Repurposing Real Estate Use?

2020 saw a slew of retail bankruptcies. Many of these companies will emerge from bankruptcy with a much smaller physical footprint, shedding both debts and brick and mortar locations. What does that mean for all of those soon to be empty locations? As you can probably guess, there is not an abundance of retail tenants to take their place. One answer has been for landlords to repurpose these empty spaces into industrial (think Amazon fulfillment centers) and mixed use (high-end condos and hotels built within a shopping mall) projects.

 Tough times call for innovation, but many landlords and tenants seeking to transform their space may not be considering the contractual and regulatory restrictions that impact their attempts to pivot, finding themselves with more, not less, problems. So, what should landlords and tenants keep an eye out for?

Lease Terms

Most leases specifically outline the allowable use(s) of the property for lease. For example, a tenant’s lease may require that it operate a retail storefront only, open from 9 a.m. to 5 p.m. Most leases also prohibit the use and generation of, among other things, hazardous materials (the type regularly used in medical offices). For example, if a tenant is looking to transform his retail space into a 24-hour urgent care facility, numerous lease provisions might prohibit him from doing this. 

Lessees should review their lease to determine how it may impact their redevelopment plans and whether a new or amended lease needs to be negotiated. Landlords are keenly aware of the financial stress tenants are under. They also know that if they do not try to be flexible, they may find themselves with empty properties and no tenants in line to fill them. Tenants should approach their landlords with a comprehensive and easily digestible proposal for amending any necessary lease terms that demonstrates why their new direction benefits both parties.

Loan Agreement

Landlords often seek financing to acquire the real estate they rent out. Many loan agreements (and related documents) contain limitations or covenants concerning uses for the real estate being financed. Any disruption to rental income for redevelopment purposes or change in use may trigger a breach of one or more of those agreements. Landlords should review their loan documents carefully when deciding to make a change or talking with a tenant about making one. 

As with the relationship between landlords and tenants, lenders do not want to see borrowers default on their loans, leaving them to pursue deficiency judgments or foreclosures of retail and office space that may be difficult to resell. Therefore, lenders may be willing to make concessions or loan modifications that would not have been realistic or possible just a year ago.

Restrictive Covenants

Property developers sometimes record restrictive covenants concerning the use of real property (often a negotiated condition for project approval). These covenants outline limitations concerning the property, including size and height of the building(s) and scope of use (e.g., retail is allowed but not a sushi restaurant). 

Property owners should make sure to know about any and all previously recorded restrictions to determine whether their contemplated redevelopment is permitted. If it is not, they will need to develop a strategy to revise their plans or negotiate an amendment to the restrictions with any other property owners benefitted by them.

Zoning

Local municipalities govern allowed uses for real property. Just because a property is zoned for retail does not mean it is zoned to allow a mixed-use project, including residential. Property owners should check their property’s status and determine what steps, if any, are necessary to get their property rezoned. 

Cities and towns benefit immensely from locations that are open for business, including through generated sales tax revenue and job creation. They also want to avoid a repeat of what happened in 2008, when cities saw entire city blocks shuttered due to business closures. As such, local governments may be more willing to allow exceptions to existing regulations, allowing their economies to get back on track faster and with less disruption. 

Change and innovation is necessary and important, especially in the current economic climate. Savvy landlords and tenants will know the full scope of their right to change course and use that information to negotiate any amendments or zoning changes necessary to make it happen.  

Courtney Beller serves as Carvana’s Senior Corporate Counsel, Litigation where she manages the company’s docket of nationwide litigation and arbitration matters. Before joining Carvana, she served as a director and vice chair of the Business Litigation practice area at the law firm of Fennemore. She litigated cases concerning intellectual property disputes, misappropriation of trade secrets, breach of contract and claims against state and local agencies in Arizona and Nevada. She handled cases for major real estate developers and helped health care clients navigate the ever-changing regulatory landscape.  carvana.com