Two centers the same size and fully leased can be very different assets. How to read your tenant mix for concentration, co-tenancy and exclusive-use risk, when local operators work, and how to choose who gets the next open space.
Most owners think of the tenant mix as a leasing question. Who fits the empty space. What the broker can bring in this quarter.
It is an ownership question. The mix decides how durable the income is, how much a lender will advance against it, and what the center is worth when you sell. Two centers with the same square footage and the same occupancy can be very different assets, and the difference is almost entirely who is in them and what their leases say.
Three jobs a tenant can do
Every tenant in a strip center does at least one of three jobs.
Traffic generators bring people to the property who would not otherwise come. A grocery store, a fitness club, a busy coffee drive-thru, an urgent care. They pull cars into the lot several times a week, and every inline tenant benefits from the visits.
Destination tenants bring their own customers, who come for that business and leave. A mattress store, a dentist, a tattoo shop, a specialty bike shop. They do not need your traffic, and they do not create much for anyone else.
Convenience tenants live off the traffic that is already there. A dry cleaner, a sandwich shop, a nail salon, a pack and ship store. They do well when the lot is busy and struggle when it is not.
A healthy center has all three, and none of them carries the whole property. The question to ask about any lease is not just "will they pay" but "which job does this tenant do, and who depends on it?"
There is a fourth test that cuts across all three: can the thing this tenant sells be bought through a screen? Haircuts, dental cleanings, physical therapy, a hot lunch, a dog groom and a dry cleaning order cannot. Phones, mattresses, supplements and party supplies can, and the tenants that sell them compete with a delivery truck every day. Needs-based and service uses are not immune to a bad economy, but they are not exposed to the same slow leak.
Two centers, same size, different assets
Take two 24,000 square foot centers in the same suburban trade area, both fully leased on net leases.
Center A has a 10,000 square foot fitness club as its anchor tenant at $11 a foot, plus eight inline tenants: a mattress store, a party supply store, a pizza carryout, a cellular store, a supplement store, a nail salon, a vape shop and a tax preparer. Base rent is $365,400.
Center B has no anchor. Its largest tenant is a 4,000 square foot urgent care at $19. Around it: a coffee drive-thru on the end cap, physical therapy, a dental office, a fast casual restaurant, a taqueria, a pet groomer, a hair salon, a pack and ship store, a dry cleaner and an insurance agency. Eleven tenants, $451,700 of base rent.
- Center A largest tenant
- 30.1%
- Center B largest tenant
- 16.8%
- Center A top three
- 54.7%
- Center B top three
- 41.4%
At Center A, one tenant pays nearly a third of the rent, and three tenants pay more than half. At Center B, no tenant pays more than about a sixth, and every tenant sells a service, a treatment or a meal. At Center A, a little over half of base rent comes from service and food uses. The rest is goods retail that competes with the internet.
Neither center is broken. Center A may even look better from the road, with a busy gym and a full parking lot at 6 a.m. But now ask the question a buyer or a lender will ask: what happens if the largest tenant leaves?
The clause that multiplies a vacancy
When the urgent care at Center B leaves, the center loses $76,000 of base rent, about 17% of the total. That hurts. It is also a single 4,000 square foot box in a center with ten other tenants still open and paying, and a medical or service user can take it with modest work.
When the fitness club at Center A leaves, the direct loss is $110,000. But three inline leases (the pizza carryout, the supplement store and the nail salon) were signed with co-tenancy clauses tied to the gym. If the gym goes dark and is not replaced within six months, their rent drops to half until it is. Those three tenants pay $86,600 a year. Half of that is another $43,300.
That is $153,300, or 42% of the center's base rent, from one tenant decision. At a 7.5% cap rate, it is roughly $2.04 million of value, against about $1.01 million for the same event at Center B. And a 10,000 square foot fitness box is not easy to backfill. Few users want that size, and fewer want a space already built out with locker rooms.
Co-tenancy is not the only clause that turns a tenant into a dependency. Watch for three.
Co-tenancy. Inline tenants ask for it when a single tenant is the reason they are signing. Sometimes it is a fair ask. If you grant it, cap the remedy (reduced rent, not a right to terminate), give yourself a long cure period to replace the named tenant, and allow a replacement of similar size and use, not only the original name.
Exclusive use. An exclusive use clause promises a tenant that you will not lease to a competitor. Written loosely, it quietly removes whole categories from your leasing options. A pizza carryout with an exclusive on "pizza, subs or Italian food" can block a fast casual concept that sells a flatbread. Before granting an exclusive, define it by primary use and a percentage of sales, exclude existing tenants, and make it die if the tenant goes dark, assigns, or falls into default.
Radius and relocation rights. These cut the other way, and they are usually yours to ask for. Just know which ones you already gave away.
Pull every lease and list the clauses in one place. Most owners who do it find at least one they did not remember. This is not legal advice, so have your attorney review anything you plan to rely on.
Credit is not the only answer
The easy conclusion from all this is "lease to national credit only." That is not available to most Southeastern Wisconsin strip centers, and it is not even the right goal.
A credit tenant gives you a balance sheet behind the lease. It also gives you a tenant with a real estate department, a standard lease form written in its favor, a lower rent, and a corporate decision to close 40 stores that has nothing to do with your location. National tenants leave good centers all the time.
Local and regional operators are the backbone of this property type, and they work when you underwrite them like the business they are. Four things matter.
- Operating history. How long has this business been open, and where? A second location of a salon that has run for eight years three miles away is a different risk than a first-time owner. Ask for two years of tax returns or financial statements for the existing business.
- The owner's experience. Has this person run this kind of business before, as an owner, not just as an employee? A great stylist is not automatically a great salon owner.
- The guaranty. For a local tenant, the personal guaranty of the owner is often most of the credit you are getting. Know what the guarantor actually owns and what the guaranty actually covers.
- The tenant's own money in the space. A tenant who spends $60,000 of its own cash on a build-out is committed in a way that a tenant building entirely on your tenant improvement allowance is not. If you are funding most of the improvements, the lease and the guaranty have to carry more of the weight.
A local operator with a solid track record, meaningful money in the build-out and a real guarantor is often a better ten year tenant than a regional chain with a cheap lease and a termination right.
Choosing who gets the next open space
When a space opens up, the tempting move is to take the first credible prospect at the best rent. Before you do, score the prospect against the center, not just against the space.
Does it add a job the center is missing? If you have plenty of convenience tenants and no traffic generator, a strong convenience tenant does less for you than a service business that brings people in every week.
Does it raise or lower concentration? A tenant that takes three spaces and becomes 25% of your rent is solving a vacancy by creating a dependency. Sometimes that is still the right call. Know you are making it.
Is the use internet-resistant? Service, medical, food and fitness uses get the benefit of the doubt. Goods retail needs a reason: a strong operator, a specialty the internet serves badly, or a low rent that reflects the risk.
What does it ask for? Price the clauses, not only the rent. An exclusive, a co-tenancy right or a kick-out clause has a cost that shows up years later.
Does it clash with what is already there? Parking-heavy uses next to each other, a restaurant venting next to a dental office, an exclusive you already granted. Walk the use through the whole site plan before the LOI.
Is the space itself flexible? A 1,500 square foot inline space has dozens of potential users. Heavily customizing it for one of them narrows the list the next time it turns over.
The best rent on the table is not always the best lease. A dollar less per foot from a tenant that lowers concentration and adds weekly traffic can be worth more than the top offer from a tenant that deepens the dependence you already have.
An hour with the rent roll
Do this once a year, and again before any lease with a new tenant is signed.
- List every tenant with its annual base rent. Divide the largest by the total. Over 25% deserves a plan.
- Add the top three. Over 50% means a few decisions you do not control decide your year.
- Tag each tenant as traffic, destination or convenience, and as service or goods. Look for a job nobody is doing.
- Pull every co-tenancy, exclusive and kick-out clause into one list, with the tenant it depends on and the remedy.
- Run the loss of your largest tenant, including every clause it triggers. Multiply the lost rent by your cap rate. That is what that one lease is carrying.
- For each local tenant, note years in business, the guarantor, and how much of the build-out they paid for.
- Write down which job the next vacancy should fill before a prospect shows up.
If the answer to step five is a number you would not want a buyer to calculate first, that is the leasing plan for the next three years. If you want a second set of eyes on the rent roll, send it to us.