Retailers Turn Department Stores into Mini-Malls

August 2014

As retailers balance the increasing need for varied products and the decreasing need for space, many large anchor tenants like Macy’s and J.C. Penney are choosing to lease their square footage to specialty retailers, creating “stores-within-a-store” or “mini-malls.”

These sublease arrangements can provide various benefits to the anchor tenants. For example, they can:
  1. Enable retailers to offer their customers new, varied products;
  2. Provide an opportunity to attract customers who may not otherwise frequent the store;
  3. Increase sales per square foot by driving traffic to underutilized in-store space, thereby boosting revenue; and
  4. Reduce leasing costs through the additional sublease income.
Given these advantages, analysts expect the trend will continue to accelerate in coming years. Still, these arrangements come with their own risks.  All retailers in a shopping center—anchor tenants, sublessees and in-line tenants alike—can be directly and indirectly impacted by the stipulations of their landlord’s leases.

The following concerns are shaping landlords’ decisions as they structure leasing agreements:

Regard other occupants when developing co-tenancy clauses: Landlords must consider the potential of violating co-tenancy provisions with other in-line tenants. If an anchor tenant signs more than one sublease tenant, a mini-store can be created. However, landlords acknowledge that other mall in-line tenants’ foot traffic can often be dependent upon anchor tenants’ business. Therefore, typical leases for in-line tenants provide that they will not be obligated to remain open or operating at full rent unless one or more anchor tenants are also operating. If the anchor tenant breaks its lease or ceases to exist either independently or as a result of the “mini-mall”, issues can arise with other in-line tenants.

Landlords, as a result, have to control anchor tenants’ ability to sublet their space. Since most anchor tenants want flexibility, landlords can meet them halfway by allowing them to assign to another national, single-occupant retailer. They may also allow anchor tenants to sublease space to no more than two outside retailers, while maintaining the appearance of a single operator.

To protect themselves from violating co-tenancy clauses, landlords carefully draft the co-tenancy language of the other in-line tenants’ leases to protect themselves in the event that an anchor tenant vacates. It makes sense to keep the terms of the lease broad and avoid specifying the anchor tenant when discussing the requirements for another tenant’s continued lease obligation. On the other hand, in-line tenants should make sure that replacement tenants are allowed if an anchor tenant ceases to exist.

Check in-line tenants’ lease agreements for anti-competition clauses: Landlords are also careful to avoid violating anti-competition clauses that may be outlined in other in-line tenants’ lease agreements. When anchor tenants begin conversations around subleasing their space, they should first consult with the landlord to confirm that their prospective subtenants are not selling any products or services that will compete with those of other in-line tenants. While this consideration has not proved to be a large issue to date, it is certainly worth noting as this trend expands.

As more retailers adopt the store-within-a-store approach, it is important that those involved recognize not only the opportunities, but also the potential challenges that these arrangements pose. In understanding the aforementioned details and stipulations from a landlord perspective, all retail tenants can act accordingly and ensure they are laying the groundwork for a successful and profitable relationship.