FEATURE ARTICLE, MAY 2006

DE-MALLING A SHOPPING CENTER
The top 10 issues a developer should address before taking on a de-mailling project.
Matthew Seeberger

Seeberger

One such development strategy in this situation is “de-malling,” which primarily involves removing the roof over the common area of a mall. This article will briefly review a number of considerations that a developer should take into account when evaluating whether de-malling is viable.

1. Reasons Renovation Needed. Some of the major reasons a shopping mall may need renovating are decreased traffic and demographic changes, which are not themselves entirely independent. A decline in traffic can occur because many non-fashion, anchored, enclosed malls do not offer the customer appeal or the desired location for today’s more current, popular specialty stores. For example, a center, which was at the forefront of and benefited from early suburbanization when it was built, may have witnessed a decline in disposable income due to the aging of the surrounding areas in terms of both the residents and the housing stock, and the movement of growth to newer suburbs. An influx of immigrants, whether a mix of ethnic groups or comprising primarily one particular group, could result in a dramatic change in spending and shopping patterns in the mall’s trade area. In either situation, the existing mall structure may no longer be optimal, being either too expensive (from a maintenance/operating cost standpoint and/or the pricing of goods perspective) or simply being “foreign” to the new dominant group of potential customers. Either of these may doom the existing tenant mix to lackluster sales growth or even declining sales. Alternatively, the surrounding area may have gentrified and the new customer pool may be more interested in contemporary developments in shopping, such as more upscale lifestyle centers.

2. Who Are the Anchors, Majors and Other Land Owners? Anchors, majors and/or other land owners in older malls often use a renovation project as an opportunity to extract concessions from a developer, which need to be factored into the developer’s pro forma. De-malling (due to the extent and nature of the work being done) can offer considerable opportunities for such concessions. These may range from financial (in a recent de-malling project, an anchor/major refused to consent to the planned development unless the developer agreed to spruce up the exterior of its store, which was long overdue but had been deferred for some time) to more floor area (that same anchor also insisted on the right to expand its store or to develop outparcels on its land; a second anchor, after seeing this concession, also required the right to develop outparcels on its land) to greater signage (the addition of a large new anchor/major prompted others to demand new signage rights, including changing the priority of the existing signage). There may simply be plain old indifference. In a recent de-malling project, a ground lessor of an anchor/major, which had essentially obtained the bulk of the benefits from a sale-leaseback financing transaction and had minimal rental income to look forward to for up to 60 additional years, would not even discuss a developer’s plans as it saw no benefit to itself.

3. Who Is the Lender? Although a lender obviously wants its borrower to succeed, a lender usually is more focused on ensuring that its collateral does not suffer a decline in value, which could lead to a foreclosure and potentially could result in a “fire sale.” Therefore, a lender may have different ideas about what is best for the success of the center. For example, a developer may be primarily interested in getting a big box retailer to come into the center to increase customer traffic and draw higher-credit regional and national tenants (as opposed to being weighted with “mom and pop” shop tenants), and thus be willing to make significant accommodations to such a retailer to get it under contract. Conversely, a lender may be more concerned that the developer is making too many concessions to the anchor tenant, and thus not giving enough consideration to the upgrade in tenant mix and higher shop rents the anchor will bring to the center.

4. Relocating Existing Tenants. In any renovation, it will be necessary to move a number of tenants to other spaces in the center. Although most shop leases will allow a landlord to relocate a tenant in the event of a major renovation, they usually also require that the tenant’s business operations not be disrupted in a significant manner. For larger tenants, the landlord’s relocation right may be limited to a particular area in the center or simply be non-existent. In either case, it may take additional concessions to convince the tenant to move. In addition, coordinating the relocation of tenants, when combined with scheduling work on the common areas and constructing new tenant spaces, is a daunting challenge for any developer.

5. What Is the Status of the CC&Rs? Many older centers have covenants, conditions and restrictions (CC&Rs), which govern the operation and use of the shopping mall. CC&Rs are often entered into by the various owners of the land under the center, although anchors/major tenants also often have rights regarding what can be done with respect to the center’s common area, which usually is owned by the developer. The primary difficulty in such a situation is that frequently the unanimous agreement of all the parties to the CC&Rs is required to effect any significant change, and, as noted above, anchors, majors and other land owners will often use a needed change to the CC&Rs as a way to get concessions from the developer.

6. Cooperation With/From Local Government. Local governments usually are receptive to renovating an outdated shopping mall, but, as with lenders, anchors, majors and other land owners, a local government may have different priorities, such as upgrading public transit access, upgrading fire ratings for existing structures or increasing sales taxes. While this will not usually prevent a renovation project from occurring, it can lead to delays and additional costs.

7. You Can’t Please Everybody. While it is only natural for a developer to want to maintain good relations with its tenants, there are times when it is necessary to make a decision that does not coincide with what a particular tenant wants. For example, in a recent de-malling project, a small tenant near the end of its term wanted to stay and extend its lease, but was concerned about a decrease in business due to the renovation, the increased rent needed to service the developer’s loan and the cost of renovating its store, which was outdated. The developer, which had recently purchased the mall, convinced the tenant to stay and extend its lease. However, despite the favorable economic terms that the tenant received, it subsequently attempted to bootstrap a limited exclusive use provision in its lease into an argument that would have given it a broader exclusive right to market certain items, even against the anchor/major that the developer was bringing into the mall to increase foot traffic.

8. Make Sure You Have the Right Consultants. It is critical in undertaking a project as complicated as de-malling a shopping center that a developer have the right consultants. This may mean bringing in new people, but it may also mean keeping those who have knowledge of the center. For example, an in-house mall manager is likely to know the character of the various tenants and the physical condition of the structures, and thus is an invaluable resource in determining which tenants to keep and what areas of the center may need work. Engineers, architects and/or contractors who have done similar projects and/or have worked with the relevant local government can provide key assistance in shepherding plans and specifications through building and planning departments. Real estate and land-use attorneys can also assist in facilitating development plans, as well as provide guidance for transactional issues. Leasing agents can provide contacts for the types of tenants that may be interested in coming into a renovated property. And a project manager to coordinate all of the various aspects is strongly recommended.

9. Expect the Unexpected. No matter how much foresight a developer puts into planning, there will always be unexpected delays and costs. This past winter offers a prime example: In a proposed de-malling project, a developer was hoping to do most of its construction work in the summer. Due to delays, much of the work was not started until late fall, which meant that when Los Angeles suffered its second wettest year on record, the developer was forced to deal with flooding of existing spaces and the inability to make meaningful headway in grading for a new anchor store, which led to further delays and costs.

10. Climate. De-malling is a popular alternative in California due to its relatively temperate climate, particularly in the southern part of the state. De-malling is not as feasible wherever extreme cold or heat is characteristic of the regional climate. For example, de-malling may not be practical in northeastern or midwestern states given the variations in weather throughout the year — long periods of cold temperatures in the winter, excessive rain in the spring and/or oppressive heat in the summer, any or all of which generally dictate a need for some protection against the elements.

In determining whether de-malling a shopping mall is feasible and economically viable, there may be factors other than the foregoing that need to be addressed. However, the above 10 issues will assist in evaluating and executing the de-malling process.

Matthew Seeberger is a senior counsel at real estate law firm Cox Castle & Nicholson LLP in Los Angeles.

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