Why Does It Take So Long to Redevelop Malls?

In this two-part series, LoopNet provides an overview of the challenges facing mall owners, retailers and suburban communities, concerning what should be done about closing or underperforming malls. The first part focused on new uses to consider, based largely on converting, rather than demolishing, existing malls. This companion piece looks at barriers that must be addressed in order to convert malls into financially viable real estate assets.

Many underperforming malls in the U.S. are limping along, suffering a glacial decline, lasting not just years, but often decades. Once teaming with foot traffic and economic vibrancy, many now persist in a sort of zombie state, with roughly half of the department stores and small retailers open and the remaining spaces shuttered.

It is generally agreed among real estate experts that brick-and-mortar retail activity has declined for three main reasons:

• The growth of e-commerce.
• The shift from purchasing goods to buying services and “experiences.”
• Too many stores per capita.

The time saved by purchasing items online and having them delivered is significant, for people of all ages and abilities, but especially for working parents, who are in their peak spending years as they furnish houses and raise children. Many consumers leave their houses to shop less frequently than they did in the past; but when they do, they go in search of manicures and yoga classes, offerings largely located in community shopping centers rather than malls. These changes have reduced the amount of foot traffic in retail centers, especially malls, over the past 10 years. However, many years before the shift to ecommerce and experiences, the U.S. was already on a path to becoming “over-retailed,” as department stores and specialty retailers opened multiple locations. Instead of two store locations inside a 30-mile radius, some retailers opened six, in essence competing with themselves, resulting in less foot traffic and fewer transactions in each store.

These forces and others have been at play for decades, and affect all types of shopping centers, but malls have been particularly hard hit. So, why is it that many mall owners struggle, sometimes for decades, to keep up with consumer preferences and change their retail mix or to completely redevelop their properties?

LoopNet spoke with various real estate professionals who discussed some lesser-known elements of mall ownership and operations that contribute significantly to the challenges of repositioning or redeveloping malls. These conditions are often intertwined, adding greater complexity to the problem, but for explanatory purposes they have been pulled apart in this article. Specifically:

• Malls are owned by multiple parties.
• Complex ownership agreements require consent from multiple parties.
• Complex retail leases complicate the mall operator’s ability to freshen the retail mix and/or redevelop.

Department Stores. What is not readily understood is that mall structures and their surrounding parking and road facilities are rarely owned by just one entity. A major mall operator like Simon Property Group may own and lease the inline spaces occupied by small retailers that spill out onto the mall concourse, but in older malls, “department stores often own their boxes,” said Mike Smith, director of real estate at Streetsense, a strategy firm focusing on the retail, restaurant and hospitality industries. This means that national department store chains like Macys, that occupy the “boxes” — or locations at the ends of the mall — often own, rather than lease, their facilities.

So why would a developer give up ownership, and by extension, control?

This shared ownership arrangement was employed (and in many cases is still used) by mall developers that wanted to attract national chain department stores. Referred to as “anchors,” these department stores were considered the basis for incentivizing consumers to make a trip to the mall. When malls were first conceived, it was readily understood by developers that department store anchors set the tone and brand of a shopping mall. For example, those anchored by Sears and JCPenney featured retailers and eateries that catered to middle class populations while others, anchored by Saks Fifth Avenue and Neiman Marcus, drew wealthier consumers.

Once mall anchors were in place, developers were able to lease “inline,” or concourse-facing space, to smaller retailers that depended on the anchors to generate foot traffic. The inline retail mix was carefully curated so it would appeal to the same demographic groups that were drawn to the department stores. Because these anchors were vital to the brand and the financial viability of the mall, developers were willing to sell, not just lease, a portion of the mall to a department store.

However, department stores were not given free rein to do whatever they wanted with the portion of the building that they owned. The purchase came with requirements, responsibilities and restrictions that were codified by reciprocal easement agreements (discussed below) so the department store boxes would integrate physically and operate seamlessly with the other retailers in the mall.

Chris Haley, co-founder of Palladian Realty Capital, LLC, a boutique real estate merchant- and investment-banking firm, summarized the challenge that this once beneficial arrangement now creates for mall redevelopment schemes. “Even though you'd like to think that you could work with one owner on a mall, what you might find is that the original developer sold two of the four anchor boxes and owns and leases two of [the others]. And that's even more convoluted because then you're dealing with co-owners that also have leases, that’s more unraveling.”

Out parcels. Further complicating ownership is that mall properties often include “out parcels” or plots of land dispersed around the parking lot that are owned by banks, restaurants, pharmacies, etc. Parking structures and ring roads or circulation routes may also be owned (entirely or partially) by other private entities or even municipalities.

Ellen Sinreich, Managing Principal of The Sinreich Group and an experienced leasing attorney, said that “oftentimes in assembling the land necessary to build a mall, agreements are made with the parties who are selling the land or contributing land in exchange for an ownership interest in the mall.” She added that those parties may have consent rights that are codified in legal documents, such as reciprocal easement agreements, discussed below.

Sinreich gave the example of a 1970s mall that began as a strip shopping center, noting that over the years other shops and more land were acquired to eventually create a large contiguous parcel. “So, then there were five or six reciprocal easement agreements amongst different parties … and they all have rights,” she said. “The result was a very complicated and jumbled situation. Although the facts differ from mall to mall, many are saddled with similarly complicated rights and obligations between and among various parties.” The bottom line according to Sinreich is that “mall owners must often obtain third-party consents before they can make changes to their malls.”

Two main operative types of legal agreements cement the relationships between and among mall owners and retail operators. Reciprocal Easement Agreements (REAs) are typically executed between the mall developer/owner and each owner of a box or outparcel and complex retail leases commonly exist between the mall operator or owner and retail tenants.

REAs generally lay out the covenants, conditions and restrictions for a large development project and govern what the parties to the agreement must do, be they landlords, developers, operators or some other entity. They address considerations such as access to parking and the location of entrances and exits. These terms provide assurances to retailers that access to their property and parking spaces will be available and not blocked by an intrusive neighbor that may want to use it as a staging area for construction or to set up a temporary circus tent.

Signage locations, common area improvements, building maintenance and taxes are also typically covered in REAs. They include what parties to the agreement can and cannot do relative to these items, who they should contact in case there is a problem and the process they will navigate to resolve any issues. In some cases, the agreement can stipulate how to modify the REA, if necessary.

Restrictive easement agreements may be effective in perpetuity, and thus “run with the land,” and bind future owners. The REA also might have a more limited term, but they are usually operative for long periods of time. It is not impossible to change REAs with legal remedies like quieting the title, abandoning the easement or releasing the easement. However, these approaches are complex, time consuming and expensive.

So why are these agreements an impediment to redevelopment?

Because significant and often insignificant changes require consent from multiple parties. Further complicating these arrangements is that not all parties are privy to each others agreements. So three owners may need to resolve an issue here and a different cluster of owners may need to resolve an issue there before larger issues can be addressed collectively by all of the mall owners.

Retail leases govern the relationship between landlords and tenants. In the commercial real estate industry, retail leases are typically considered more complex than office or industrial leases largely because of restrictions on what the tenant can sell, restrictions on the activities carried out by other tenants and co-tenancy clauses. These clauses stipulate a series of conditions that provide both protections and restrictions for a retailer, in some cases, based on the performance of other retail businesses co-located in a shopping center or mall. For example, if an anchor tenant leaves or ceases to operate, other tenants may be allowed to pay less rent, reduce their operating hours or even terminate their lease.

“Occupancy clauses allow [retailers] to make certain decisions based on other things that are happening in the mall,” said Smith. For example, if occupancy among small retailers dips below a certain number, a department store may be able to pay less rent until occupancy returns to a certain level. Or, if a department store or a series of department stores leave, the inline retailers may be able to extend their leases for another couple of years, at below-market rates.

Additionally, legal clauses often enable a tenant to have a say in the other tenants that co-locate in a shopping center or mall. For example, one coffee shop may oppose another one from taking space, seeing it as a direct competitor. But a pastry shop that serves coffee may be perceived as complimentary, so the existing coffee shop would not oppose it’s leasing space and co-locating in the center.

Other language in leases states very clearly that if a tenant ceases to operate, it must be replaced with a tenant that meets certain criteria, further limiting the flexibility of the mall operator to backfill space with something different or more current that what could have been envisioned in a lease executed 10 years ago. The difficulty of making such changes to the retail mix has left many malls with a combination of retailers that reflect vastly outdated consumer tastes.

Other clauses, sometimes called prohibited use clauses, make it clear that certain types of businesses cannot take space in the mall or retail center, such as vaping venues and nightclubs. However, prohibited use clauses can be tricky if either too much or too little detail is provided. For example, a lease might state that heavy parking users are prohibited, but not provide details about what constitutes heavy parking. Does it mean many cars that turn over every 30 minutes, few cars that turn over every two hours or is it something in between?

In other cases, prohibited use clauses provide examples of uses that constitute heavy parking such as sports or fitness facilities. Specific language like this has created challenges for mall owners in the recent past trying to backfill space with non-traditional retailers such as fitness facilities or other service providers. The unintended consequences of lease language need to be considered very carefully.

“Aside from critical mass, one of the fundamental assets that a mall owner had was control. They controlled the entire environment, the messaging and the marketing,” said Smith. This helped malls attract many retailers who wanted to know who their neighbor was going to be, in order to create branding and experiential synergies. Owners used these complex lease agreements to incentivize retailers. They enabled rents and concessions to rise and fall for the retailer as retail synergies and foot traffic ebbed and flowed. These leases gave retailers flexibility that could directly impact their bottom line; if foot traffic declined, potentially eroding their sales, they could pay less rent.

So even in situations where malls were viewed as inferior because they lacked the ambiance or charm of a main street location, “the allure of control and knowing who your neighbors were going to be, made for some, a compelling opportunity,” said Smith. One that was attractive enough for them to agree to these very complex leases and tie their fortunes to those of neighboring retailers and so “small tenants benefit from the department stores and the department stores benefit from the aggregation of the smaller tenants,” said Smith.

Adaptability is one of the keys to longevity and complex retail leases along with reciprocal easement agreements have tied the hands of mall owners.

As noted above, in many cases the lease agreements have kept landlords from re-tenanting malls with more current uses and retailers, resulting in outdated retail mixes that have lingered. These outdated retail environments failed to draw shoppers, further eroding malls. Had the retail mix been easier to refresh, some malls might have been spared from the deep state of decline that tipped them toward needing full-blown redevelopment.

While these lease structures have certainly impeded re-tenanting and to some degree redevelopment, Sinreich believes that reciprocal easement agreements may be an even greater obstacle to redevelopment.

She noted that “most leases don’t give a tenant the right to stop a landlord from doing anything with the center outside of its premises. In some cases, the tenant may have the right to pay less rent, or terminate the lease or to stop operating. These remedies are painful, but that wouldn’t stand in the way of a redevelopment.”

A mall owner that recognizes that redevelopment is necessary and has made the decision to do so, can plan for the reduced cash flow that may result from the exercise of these remedies, and essentially welcome a possible vacancy so construction can move forward. Once an owner is on a path toward redevelopment “it might not care if one or more tenants pay less rent or terminate or stop operating; what an owner cares about is that the tenant doesn’t have the legal right to stop the owner from doing something by withholding its consent,” said Sinreich.

Additionally, she noted that the typical lease has a limited term, but a typical reciprocal easement agreement could run with the land. “Sometimes there's a 50-year term, but sometimes it's in perpetuity,” so working through the reciprocal easement agreement needs to be a major focus of a mall redevelopment effort.