BUYING & SELLING TRIPLE NET LEASES Andrew M. Hodgson Attorney Husch Blackwell LLP
Contents Uses/Protected Areas/Offsite Obligations... 1 Access & Parking... 2 Development... 3 Contact the Author: Andrew.Hodgson@huschblackwell.com www.huschblackwell.com/professionals/andrew-hodgson This article originally appeared on Law360.com. 2018 Husch Blackwell
Retail real estate assets include much more than shopping centers and outlet malls. Existing triple net ground leases are becoming attractive to landlords, investors, and developers. In particular, there has been an increase in the past few years in the sale and purchase of triple net ground leases of peripheral properties surrounding retail centers (i.e. outparcels). 1
BUYING & SELLING TRIPLE NET LEASES: COMMON OFFSITE PROBLEMS While triple net ground leases are the primary focus of this article, some of the issues discussed below can arise wherever a ground leased parcel is part of a larger commercial development. For purposes of this article, landlords are the sellers, and investors or developers are the buyers. Landlords like these deals because they can maximize the value of the outparcels (i.e., avoid diluting the typically higher sales per square foot and better cap rates through blending with the adjacent retail center) and redeploy cash to new investment opportunities. Investors like these deals when there is a long-term ground lease with a creditworthy tenant because of the coupon-clipping opportunities. Developers like these deals when there is a ground lease with a shorter term or with a distressed tenant because of the redevelopment potential of real estate with completed infrastructure located next to established, mature retail centers. Whether a deal involves a more traditional ground lease or a build-to-suit ground lease, participants will be focused on economic factors like capitalization rates, coupon rates, and true triple net costs. While they are focused on the money, lawyers should focus on some of the most common offsite problems relating to other areas of the retail center. Uses/Protected Areas/Offsite Obligations Tenants in a retail center rely on the same customer base and common areas for operations. As such, tenants may want to protect their sales, access, and visibility through use exclusives, use restrictions, and protected areas that affect other areas of the retail center. Use exclusives are provisions that grant tenants an exclusive right to operate for a particular use in a certain area of the retail center. Their purpose is to ensure that tenants are not splitting sales across the same customer base. Use restrictions are provisions that restrict landlords from permitting certain uses in a particular area of the retail center to ensure that the character of the retail center stays at a level desired by the tenants. Protected areas are portions of the common areas of a retail center that are vital to tenants. Oftentimes, protected areas are parking fields that must be maintained, must contain a certain number of available parking spaces, or must be free of improvements obstructing access to and visibility of tenants. These provisions can originate in other leases and impact the ground-leased parcel or in the ground lease and impact the adjacent retail center. If these provisions are not spelled out in a recorded instrument, landlords (as to the former provisions) and investors (as to the latter provisions) will want to ensure that their counterpart does not violate one of these provisions and throw them into default after a deal has closed. 1
Landlords should be proactive and review their leases to establish any exclusives, prohibited uses, or protected areas that are not recorded. Investors should be proactive and request those from the landlords. Investors should also review the subject ground lease for the same types of provisions plus any obligations of the landlord under the ground lease that reach beyond the ground-leased parcel (e.g., maintenance, lighting, signage). The two sides could then bind each other in the assignment of the subject ground lease or in a separate recognition agreement. Ultimately, the idea is to record provisions that a party will not be able to police after the closing because of the fact the party no longer owns the land subject to the provisions. Access & Parking Most shopping centers have outparcels along the outskirts of a ring road that circles the enclosed mall. Like the enclosed mall, outparcels will typically need access to the ring road. Unlike the enclosed mall, outparcels will typically, but not always, have sufficient on-site parking. However, it is important to establish how both the ground-leased parcel and the ground tenant have access and parking rights because there are a number of possible scenarios. If there is a ring road that the investor either wants or needs to access, the first question is whether the ring road is a public right-of-way or a private drive. When dealing with a private drive, it is important to determine whether the ground tenant has an exclusive access easement or whether an access easement runs with the land to the benefit of the ground-leased parcel. For the former, it is necessary to obtain from the landlord an access easement to a public road that runs with the land. For the latter, parties need to determine where the right originates and whether that right could potentially expire. As an example, reciprocal easement agreements at retail centers may state that all easements granted therein other than easements for access to the ring road will expire when the agreement expires, and some may not. As for parking, it is common that a ground-leased parcel will contain (and be required to maintain) sufficient on-site parking for the uses permitted on the ground-leased parcel. However, outparcels at retail centers are often occupied by restaurants, which require substantially more parking under zoning codes than typical retail. In some cases, the restaurants will not contain sufficient parking on site and must rely on offsite parking rights to meet code. In other cases, the restaurants will simply want access to more parking than exists on site because of demand. In rare cases, the ground-leased parcel will be just the building pad and will need parking rights over the parking areas of 2
the surrounding retail center. In these cases, the analysis for parking rights is the same as the analysis for access rights above. More often than not, the access and parking rights will be spelled out in reciprocal easement agreements covering the entire retail center, including the outparcels, or just the outparcels. Unfortunately, the heyday of mall development was long enough ago that a number of these reciprocal easement agreements are nearing the end of their stated terms. If a reciprocal easement agreement creating rights in favor of the ground-leased parcel is set to expire, it would be wise to request a separate agreement from landlords, to the extent the landlords can grant easement rights necessary to access ring roads and adjacent public roads, as well as the parking areas of the retail center. Development Lastly, it is important to review covenants, conditions, and restrictions affecting title to the ground-leased parcel for matters tied to parties elsewhere at the retail center. These will be more important to developers instead of investors because the developers will want to change the nature of the property sooner than coupon-clipping investors. The most common types of these matters are rights of first refusal, operating covenants, and construction restrictions (i.e. permitted heights, staging areas, fencing requirements, and construction blackout periods). Here, it is important to advise clients of the development parameters in place on the ground-leased parcel to determine if there are any immediate conflicts that need to be waived or addressed before the deal closes, such as rights of first refusal. 3
Triple net leases offer benefits to everyone, but, as with any real estate transaction, require all parties to fully consider the short- and long-term aspects of the agreement. As outparcels become more and more utilized in retail environments, knowing how to minimize potential offsite complications can save landlords and investors significant time, frustration and expense. 1
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