The Domino Effect: Understanding Co-Tenancy and Its Triggers in Today's Retail Market

One of the key concepts I deal with as an investor is co-tenancy in retail real estate. These clauses are powerful factors in retail leases, both for tenants and landlords, and they can make or break a deal. 

For new real estate investors, understanding how co-tenancy clauses work is crucial. 

These provisions can influence leasing strategies, impact cash flow, and determine whether a shopping center thrives or fails.

Let me walk you through co-tenancy, why it matters, and how it plays out in real-world scenarios. Additionally, we will detail how RockStep Capital approaches co-tenancy clauses and why we follow the strategy we do.

What Exactly is 'Co-Tenancy'?

Co-tenancy is a clause or provision written into leases with the key objective of protecting tenants, particularly smaller or dependent ones, from suffering when key tenants leave a shopping center. 

At its core, co-tenancy is a lease provision that protects tenants if certain shopping center conditions change. 

The idea is simple: if I, as a retailer, come into your shopping center because of the great tenants you promised me, and those tenants leave, I need to protect my business. My sales will suffer, and I can’t afford to pay the same rent. Co-tenancy clauses give me an out or a financial adjustment to mitigate my losses.

For example, if key anchor tenants like Macy’s or Best Buy close and aren’t replaced within a set timeframe (usually 12 to 18 months), co-tenancy clauses might allow smaller tenants to reduce their rent—or even terminate their leases.

Types of Co-Tenancy Clauses 

Co-tenancy provisions generally fall into two categories, which are negotiated during the lease or even earlier during the letter of intent phase:

1. Opening Co-Tenancy Clause 

An opening co-tenancy lease clause applies when a shopping center is being developed. 

Let’s say I’m a tenant, and you’re building a power center with five big anchors. I don’t want to pay full rent if I’m the first one to open. 

My lease might include a clause saying I won’t pay full rent until three of the five major tenants (say, Kohl’s, Best Buy, and TJ Maxx) are open and operating. 

This protects me from being the only retailer in an incomplete shopping center.

2. Ongoing Co-Tenancy Clause 

This clause kicks in after the shopping center is fully operational. 

If key tenants close and aren’t replaced—whether we’re talking about anchors like Macy’s or a certain percentage of the shopping center’s total occupancy—co-tenancy provisions might reduce rents for other tenants.

For example, Bath & Body Works might negotiate a clause where their rent is cut in half if two out of four anchors in a mall close without suitable replacements.

Negotiating Co-Tenancy Clauses 

Co-tenancy provisions are one of the most contentious points in lease negotiations. 

When you’re dealing with national tenants, these clauses often get hammered out during the letter of intent stage. 

For additional context, a letter of intent is a non-binding document that outlines an agreement in principle between two or more parties before reaching the stage of a legal contract. A letter of intent for a national tenant can run 20 pages or more. It’s not a one-page handshake deal; it covers everything down to the smallest detail. 

By the time the landlord and tenant are done, they might have spent more energy on that letter than the lease itself.

Let me be clear: tenants love co-tenancy provisions. For them, it’s about limiting their risk. If a shopping center fails to maintain its tenant mix, tenants want the flexibility to reduce costs or walk away. For landlords like RockStep Capital, co-tenancy provisions can be painful. They create financial uncertainty and can tank cash flow if triggered.

As with most things, finding balance is the key to effective co-tenancy clauses. Tenants want maximum protection, while landlords wish to limit exposure.

Members of the RockStep Capital team often spend hours on these negotiations, weighing how much one of our properties needs a particular tenant against the risk the details of their co-tenancy clause create.

Risks of Co-Tenancy Clauses 

Co-tenancy provisions are a double-edged sword. On the one hand, they’re necessary to attract quality tenants and big-name retailers. On the other hand, they can lead to serious financial problems if triggered. Here are some of the biggest risks:

1. Financial Exposure

One of the biggest risks with co-tenancy is the financial blow it delivers. Let’s say you’ve got a tenant paying $200,000 a year in rent. If their co-tenancy provision is triggered, that rent might drop to $100,000—or even less. Some leases move tenants to percentage rent, where they pay a portion of their sales instead of a fixed rent.

Here’s the catch: some tenants deliberately design their co-tenancy clauses to ensure they’ll almost always get a rent reduction. It’s a “gotcha” move that increases their chances of reducing occupancy costs, even if their sales aren’t impacted.

I’ve dealt with tenants who write co-tenancy clauses that are nearly impossible to satisfy. They might say, “If two of these three anchors close without a suitable replacement, we get reduced rent,” but then define a “replacement anchor” so narrowly—specific square footage, certain national presence, even minimum sales levels—that no landlord could realistically satisfy it.

 It’s a nightmare to negotiate, but if you want big-name tenants like Ross or Victoria’s Secret, the risk may be worth it.

2. Ownership Issues 

In many malls, anchor tenants like Macy’s, Dillard’s, and JCPenney own their buildings. They’re not paying rent to the landlord—they own the dirt and the walls. So, if Macy’s decides to close, the landlord has no say in what happens next.

The problem is that Macy’s closure might trigger co-tenancy clauses for all the tenants whose leases depend on Macy’s being open. Suddenly, I’ve got a problem but no way to fix it. I can’t bring in a replacement because I don’t own that space. It’s like being tied to the mast of a sinking ship—you see the disaster coming, but you can’t steer away from it.

When underwriting a shopping center, always look at ownership structures. If too many anchors own their spaces, consider that a red flag. You can’t control what you don’t own; in retail real estate, control is everything.

3. Chain Reactions 

One of the scariest risks of co-tenancy provisions is how quickly they can spiral out of control. 

I’ve seen it happen: a major anchor leaves, triggering rent reductions for smaller tenants. Those tenants start paying less, which hits the shopping center’s revenue hard. Then, some tenants exercise the right to terminate their leases altogether.

At that point, the mall starts to lose foot traffic, which puts even more pressure on the remaining tenants. They’re not getting the traffic they need to hit their sales targets, and their leases might include similar co-tenancy clauses. The shopping center doesn’t take long to fall into a death spiral.

That’s how you get dead malls. Co-tenancy clauses, triggered at the wrong time or left unaddressed, can wipe out a property’s income in just a few years. And once a mall’s NOI (net operating income) drops below a certain point, it becomes nearly impossible to refinance or sell. Lenders don’t want to touch it, and potential buyers see the writing on the wall.

Opportunities for Investors: look for co-tenancy clauses that have already been triggered 

While co-tenancy clauses are risky, they also present opportunities. Here’s my take: you want to buy shopping centers where co-tenancy provisions have already been triggered. 

Why? Because the worst has already happened. The previous owner has taken the financial hit, and the asset is de-risked. You can often buy these properties at a steep discount, reposition them, and stabilize the income. That’s how you turn co-tenancy risk into a competitive advantage.

How the Market is Changing

The retail landscape has shifted. COVID and e-commerce hit the sector hard, but the survivors are thriving. They’ve figured out how to compete with Amazon. And here’s the kicker: there’s almost no new retail construction. That means demand for existing spaces is growing. This brings the leverage back to the landlords, who now have more power to decide who occupies their space and what clauses their leases will have. 

For example, if a tenant like Ross insists on an aggressive co-tenancy clause, as the landlord, I can say, “No thanks. I’ve got three other tenants interested in this space.” That’s a shift from the past when landlords had significantly less bargaining power.

What Investors Need to Know About Co-Tenancy Clauses 

Here’s what I tell investors: co-tenancy is both a risk and an opportunity. When evaluating a property, you must understand how these provisions affect cash flow. If Macy’s closes, you have to assume co-tenancy will be triggered. Underwrite for the worst-case scenario and hope for better.

• Understand the Clauses: Every lease is different. You need to know exactly what will trigger co-tenancy provisions and what the financial impact will be. 
  
  
• Underwrite Worst-Case Scenarios: Assume co-tenancy will be triggered and see if the numbers still work. If you can live with the downside, it might be a good deal.
  
  
• Look for De-Risked Properties: Properties where co-tenancy provisions have already been triggered are often safer bets. The risk is already baked into the price.

Final Thoughts on Co-Tenancy Clauses 

Co-tenancy is a necessary evil in retail real estate. It’s about balancing risk and reward. For tenants, it’s a lifeline if the shopping center struggles. For landlords, it’s a liability to manage. For investors, it’s a factor to analyze carefully.

At RockStep, we’ve learned how to navigate these clauses, negotiate smart deals, and identify opportunities in challenging markets. Co-tenancy might seem like a headache, but knowing how to handle it can also be an opportunity. As landlords, we work hard to limit our exposure. As buyers, we look for opportunities where the risk has already been triggered.

At the end of the day, co-tenancy is about balancing risk and reward. You can’t avoid it—it’s part of the business. But you can manage it. If you understand how these clauses work, you’ll know how to underwrite them, spot opportunities, and avoid disasters. Retail real estate is risky, and co-tenancy can offer one of the biggest risks. Co-tenancy clauses are complex, but understanding them can be the difference between a smart investment and a financial disaster. 

Now that you understand co-tenancy clauses in retail leases, continue your learning journey with the other educational content on our Learning Center. Remember, the more you learn about the industry, the more power you have as an investor and the better positioned to make wise choices with your investing strategy, partner, and methods.