With assistance from Stela Lito
One of the most significant trends in post-COVID retail real estate has been the rapid expansion of emerging and evolving brands. Online retailers establishing brick-and-mortar locations, such as Warby Parker; international concepts entering the United States market; and quick-service restaurant concepts, such as Crumbl Cookies, have all expanded at a notable pace. The growth strategies supporting this expansion are often tied to private equity investment and franchising. Both models can enable brands to reach mass markets quickly, but they also present important risks for landlords to evaluate carefully.
Franchising allows brands to expand rapidly by shifting much of the initial capital investment required to build out new stores from the central corporate entity to individual franchisees. This model enables brands to grow nationally without raising substantial corporate-level capital or developing large, regional operating infrastructures. For landlords seeking to lease retail space, franchised concepts can also bring high-profile, sales-driven tenants into shopping centers, including trend-forward brands with strong consumer recognition (such as the Instagram-famous Crumbl cookie boxes). However, landlords should carefully assess the risks associated with franchisee tenants.
What Should Be Considered with the Landlord-Tenant Relationship
Franchisors often seek a degree of control over the landlord-tenant relationship and may require riders or ancillary agreements to the lease. Some franchisor requirements, including clauses granting the franchisor a security interest in the tenant’s personal property, may be directly adverse to the landlord’s interests. Article 9-322 of the Uniform Commercial Code addresses priority issues between landlords and secured parties based in part on whether property is affixed to the leased premises, but disputes over priority can become protracted and costly. Accordingly, landlords should exercise caution before entering into agreements with franchisors. A landlord generally has an interest in removing a non-performing tenant quickly and replacing that tenant with a stronger user. By contrast, a franchisor may seek an opportunity to intervene and may attempt to require litigation concerning the default to proceed outside the state where the premises are located, further delaying the eviction process. Although some states, including Illinois, limit the ability of a franchisor to require franchise disputes to be litigated outside the state where the premises are located, landlords should still scrutinize jurisdiction and choice-of-law provisions carefully. In general, landlords benefit from proceeding in the state where the property is located in order to expedite eviction remedies, but an unfavorable franchise agreement can draw a landlord into a choice-of-law dispute and further delay enforcement.
Private Equity Investment in Retail and Service Sectors
In addition to franchising, private equity investment has helped accelerate growth across the retail and service sectors. Private equity firms have become increasingly active in service-based businesses, injecting capital and professionalizing operations to improve profitability and support expansion. Businesses such as veterinary services and dental practices have benefited from this investment model. For landlords, these tenants may offer experienced operators the financial capacity to open and operate successfully. At the same time, private equity-backed operators are typically sophisticated in minimizing capital outlays and maximizing the use of landlord-funded tenant improvement allowances. They are also often experienced in asserting priority claims against collateral. In states where landlords are entitled to a lien on a tenant’s personal property, landlords should take steps to understand and, where possible, preserve the priority of that lien relative to competing claims against the tenant’s assets. Because lien priority issues can be highly nuanced, a landlord dealing with a default by a private equity-backed tenant should consult counsel promptly to evaluate available rights and remedies.
Another priority of private equity firms is that they will try to limit the guaranteed obligations of the fund or owners if the business is sold or if it goes bankrupt. A maxim in real estate is “the guarantor is the favorite of the law,” and any guarantees must be written in such a way as to maximize their claim on a guarantor.
International Retailers and the U.S. Market
Finally, international retailers, such as Daiso, are increasingly entering the United States market. These companies often bring successful operating histories abroad, strong capitalization, and steady cash flow from their home markets. Landlords negotiating leases with international tenants may benefit from the combination of a novel concept in the domestic market and an experienced operator with an established track record. However, these tenants can also present unique enforcement challenges. In particular, it may be difficult to pursue claims for unpaid rent against an overseas entity, especially if the tenant abandons its United States retail operations. Landlords often address this risk by requiring a letter of credit, which may provide at least partial recovery for losses. Letters of credit have become a favored form of security for landlords with international tenants because courts have repeatedly found that they can survive bankruptcy proceedings and remain collectible in the United States, even if the tenant disappears. (See, e.g., In re Kmart Corp., 297 B.R. 525 (2003)).
Practical Takeaway for Landlords
Taken together, these trends reflect a retail market in which growth-oriented tenants may offer landlords meaningful upside, including recognizable brands, expanded customer traffic, and diversified merchandising. At the same time, the legal and financial structures that support that growth can complicate enforcement, collateral rights, guaranty obligations, and recovery following a default. The practical takeaway for landlords is to evaluate not only the strength of the concept, but also the structure behind the tenant—including franchise documentation, secured financing arrangements, guaranties, jurisdictional provisions, and available security (such as letters of credit)—and to fully understand their implications following default before committing to a lease.
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