of the shopping centre, with the two parties then entering into a reciprocal operating agreement. This reciprocal operating agreement will grant rights of access and parking between the two sites.

A Tenant on a pad site on the shopping centre side will want to ensure that its rights under the lease include the ability to exercise the rights granted to the Landlord under the reciprocal operating agreement from the abutting owner. For example, a key access point may be across the abutting owner's property and the pad site Tenant will want to ensure that it and its customers can use that access. This may be critical enough for the Tenant to require an initial condition as to it being satisfied with the terms of the reciprocal operating agreement. Alternatively, the Tenant may rely on a covenant from the Landlord that such an agreement is in place.

Visibility and Signage

Just as access needs to be protected, the Tenant will want to protect the enhanced visibility a pad site provides. The granting of a specific no-build zone, identified on a schedule, provides certainty for both parties. A general covenant by the Landlord not to effect any changes that might materially affect the visibility is less specific and leaves open the possibility of a future debate. In both cases the Landlord will, to some degree, be limited in respect of future redevelopment and other changes to the shopping centre

The visibility bargained for may include some signage situated at a location remote from the premises. This may be shared pylon signage or perhaps some directional signage.
As for signage on the building, if the Tenant is anticipating the right to have signage on all four sides, the Landlord's typical signage provision of allowing and requiring only storefront signage would obviously be deficient. Similarly, if the Tenant has standard national signage, it will not want to simply agree to be subject to the Landlord's signage criteria for the shopping centre.

Use of Outside Areas

A pad lease gives flexibility for a Tenant to negotiate for the use of certain outside areas such as a drive-thru facility, a patio area and/or exclusive parking. These types of rights need to be considered up front, both to negotiate for the right in the agreement to lease and also to determine if there are zoning and/or site plan issues to be dealt with.

The cost associated with these areas also needs to be dealt with. Typically, minimum rent is not charged for such areas and the square footage is not included when determining the Tenant's proportionate share of additional rent. However, the Tenant will have some specific maintenance and repair obligations. For example, notwithstanding that the patio may not be part of the premises, the Tenant will likely have the full obligation to operate, maintain and repair the patio area.

On the other hand, a provision that the Tenant is responsible for maintenance may not make as much sense for a drive-thru facility. The landscaping and snow removal contractor for the shopping centre will likely do the drive-thru areas (as opposed to the Tenant hiring a contractor just for the drive-thru area). The question is, then, will the Tenant pay the cost attributed to the drive-thru or will it simply fall into the overall operating costs?

Operating Costs

The operating costs provisions in a pad site lease are often different than in an in-line lease. The pad Tenant will want to be treated differently and, in particular, may want to limit operating costs to exterior common area costs for the following reasons:

  1. where there is an interior mall, the pad site Tenant argues it gets no benefit from this and should not have to contribute to the cost; and
  2. the pad site Tenant operates its own building and does not want to see all building costs pooled with an obligation to pay its proportionate share of such building costs. The pad premises may be relatively new compared to the remainder of the shopping centre and a Tenant may feel it is therefore unfairly disadvantaged if all building repair costs are pooled and paid as operating costs. For example, the pad site Tenant will not want the costs of roof repairs on the 20 year old main building to be included in the operating costs paid by it.

Landlords may resist having two separate methods of calculating operating costs, as it will create more work. Even when the Landlord does agree to creating two separate methods, it is not as simple as limiting operating costs to exterior costs. The Landlord will need to capture certain costs that might not be defined as exterior costs. These would include insurance costs for the shopping centre (including building insurance, which is likely to be pooled in any event) and its management costs or administrative fee.

If the various building costs are not pooled across the shopping centre and operating costs are limited to exterior common areas, then those building costs relating specifically to the pad site premises need to be dealt with. This would include items such as HVAC costs and roof repair costs to the pad site building.

End of Term

Although the issues may not be unique, issues arising at the end of the term may have more importance in a pad site situation. These include the following:

  1. in negotiating any renewal rights, the Landlord should consider whether it should seek a longer notice period than it requires for in-line tenants. Given the unique features of a pad site lease, the Landlord may require a longer lease-up time. The usual six or nine months may not be enough;
  2. the allocation of a restoration obligation to the Tenant is a matter of dollars and cents in any lease negotiation. It may be seen as a more expensive issue in a pad site lease, where the restoration may be more extensive due to the specific branding of the building and due to the fact that the building may have been built for a specific purpose. For example, will the Tenant have the obligation to remove the drive-thru facilities?
  3. the existence of this branding will also result in the Tenant seeking a right to do such work as required to remove such branding. For example, the colours on certain parts of the building may be identifiable with the Tenant and such Tenant will want to change those colours. Some indicia of the branding may even form parts of the building itself and the Tenant will want to ensure that it can remove these items.

Conclusion

A pad lease is of course a retail lease, so all of the other usual retail lease issues will also be relevant. In fact, because a pad Tenant is typically one of the stronger retail tenants, it is more than likely that these issues will be subject to greater negotiation than normal. These may include the Tenant seeking provisions such as an expanded and evolving use provision and an exclusivity right.

Ed.: This is an edited version of a paper presented by Bill for the Law Society of Upper Canada at the Six Minute Commercial Real Estate Lawyer on February 15, 2006.

This article appeared in Real Estate Brief April 2006.