Out is Now In – Understanding the Outparcel Trend and Potential Pitfalls
November 30, 2017
During the last several years, we have noticed a trend in the world of retail development. More and more “big-box” retail companies are carving out parts of their parking lots to create new outparcels. To understand the market forces behind this trend, we turned to some of our friends in the commercial brokerage community. According to John Ruffin with Meridian Realty, “[t]here are two forces at work here. The first is that corporations are always trying to find ways to unlock opportunity and profits through better management of their assets. Selling land that is not essential is part of that process. Second, big-box retailers and property owners are analyzing current conditions and emerging trends, looking out into the future and trying to base asset allocation on many factors including the impact that internet sales are having on in-store purchases. Said another way, they just don’t need the huge parking fields at their stores today that they have required in the past due to fewer customer visits.”
Brian Ross with Deep River Partners also noted the impact of internet sales as a driving force behind this trend. “Big-box outparcel sales stem from The Great Recession causing a significant decline in retail store sales. This declining sales trend, combined with competition against online retailers that have no true real estate footprint, caused big-box retailers to look for alternative sources of revenue. One avenue to create new revenue is through the sale of underutilized portions of their parking lots. Many of these stores, due to city codes and their own criteria, had vast parking fields designed to handle the parking on their busiest days of the year, but were significantly overparked for the average day, and more overparked as big-box retail sales fell. Most of these big-box retailers have large parking lots inconveniently located for their customers, but on main road frontage that provides great visibility and access for outparcel tenants.”
From our experience, while the creation of these types of new outparcels often makes perfect business sense (a classic win-win for the big-box company and the outparcel developer or end-user), from the legal and engineering perspectives these projects can be much more complex than they seem at the outset. There are several common issues that arise in the process of creating new outparcels, and those issues often cause substantial delays in the project or, in some cases, kill the deal due to the unexpected time and cost involved. In addition to making the business deal work, here are some of the common issues that should be evaluated when planning and budgeting for the creation of a new outparcel.
Depending on the age and location of the original big-box retail project, there can be issues relating to the original zoning approvals. For more recent projects that are located in larger cities and towns, it is likely that the project was approved under some sort of “special use” zoning classification or permit that was linked to a specific site plan. The creation of a new outparcel would be a material change to that site plan and likely would trigger the need for a new special use zoning approval based on the addition of the new outparcel. The requirements and time involved in obtaining zoning approvals vary from state to state and from one city or county to another. Therefore, before finalizing any purchase agreement, it is advisable to do some preliminary legwork to determine the zoning status and approval process required to create the new outparcel. Investing some time and money in this early research will undoubtedly payoff – not only will it provide a better idea on timing and budget required for the project, but it will also allow a developer to negotiate a purchase contract that provides reasonable amounts of time for the due diligence and zoning approval/permitting periods.
The new outparcel will require an approved subdivision plat. In addition to confirming the zoning status and process, the developer will need to confirm the details of the subdivision process with the local planning department. Like the zoning process, the subdivision approval process varies from state to state and from one city or county to another. Business decisions often are made based on preliminary “sketch plans” that make assumptions about parcel site and shape, access points and building and parking configuration. It is wise to check these assumptions with the local planning staff as early in the process as possible to make sure there are no deal-breaking issues at the outset. Some planning departments hold informal meetings where developers can receive feedback on sketch plans to help identify any deal-breaker issues before investing too much time and money into the project. These meetings are very helpful and if the local planning department offers this type of meeting, a developer should take full advantage of this opportunity for initial feedback.
One of the key components of any retail project is signage. For some retail companies, if they cannot get a specific type of signage in a specific location with ample visibility, it will be a non-starter and they simply will not go in that location. Accordingly, as part of the zoning and subdivision analysis described above, it is important to determine what signage opportunities will be available for the new outparcel. Keep in mind that almost all jurisdictions have limits on the amount of pylon and monument signage that is allowed in a particular area, and the original big-box company typically will have already accounted for the permitted signage. As a result, there will be issues (or at least challenges) with getting the types of signage that would be standard if the outparcel had been part of the original development.
ECR or REA Restrictions
Most big-box retail stores are part of a larger shopping center. When that is the case, in addition to potential zoning restrictions, also there will be a set of private easements, covenants and restrictions (often called an “ECR” or “REA”) that apply to the overall development. The restrictions imposed by an ECR/REA often will include limitations on the use (protecting prior tenants or owners from competition), building size, building structure, parking, and, in some cases, signage for new or existing buildings and occupants within the development. Also, the ECR/REA generally will require that the building plans be approved by one or more owners or tenants or the development’s property owners’ association. This is often the case even if the building and site plans comply with all of the restrictions or other requirements contained in the ECR/REA. Therefore, even if the building plans are in compliance with all of the stated restrictions, they still will be subject to the approval of third parties, requiring additional time and cost to the development process.
In addition to restrictions that can be found in recorded ECR/REA documents, there are often restrictions found in the lease agreements between the original developer and the current tenants of the shopping center. Because these restrictions are in privately negotiated lease agreements between third parties, unless the restrictions are recorded in a memorandum of lease, the developer would not know about them unless they were disclosed by one of the third parties. Therefore, as part of an outparcel developer’s initial due diligence, the developer should request a complete list of applicable lease restrictions or “exclusivity” clauses that could limit the use of the new outparcel.
In addition to the restrictions discussed above, the ECR/REA (and sometimes separate easement documents and plats) will contain access and utility easements that allow the various parcels that make up the shopping center to function together and tie into public utilities and roads. Accordingly, a key aspect in forming the new outparcel will be to establish what easements may already be available to the outparcel and what new easements are necessary for the new outparcel to function. This typically would include easements for access, utilities, and parking. As one can imagine, the more easements that are already available to the new outparcel, the better. If new easements are necessary, the developer will be forced to negotiate with the other owners or tenants of the parcels in the development to obtain whatever easements will be needed to create a functioning new outparcel. Because the new outparcel was not contemplated at the time many of these documents were drafted, determining what easements already are available can be an issue in and of itself. It may not be clear if the easement language contained in an existing ECR/REA and other easement documents applies to or was intended to apply a new outparcel. The developer’s real estate counsel should evaluate and consult with the insuring title company to confirm that it will provide coverage for the particular easement rights based on the language in the existing documents. If the existing documents do not contain insurable easements, the developer may need to obtain a new easement despite the existence of the ECR/REA or other easement documents.
While the developer’s real estate counsel is reviewing the ECR/REA and other legal documents that govern and restrict the new outparcel, the developer’s civil engineer will be analyzing parcel size and location, the size and location of existing utilities, stormwater facilities, and access points to determine what is needed for the outparcel to function from the engineering perspective. In one recent project that we were involved in, although our developer client had certain existing easements rights for the new outparcel, the engineer determined that sewer line needed for this new outparcel could either (i) run through the existing easement (across the entire big-box retailer’s parking lot) at a cost so substantial that it could kill the entire deal, or (ii) run the sewer line through adjacent outparcels’ property to the nearest public sewer line. However, there were no existing utility easements through the adjacent outparcels’ property. With this information, the developer optimistically went to the adjacent outparcel owners to ask for easement rights for the sewer line. Unfortunately, the adjacent outparcel owners were not feeling particularly neighborly and would only agree to the sewer line easement in exchange for a very steep price and with the addition of some new use restrictions. As a result, this dilemma with the sewer line was the straw that broke the camel’s back and the deal was terminated.
In conclusion, while the creation of these new outparcels makes excellent market sense, the fact of the matter is that nobody had these outparcels in mind when the shopping center was originally designed and developed. As a result, there can be significant challenges relating to the original zoning approvals, the ECR/REA and, in some cases, the engineering for a new outparcel site. Accordingly, it is important that the developer build in realistic assumptions about the potential complexity of the process before expending substantial time and money on an outparcel project.