By Fernando Landa, Partner
Retail real estate owners continually need to modify their projects to meet the evolving needs of retail tenants and customers. Among the most difficult challenges in reimagining or redeveloping retail projects are restrictions within existing REAs, CC&Rs and other recorded encumbrances. There are several key legal and business issues arising from existing REAs, CC&Rs and other recorded encumbrances that need to be considered:
1. Changing Tenant Mix Considerations
Not long ago, movie theaters, gyms and other tenants with high parking requirements fell out of favor with retail landlords because other tenants demanded assurances of adequate parking. As a result, many REAs, CC&Rs and other recorded encumbrances restrict or entirely prohibit such uses.
However, as many retail sales have moved online, these tenants that use more parking spaces are now a major draw for customers – and more customers visiting a shopping center benefits all its tenants. When a landlord wants to lease space to a movie theater, gym or other high-parking user, they must review recorded encumbrances for restrictions on high-parking users.
Similarly, uses that used to be considered taboo, such as massage parlors and liquor stores, are often prohibited in recorded encumbrances. However, a landlord may want a specialty spirits or wine store or a high-end wellness center that offers massages in its shopping center.
To accommodate tenants that may be restricted or prohibited, landlords should proactively review recorded encumbrances and, if such prohibitions and restrictions do apply, amend the recorded encumbrances and obtain any necessary waivers. Otherwise, a prospective tenant whose use is prohibited or otherwise restricted by a recorded encumbrance may not be interested in waiting for the landlord to go through the amendment and waiver process. Proactively reviewing recorded encumbrances and working to remove any cumbersome restrictions will make future leasing efforts easier.
2. Cannabis Tenant Concerns
CC&Rs and REAs often prohibit illegal uses and other objectionable uses within a shopping center. Before leasing to a cannabis tenant, landlords should carefully review applicable recorded documents to ensure such a cannabis lease will not trigger a default under any CC&Rs, REAs or similar instruments.
While certain states have legalized the sale and use of cannabis for medicinal and/or recreational purposes, cannabis remains illegal at the federal level. Because of the Supremacy Clause of the United States Constitution, the sale of cannabis is – simply put – illegal. Under federal law, the U.S. government may seize property of used for the sale of narcotics. 18 U.S.C §881(a)(7). While the federal government is not actively seizing property related to cannabis sales in states where cannabis is legal pursuant to the Obama-era Cole Memorandum, such policy has not been codified and can change with the political winds. As of the date of this writing, the Biden Administration is reevaluating the federal cannabis legal regime.
However, until cannabis is made legal under federal law, any tenant that sells cannabis at a retail location will likely violate any CC&Rs and REA because most CC&Rs and REAs require compliance with all laws. It is not recommended that a retail owner amend applicable CC&Rs and REAs to permit violations of law generally or permit cannabis tenant specifically. However, landlords should closely monitor changes to the cannabis legal landscape as the restrictions on cannabis tenants may be soon lifted or reduced.
3. The Draw of Green Technology
The federal government, many state governments and private industry are all investing billions of dollars in building out America's "green" infrastructure. Solar panels can be installed on retail roofs as well as covered parking structures. In addition, shopping center parking fields have been the target of such investments for their ability to accommodate a large concentration of electric vehicle charging stations.
While retail owners can capitalize their roofs and parking spaces by installing green technology, recorded encumbrances and leases must all be reviewed to ensure that the installation of such infrastructure does not trigger a default thereunder. If a proposed green technology project requires an amendment of a recorded encumbrance or a waiver of any encumbrance requirement, then the retail owner should obtain such waiver or so amend the recorded encumbrance before expending too much time and resources on the project – and before processing any governmental permits or applying for any governmental grants for the project.
Similarly, recorded encumbrances and leases should be reviewed to see how the cost of installing green infrastructure and the revenue derived from EV charging stations should be accounted for under common area expense provisions. In some cases, the cost of the improvements can and should be passed through to tenants and other parties subject to applicable recorded encumbrances.
4. Ride Sharing and Food Delivery Services
The rise of ride-sharing services and food delivery services has implications for retail real estate operations. Prior to carving out parking spaces for short-term parking to accommodate such uses, landlords must review recorded encumbrances to ensure designating parking spaces for a particular use or a particular tenant does not trigger a default under the encumbrance. If an amendment to a recorded encumbrance is necessary to accommodate a request for designated short-term parking by a particular tenant, then it is a best practice for the landlord to require such tenant to pay for the cost of processing that amendment (including paying for the legal fees to draft and negotiate the amendment). In case the amendment is held up for one reason or another, it is also best practice that the amendment not be a condition precedent to the effectiveness of the applicable lease.
5. Parking Technology Integration
Advancements in technology have revolutionized the way parking is managed and utilized within retail projects, particularly large shopping centers and mixed-use projects. From mobile apps that enable convenient payment and reservation systems to sensors that monitor parking space availability in real-time, integrating technology can enhance the efficiency and effectiveness of parking operations. Prior to installing such technology, landlords should review leases, CC&Rs and REAs to create a roadmap for the approval and installation of this technology and to confirm whether any of the cost of such installation can be recovered from third parties. As noted above for green technology improvements, the retail project owner should address any concerns arising from a recorded encumbrance before investing too many resources in the improvement project.
7. The Old Rules of Risk Management in this New Environment
While landlords reimagine and redevelop their retail centers to accommodate the changing demands of tenants and customers, they should also remain vigilant to the traditional concerns of operating a shopping center. For example, the installation of solar panels on canopies in parking areas should not obstruct tenant signage. Similarly, any construction efforts should be done in a manner that minimizes disruption to retail tenants, including any impacts to storefront access.
As accessibility claims against landlords continue to rise, any changes to the retail center should be made in strict compliance with the Americans with Disabilities Act (ADA) and other accessibility laws. Similarly, reimagining retail project parking fields should seek to minimize slip-and-fall accidents and vehicle collisions that can result in costly litigation and reputational damage. Landlords should implement traditional risk management strategies – such as regular maintenance, adequate lighting, and security measures – to minimize legal liabilities.
8. Creating Consensus to Rework Recorded Encumbrances
To accommodate new technologies and meet customer demands, retail project owners will need to collaborate with tenants and other parties subject to applicable recorded encumbrances to rework those encumbrances. While litigation may be used to force changes to an encumbrance, that process is costly, time consuming and unpredictable. Moreover, litigation regarding a recorded encumbrance can poison relationships among neighbors whose cooperation is necessary for the orderly operation of a retail project. Therefore, litigation should almost always be used as a last resort in addressing operational concerns arising from an encumbrance. To that end, retail project owners must create a consensus among stakeholders to modify an encumbrance and address the future needs of a retail project.
9. Futureproofing Recorded Encumbrances
Recent history has shown that consumer preferences and technology can evolve quickly – while CC&Rs, REAs and other recorded encumbrances often feel archaic and limit retail center owners' ability to adapt to these changes. When addressing current issues such as the installation of green technology, shopping center owners should work operational flexibility into recorded encumbrances to allow them to remain competitive and relevant in the evolving marketplace. For example, recorded encumbrances should anticipate the installation of data collection equipment and smart parking infrastructure and should also allow for the implementation dynamic pricing parking models and mixed-use development opportunities. By proactively anticipating future trends and challenges, landlords can future-proof their parking solutions and ensure long-term success.
In summary, evolving customer tastes and new technology present opportunities for retail landlords and retail tenants. However, recorded encumbrances may be outdated to seize on these opportunities. Retail project owners should consider whether they need to rework such recorded encumbrances in collaboration with their tenants and other related parties to pave the way for new technologies and meet future customer demands with greater ease.