Owners of shopping centers and other retail spaces are again increasingly looking to novel uses, including distribution and warehouse uses, sometimes called “fulfillment centers”, to fill growing vacancies. These emerging uses raise a number of potential legal issues.
The retail industry is undergoing what appears to be a reset that began before the pandemic. Landlords who had sought to rebalance tenants with an increasing mix of restaurant and experiential tenants are now facing unprecedented declines in foot traffic as people stay home and uses remain subject to various degrees of government-imposed closures. As a result, owners of shopping centers and other retail spaces are finding themselves looking to backfill spaces vacated by shuttered tenants or never filled in the first place.
Before the pandemic started, some retail landlords were already considering or moving forward with incorporating multifamily residential uses into existing shopping centers. However, the residential densification of shopping centers is a long-term, high-cost, complicated process. It’s an especially challenging pivot to make during a pandemic and the related economic downturn. For urban retail landlords of already mixed-use buildings, ground floor retail spaces may not lend themselves to conversion to residential for a number of reasons, including existing layout constraints.
On the other hand, warehouse and industrial uses are one asset class that seems to be growing and perhaps even poised to thrive as consumer spending shifts increasingly online. Such uses may present an opportunity for retailers to reposition vacant space.
Converting retail space to warehouse space need not require the comprehensive overhaul that a residential mixed-use conversion requires. It can be done incrementally and is much more “reversible” once retail foot traffic rebounds given that certain development parameters are similar for retail and warehouse use, as opposed to retail versus residential use. For example, retail buildings might already have adequate loading and other facilities to ease a transition to a storage or distribution center use. In addition, retail centers are geographically well-positioned to be closer to the customers who are buying products online and increasingly expecting next day or same-day deliveries. There may even be opportunities for short-term, scalable, online exchange-driven distribution center users (think WeWork or AirBnB for e-retail) or for take-out and delivery-only restauranteurs (e.g., “ghost kitchens”) to speed up the matchmaking process.
But a pivot to warehouse or distribution centers for “last-mile” deliveries, has its potential legal and operational issues, such as:
- A distribution or warehousing use is often considered a separate category of use under municipal zoning regulations. The new use simply may not be allowed or may require a lengthy entitlement effort to be allowed. It may generate concerns about truck traffic, loading, nighttime noise, and other issues that typical retail uses do not.
- Retail tenants who remain in business may have leases that prohibit warehouse or distribution center uses, or these new uses might not satisfy co-tenancy requirements.
- Similarly, shopping centers that are subject to REAs with co-located big box stores or grocery or other anchor stores may be prohibited under those documents from pivoting to a distribution center use that could be a direct competition to those existing retailers’ business models (or who are themselves pivoting to a greater emphasis on deliveries).
- Loan documents may prohibit changes in use or leases to non-retail tenants and lenders may be wary of a fad, stop-gap or a use that could be perceived as value-diminishing.
- Property tax assessments might be based on assumptions that shopping centers are being leased to potentially higher-value retail uses rather than potentially lower dollar per square foot distribution uses.
- Distribution tenants might not care about or be willing to pay for common area charges retail tenants typically pay for (e.g., advertising, programming, landscape maintenance, etc.) because distribution tenants are not seeking to attract and retain patrons.
- Warehouse centers might be more likely to employ unionized labor not as commonly used in retail outlets.
Although many owners of retail spaces will look to fulfillment center tenants out of opportunity or necessity, the shift will need to be carefully considered.