The commercial real estate market has seen an interesting shift over the past few years. Fewer and fewer big-box store developments, such as South Keys, are being constructed. Instead, developers are increasingly focused on urban centres that offer a more rewarding customer experience with a greater variety of options – typically a combination of food and beverage, entertainment and retail – such as what’s offered at Lansdowne Park.
An evolving trend is the “pop-up” store. A pop-up store is a space occupied by a tenant in a commercial development, typically for a short term (six to 12 months), to promote a sampling of its products. Due to these unique circumstances, the negotiation of these short-term occupancy agreements can bring a variety of challenges.
What type of agreement best suits your needs?
The two most common agreements used for pop-up stores are a lease and a license agreement. There is a very important distinction between these two concepts. A lease conveys an interest in land, providing for exclusive use and quiet enjoyment of the premises, for which rights are typically non-revocable.
A license, on the other hand, allows the licensee the right to occupy the licensed lands; however, this is a non-exclusive right and is typically revocable.
The appropriate agreement to use will depend on several considerations, including, but not limited to: the expediency with which the agreement must come together; the complexity of business terms, namely the term and exit strategies; tenant fit-up and allowance; and rent and additional rent.
Although these negotiations may take little to no time to complete, it is important for both parties to turn their minds to these basic questions in order to capture all critical terms. If the terms of the occupancy arrangement are basic and straightforward, a license agreement may suffice. The more complex the arrangement, however, the better suited a lease will be.
Critical issues to consider
Rent: Gross vs. percentage
Due to the short occupancy terms of pop-up tenants, there are typically two different rent structures that are available: gross rent and percentage rent.
Gross rent is preferred by landlords who are able to accurately assess their monthly operating costs and, consequently, can charge their tenants a fixed monthly rate. Although this can be beneficial for a tenant because their monthly rent will remain stable, it can be a detriment if the landlord overestimates their annual or monthly costs, as gross rent is typically established at the landlord’s discretion.
Alternatively, a percentage rent structure dictates that the tenant pays rent to the landlord in an amount equal to a percentage of gross sales, in addition to basic rent. Percentage rent is only payable after a breakpoint, meaning the amount of gross sales after which the tenant shall pay a percentage of all sales to the landlord as additional rent.
As a tenant, it is important to understand where you are as a business, especially with respect to profitability, when it comes to negotiating percentage rent. Otherwise, you risk putting yourself in a financially unpredictable situation.
Tenant allowance / improvements
The quick time frame that pop-up stores can be negotiated in and the short occupancy duration does not permit much flexibility, specifically from landlords when it comes to tenant allowance and improvements to the occupied space.
Landlords will typically want tenants to accept the space “as is, where is” and offer zero allowance for fit-up purposes. It will not benefit a landlord to provide an allowance to a pop-up tenant for improvements only to have those improvements removed one year later. Additionally, landlords will ensure that any improvements undertaken at the tenant’s expense be minor and require the consent of the landlord.
Unfortunately, most tenants will not have much leverage when it comes to improvement provisions, especially if they are seeking financial aid from a landlord for such improvements.
To recap
The type of agreement to be used when setting up a pop-up store will depend heavily on the time frame within which an occupancy agreement must be agreed upon and the complexity of the occupancy arrangement between the parties.
Negotiations become more complex when considering items such as rent structure, term and exit strategies, and improvements/allowance, to name a few. From a landlord’s perspective, short-term revenue goals will compete with long-term marketability of the space. The tenants, meanwhile, should have a strong understanding of their company’s financials and short-term goals to be achieved by a pop-up store.
As this is a new and emerging commercial market, I would recommend seeking legal advice prior to entering into a binding short-term pop-up occupancy agreement, to ensure that both your rights and wants are accounted for.
For more information on how to negotiate a short-term occupancy agreement, contact our Real Estate and Development Group.
