Are Medical Office Tenants Displacing Retailers?

MIAMI—Over the past five years, the retail world has seen tenant activity diminish and shopping center vacancy rise—and landlords have been forced to find creative ways to maintain net operating income (NOI) and reduce the surplus of shop vacancy. So says John Tennant, senior director for Franklin Street Real Estate.

As Tennant sees it, this has created a noticeable paradigm shift in retail leasing—specifically as it pertains to office and medical office tenants. Tenants traditionally found in office or medical complexes are finding that by positioning themselves within retail centers, they garner an increased exposure to consumers while reducing overhead cost.

“Regional and national tenants are capitalizing on the occupancy levels within a shopping center through the benefit of co-tenancy clauses or other restriction agreements with the landlord,” Tennant tells GlobeSt.com. “These agreements often reveal that only a certain percentage of shopping centers can be leased to nonretail tenants.”

That, he continues, is because frequently, nontraditional retailers are a second or third-tier backfill of space and don't always bring in a large amount of steady foot traffic. The dichotomy between traditional and nontraditional retailers has required landlords to find inventive ways to negotiate terms that allow them to reduce the surplus of vacancy and maintain the presence of retail tenants. In many cases, he says, this means allowing existing tenants to pay rent based on a percentage of gross sales.

“Usually, these regional and national anchors tend to restrict nonretail tenants in power centers,” Tennant says. “However, landlords are finding ways to negotiate those terms instead of settling for tenants on short-term leases. This is due to the increasing demand of landlords to place medical office tenants in shopping center spaces to drive up NOI while managing the surplus of vacancy.”

While this influx of “nontraditional retailers” may diminish the synergy desired by some tenants, he continues, having nontraditional tenants can be beneficial to other tenants by providing a steady flow of traffic by bringing customers closer to stores. This also can provide a convenience to customers.

Tennant points to an example: A patient can pick up a prescription from a pharmacy located in the same center with a medical office tenant or the family member of a patient from one of these facilities can shop while the patient is visiting the facility. Landlords have seen this mutual benefit to having nontraditional tenants in their centers.  

Most landlords welcome the potential of a good credit tenant and a stabilized NOI. However, Tennant says, landlords are still cautious when choosing nontraditional tenants as they may deter the traffic of traditional retail cotenants.

“In the next year, continued vacancy, slow absorption rates, and the need for landlords to drive up NOI will continue at shopping centers,” Tennant says. “This will create favorable conditions for nontraditional tenants. With the good credit reputation of the medical office tenant, it will continually become more difficult for national tenants to negotiate co-tenancy clauses or other restriction agreements with landlords.”