PDF DownloadNew Tenants for Big Boxes
By J.L. Cherwin Jr. and Virginia M. Harding

Probate & Property Magazine: January/February 2010, Volume 24, Number 1

Real Property|Trust & Estate

J.L. Cherwin Jr. is a partner with FSB Legal Counsel in Chicago, Illinois. Virginia M. Harding is of counsel with Gould & Ratner LLP in Chicago, Illinois.

Communities across the country are seeing an ever-growing inventory of vacant "big box" retail stores. This trend is a source of concern because a vacant big box signals that a community has lost both jobs and sales tax revenues. The longer a big box remains vacant, the more likely the vacancy will adversely affect the occupants of adjacent retail establishments whose businesses are hurt by the loss of traffic once generated by the now vacant big box. "Chronically vacant big-box stores can impose high public costs. They often: become magnets for crime and vandalism; lower property values nearby; undermine the vitality of nearby businesses; [and] create a negative image of the town that deters new businesses and investment." Big Box Blight: The Spread of Dark Stores (Institute for Local Self Reliance 2007), at 2, available at www.bigboxtoolkit.com/images/pdf/bigboxblight.pdf.

This article discusses some of the creative ways that local communities are attempting to refill and reuse this retail space, as well as some of the challenges that lawyers must help these communities overcome in the rebirthing process.

The Increase in Big-Box Vacancy Rates

"Big boxes" are freestanding buildings occupied by a single retail tenant, containing anywhere from 20,000 square feet to 200,000 square feet, and surrounded by large parking areas. Retailers that commonly occupy big boxes include discount department stores (Wal-Mart and Target, for example), wholesale clubs (such as Costco and Sam's Club), and specific product stores (including Best Buy and Home Depot).

The economic downturn has played a significant role in building the inventory of vacant big-box stores as national retailers such as Home Depot and Lowe's shuttered their underperforming stores. Approximately 1,400 additional big boxes became vacant in early 2009 when Linens N' Things and Circuit City closed all their retail locations. In addition, the 2008 demise of Steve & Barry's—once a white knight retail occupant for vacant big boxes—returned many of those reclaimed spaces to the inventory of available big boxes.

Even before the downturn, however, an inventory of vacant big boxes was being created by retailers, such as Wal-Mart, that expanded their operations within a community, not by adding onto their existing box, but by building a newer and bigger box and leaving their initial location vacant. As of September 2009, the Walmart Realty web site listed 182 buildings within the United States available for sale or lease. Walmart Realty, www.walmartrealty.com/SearchResults/SearchResults.aspx (last visited Nov. 16, 2009).

Thus, the ever-growing inventory of big boxes is attributable to the perfect storm of successful retailers moving into larger spaces and leaving their original spaces vacant; retailers abandoning underperforming locations; retailers liquidating and closing; and lack of growth within the retail sector.

Reusing and Filling Vacant Big Boxes

In the short run, with the retail sector continuing to shrink, finding new retail tenants for vacant big boxes is going to be very difficult. As the number of empty big boxes increases, planners, developers, and others have started to think about alternative uses for vacant big boxes. Big-box reuse is a hot topic today, and the question is what can be done with these large, windowless structures. Is it possible to retrofit these structures?

According to author Julia Christensen, the answer is "yes." Christensen's book presents a series of case studies describing the ways in which big boxes once occupied by Wal-Mart and K-Mart have been redeveloped into libraries, community centers, charter schools, churches, museums, and civic centers. Julia Christensen, Big Box Reuse (Mass. Inst. of Tech. 2008).

Although Christensen's case studies are encouraging in that they show ways in which big boxes can be transformed into places for positive community service that provide jobs, her studies tell the kind of stories that most communities do not want to hear. With the exception of a peddlers mall developed in Nicholasville, Kentucky, none of the new uses for the sites described in her case studies were uses that generate sales taxes. In many cases, the new user was exempt from the payment of property taxes.

Constraints and Impediments to Filling Vacant Big Boxes

Owners and potential users of a vacant big box face a number of constraints and impediments. The good news is that big boxes can be retrofitted for new users, as shown in Julia Christensen's case studies. The bad news is that retrofits cost money, which few prospective new users have.

Owners seeking new tenants to fill their vacant big boxes might be able to get assistance from communities that want to stem the loss of jobs and sales taxes revenues. This governmental assistance can include help with marketing, process streamlining, and new financial incentives. One of the major obstacles to these projects, however, is the ability to secure acquisition and construction loans to retrofit vacant big boxes to meet the needs of new occupants. These new users are often far from lenders' ideal tenants. Obtaining lender approval can be especially difficult if the financing is tied to a commercial mortgage backed security (CMBS) arrangement.

Christensen's case studies, all written before the current financial market crisis, describe additional challenges that government-supported projects must overcome. For example, the renovation of a former Wal-Mart store into a community senior center in Wisconsin Rapids, Wisconsin, required substantial fund-raising and public relations efforts. The community had to be convinced that the empty Wal-Mart space, which previously anchored a mall, could be re-energized and redeveloped into a first-class community resource facility. Moreover, under current economic conditions, public fund-raising efforts are likely to be severely constrained.

Not All Communities View Vacant Big Boxes the Same

Vacant big boxes are located in all types of communities, and the type of community will likely affect the prospect that the property can be reused by non-retail tenants. Well-established, inner-circle suburban markets and stable urban areas—where the retail landscape is likely thoroughly developed, though with some oversupply and natural, cyclical vacancies—are better able to ride out the storm and wait for new retail occupants for vacant boxes. As a result, these communities will be less willing to accept long-term nontraditional reuses of their vacant big boxes.

Communities most likely to consider proposals for nonretail reuses of their vacant big boxes are rural areas, particularly those that have lost crucial area employers and need an impetus for more jobs; distant suburbs that experienced substantial growth in large scale big-box retail development in anticipation of new residential developments that are now stalled or abandoned; and declining suburbs and urban areas.

In many instances, big-box tenants are welcomed and receive government support because of government and community expectations that the big-box site, when developed, will be a significant source of sales tax revenues and will increase the real estate tax base. The importance of these revenues to the community will affect greatly the willingness of the community to accept new occupants that do not generate sales taxes or that will take the property off the tax rolls. Churches, schools, and other public uses are generally exempt from the payment of real estate taxes. In other cases, the prospective new users are lower tier, lower rent tenants such as discount grocers or other discount retailers that are more willing to adapt their operations to fit the existing structure without a substantial capital outlay. Owners may be concerned that these users will devalue the property.

Early in the due diligence process, owners of vacant big boxes as well as potential nonretail occupants need to gauge the level of assistance that government authorities will provide and the likelihood that a nonretail use will be welcomed and supported. Without government support, the big box will likely remain vacant, waiting for a new retail tenant.

Multiple Persons and Entities May Control the Vacant Big-Box Site

The first challenge a potential reuse tenant faces is identifying, and then making contact with, the decision makers for all persons with interests in the site. Many sites are subject to ground leases and master leases held by national as opposed to local investors. Each of these persons may have different goals and objectives that the tenant must satisfy. Determining who controls a site and what those owners want is the first step.

Not all owners of vacant properties are interested in filling their spaces. The owners that are not in a rush to find a new tenant are probably blessed with a retail tenant that has "gone dark" but has continued to pay the rent, often as part of the tenant's strategy to protect market share and retain control of a valuable retail site. These properties are likely to stay vacant and continue to deteriorate until the lease ends and rental payments cease. These owners lack any real incentive to spend resources on a property that is providing them with a regular stream of income.

Big-box leases typically give the big-box tenant control of the site as long as the rents are timely paid, even after it no longer operates in the property. A retailer's willingness to relinquish control of a vacant site will depend heavily on its internal analyses, regional strategy, and determination whether it should incur the costs of maintaining a vacant site rather than risk losing market share to a competitor.

The owners of, and investors in, big-box sites that now are vacant because of the bankruptcy of their big-box retail tenants are likely to be receptive to proposals from nonretail occupants. These properties were developed, purchased, and financed with the expectation of a long-term income stream from high-credit tenants. With those tenants gone and the space vacant, these owners may be willing to fill the space with a nonretail tenant for the short term as a method of "banking" the land and covering ongoing expenses until the retail market returns.

Deed Covenants and Lease Provisions Limit the Pool of New Occupants

If the owner of the vacant big box is also the retailer that previously operated in that space, then that owner is likely to require any buyer or new tenant to agree to a restriction limiting the future uses of the big box. For example, Wal-Mart's standard letter of intent for the purchase of its properties contains the following use restriction:

The Property shall not be used for, or in support of (i) a discount store in excess of 8,000 square feet . . . ; wholesale membership/warehouse club, grocery store/supermarket, pharmacy/drug store; (ii) gas station, quick lube/oil change facility, automobile tire sales; (iii) movie theater, bowling alley, health spa/fitness center larger than 3,000 square feet; . . .

Walmart Realty, Purchaser's Letter of Intent, available at www.walmartrealty.com/Media/128566298747968750.doc.

Similarly, as a condition to leasing a big box, many big-box retailers require that the owner agree to restrictions in the lease limiting the ability to re-lease the site to a competitor for a certain period after the end of the retailer's term. This is a defensive strategy to prohibit a competitor from occupying what the big-box retailer has determined to be a desirable location. These restrictions are a significant impediment to leasing a vacant big box to another retail tenant because the most logical new tenants for that location are probably competing retailers barred by the restrictions.

Cotenancy Clauses Further Restrict the Pool of New Occupants

In a big-box multi-user development, other retail tenants flock to the site because they expect to benefit from the traffic generated by the big box. Often "cotenancy" clauses in the leases of the other tenants condition these tenants' obligations on the continued operation of the big box. Thus, the closing of a big box may trigger a landlord default under other retailers' leases, resulting in a tenant exodus, further compounding the owner's problems. Cotenancy clauses will chill the willingness of owners to consider a nonretail tenant for vacant space unless the nonretail tenant's use will satisfy the cotenancy clauses of other leases within the center, typically by generating the same level of traffic. Few, if any, nonretail tenants would be willing to invest in a study to demonstrate the level of traffic that their use will generate to overcome this obstacle.

Physical Constraints on Reuse

Big-box structures are designed with one primary purpose: to house as much inventory as possible, in the most efficient manner, with the lowest initial investment and lowest ongoing maintenance possible. Typically, they are constructed in accord with specifications tailored to the business requirements of their specific retail occupant. What worked for the first retail occupant may not work for the next retail occupant.

Except in extraordinary cases or in markets with high barriers to entry in terms of cost or permitting, the most attractive big-box retailers prefer to occupy a structure built to their particular specifications rather than adapting an older structure. Refitting the space for a use often can be more expensive than new construction, particularly in communities where land is relatively cheap. More often, if the site is to be reused for retail purposes, the succeeding user will bring less creditworthiness, will pay lower rent, and will generate less revenue.

For nonretail users, the physical constraints of a big-box structure are significant. Often the user must make costly improvements, such as windows to provide natural light, walls to create separate spaces, and reworked mechanical, electrical, and plumbing systems. Who will bear the cost of these indispensable improvements is an essential question that must be resolved before a vacant big box can be redeveloped for long-term use or "parked or banked" with a short-term tenant.

Tenants have no incentive to incur significant costs for capital improvements unless the owner is willing to enter into a long-term lease (15 to 20 years); however, entering into a long-term lease with a nonretail tenant hinders the owner's ability to merely "park or bank" the property for the short term. The owner will be forced to decide whether to tie up the property with a nonretail user generating a lower investment return for a long term, or to keep the property vacant, waiting for the opportunity of receiving greater returns in the future from a new retail tenant.

Zoning and Other Land Controls as Constraints to Nonretail Uses

Big boxes are developed in areas zoned for retail development and, in many cases, zoned specifically for this type of large-scale retail development. The zoning and land use controls that affect the vacated big-box site must be reviewed carefully to identify the potential new uses that are permitted. If a particular nonretail use is proposed, additional approvals from government authorities may be required for that use. Special uses may require consideration and votes by public officials at public meetings. The attitude of the government officials as well as the community toward the proposed use of a former retail space for a nonretail use may result in a denial of the needed permits and approvals and, instead, encourage the landowner to wait patiently for a replacement retail user for the vacant big box.

The vacant big box also may be subject to a development or annexation agreement that prohibits nonretail uses on the site or encumbers the site with a continuing obligation to pay for the construction of the infrastructure that supports the big box. The site may also be bound by covenants arising from financial incentives, such as sales tax rebates triggered by a certain level of sales.

Existing Entitlements/Incentives as Constraints to Nonretail Uses

Tax-increment financing (TIF) districts and sales tax rebates are among the common economic incentives that communities use to induce a big-box retail tenant to come into the community. The closing of the retail operations in the big-box site and a proposal that the vacant site be occupied by a nonretail tenant will affect these incentives. It is important that the owner and potential tenant determine whether the vacant big-box site is the beneficiary of any incentives that preclude its occupancy by nonretail tenants.

TIF districts are established to reimburse developers for some development costs by capturing and using the incremental increase in property taxes resulting from the higher property values created by the development. If the vacant big-box site is within a TIF district, the developer or the local government will have likely front-funded initial development costs under the assumption that the increase in valuation of the property will provide the increment necessary for reimbursement of those costs. It may be difficult for the developer or the local government to receive the return of its investment if the property value is reduced either because of vacancy or because the property is occupied by a nonretail tenant. TIF benefits can be lost by reason of the occupancy of a vacant big box by a nonretail tenant that is exempt from the payment of real estate taxes.

Any sales tax rebate arrangements that affect the property must be reviewed to determine whether they preclude the occupancy of the vacant big box by a nonretail tenant. If the developer expected to recover any development costs by receiving a portion of a sales tax rebate derived from the retail sales of its big-box retailer, the developer may not be willing to accept the loss of that rebate income caused by occupancy of the site by a nonretail user. This will not be an issue if the sales tax rebate arrangement ended when the original big-box retailer vacated the site.

Conclusion

Creative ideas for filling vacant big boxes abound. But owners desiring to redevelop the property face a number of obstacles and impediments, not the least of which is the inability to secure financing in the current economy. Ultimately, the lack of new or expanding big-box retailers, coupled with the lack of incentives for owners, communities, and local governments to support a change in the use of these properties to nonretail uses, make it likely that many currently vacant big-box sites will remain vacant.

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