Financeable Retail Leases: A Guide to the Perplexed

Our colleague Steve Friedberg recently spoke at the ICSC Shopping Center Law Conference in Phoenix, Arizona on the topic of “Financeable Retail Leases: A Guide to the Perplexed”.  The seminar explored the requirements for creating financeable retail leases from the perspectives of landlords, tenants and leasehold and fee mortgage lenders. Five key takeaways from Steve's presentation were:

1. The users of these leases are generally national credit tenants who require control over the construction of their buildings through long-term ground leases (the term generally is at least 25 years, plus 4 or more 5 year renewal options—the term, including options, has to be at least 20-30 years longer than the term of a leasehold mortgage to satisfy rating agency requirements). Because of their credit standing, these tenants can build their improvements much less expensively than a landlord (and the landlord does not have the risk of construction and its cost).
2. Because tenants will be constructing their own improvements and will be occupants of their leased premises for a long term, on a triple net basis, they need to have contingencies for (and should carefully perform or obtain) both due diligence and permits, as if they were purchasing the property.
3. Landlords are often surprised at the differences between these leases and more typical space leases, including a number of requirements imposed by the rating agencies for the lenders who make loans on these leaseholds. In many respects, these leases look as much like financial instruments as leases. Because of this, negotiations of these leases are often protracted.
4. Landlord should expect these leases to include a robust leasehold mortgage clause that provides the leasehold mortgagee with additional rights (and time) to cure a default by a tenant and the right to receive a new lease if the lease has to be terminated due to a default by tenant or its bankruptcy, among other requirements. The term of the leasehold mortgage will generally be for all or substantially all of the initial term of the lease.
5. Because of rating agency requirements, landlords should also expect that they will have no interest in the building and other improvements during the term of the lease, the tenant will have the right to assign or sublet the premises without restriction (subject some reasonable restrictions on use in a multi tenant property setting), the tenant will be entitled to all casualty proceeds and condemnation awards related to the improvements, there will be a broad use clause, and there will be obligation to record a memorandum of the lease, among other requirements.

In short, because these leases are so specialized, landlords or tenants who are contemplating entering into financeable retail leases would be advised to only use counsel who have broad experience in this highly specialized area.

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