Buried language can burn you

I am sure I sound like a broken record to anyone who has ever taken more than one of my classes because I always (seriously always) bring up how language can be buried deep within a lease that can change the cash flow from a tenant. The best example I can give is one landord’s prorata tax section requiring that tenant pay a full prorate share of taxes based upon the 「Gross Leasable Area of the Shopping Center.」 The lease continues with other excluded area definitions. But, the bottom line is that you read the requirement as 「Gross Leasable Area.」 That’s not a typo in how I used 「Gross Leasable Area」 with all caps.

When something is capitalized mid-sentence in a lease, it typically means that it is defined elsewhere in the lease. In the case of this particular landlord’s standard lease, Gross Leasable Area is defined elsewhere, and it is defined to exclude vacancy. So, if you go to the tax section only, you think you are paying based upon leasable, but you are really required to pay based upon leased.

Remember that. If it is capitalized, it is typically defined. Go look for it.

So, as someone who preaches about buried lease language, I should not have issues with it myself, right? But, this week, I got burned myself by buried language.

One particular retailer had negotiated changes to the definition of anchors to specifically exclude anchors that are a use competing with their own use. So the anchor definition essentially reads that anchors are Occupants greater than 50,000 square feet, except for Occupants selling x, y and z (a use competing with theirs). I wasn’t burned on the 「Occupants.」 (The use of Occupant vs. Premises is a major distinction in and of itself. It means that we can only consider a tenant in more than 50,000 sf. A vacant 50,000 sf space is a vacancy rather than a defined anchor. That makes a difference if a tenant does pay based upon leasable, or if a tenant pays based upon leased with a minimum occupancy.)

No – I was burned in a cotenancy section. The lease stated that a cotenancy condition only existed if there were less than three anchors. The property had three department stores, another tenant greater than 50,000 sf that was a competing use (so not an anchor), and a 75,000 sf theater. So, I had four anchors (the three department stores and the theater) when one of the department store closed. I had three remaining anchors – two department stores and the theater. But, five paragraphs into the cotenancy section, in a paragraph defining acceptable replacements was a stand-alone line. For purposes of cotenancy, a theater shall not be considered an anchor. Sure enough, I had abstracted this requirement, but essentially saying that you could not replace an existing anchor with a theater (which is a very typical limitation). However, that wasn’t the requirement. For cotenancy purposes, I did not have four department stores when I lost one. I had three when I lost one. So, a cotenancy condition existed.

Buried language burning someone who preaches not to get burned by buried language. I have to give props to the retailer’s attorney. It was intentionally buried, and it worked.

It can happen to you.

It can happen to you too!

Retail vs. office leases

Last month, we worked on a beautiful, relatively new lifestyle retail property in California. It was developed by company that traditionally develops office. We did not know that they were office developers when we started the project. It became obvious after abstracting the first two leases.

How could it be obvious by reading lease? By seeing three of the primary differences between retail and office leases. Typically, in retail, tenants pay a full prorata share of expenses. In office, tenants will often pay a prorata share of the increase in expenses over base year expenses. Second, in retail, the leasable area of the premises (and the property) is typically used for all calculations while in office, distinctions are made between the rentable and usable areas (with rentable including a common area factor applied onto the usable). Finally, to minimize the absorption of expenses due to vacancy, retail will bill based upon the 「leased」 area of the property (leasable less vacancies) while in office, we 「gross up」 expenses to what they would be if the property were fully leased (or leased to some other level).

Personally, I prefer retail leases. To me, the calculations always seem absolute. If the property has $1,000,000 of recoverable expenses, the tenants will pay their full share of the $1m. In office, they pay excess over their base year. Therefore, the excess amounts will vary from tenant to tenant. And, if a tenant audits, it almost becomes necessary to audit the current year and the base year to determine the proper excess. Related to square footage, in retail, once a premises has been measured as 1,000 square feet of leasable area, it will always be 1,000 square feet. However, in office, a premises that has been measured as 1,000 square feet of usable area will have a rentable area that will vary over time based upon the then-current common area factor of the property.  A 10% common area factor would make for an 1,100 sf rentable area, while a 20% common area factor would make that same space 1,200 square feet of rentable area.

And, finally, in office, we gross up the variable expenses. If we are at 80% occupied, we determine what expenses would be if we were at 100% (or some other negotiated percentage) occupied. Some calculations are simple math. 100/80 x the expense. Others are determined by contract. An elevator contract is $x if we are at 80% occupied and $y if we are at 100% occupied. Others are more subjective. Would we have to add another day porter if we went from 80% to 100% occupied? Still others can be argued endlessly. Do we gross up taxes – possibly if we are in a municipality where the assessments are determined by an income approach and they factor in vacancies. But, we do not get to gross up expenses that are not variable. We end up with some degree of absorption. But, in retail, billing based upon leased, we essentially get to 「gross up」 (algebraically) all the expenses based upon that simple math. All expenses – fixed and variable.

You can always find retail-type clauses in office leases and vice versa, but when you see those concepts above, you will know where they came from.

The landlord’s best case scenario – Its standard lease

It doesn’t get better than the landlord’s standard lease. Seriously. The language in the standard lease is typically the best the landlord can possibly do because changes negotiated from its standard almost always favor the tenant.

A landlord doesn’t have a standard lease form and then have the ability to say 「We are going to add a clause that increases minimum rent by 10% when we add an anchor.」 A landlord doesn’t have the ability to say 「While the lease requires the payment of taxes based upon leasable area, but we are going to change it to leased.」 A landlord doesn’t have the ability to add management fees to the definition of operating expenses if it is not already in the standard lease form.

When the landlord presents its standard lease form, the tenant starts chipping away. There are no 「adds」 for the landlord. (One exception to this rule is that if the tenant does negotiate a change and the landlord has a firm concept of the value and meaning of that change, other language favoring the landlord can be added in response. For example, the tenant negotiates a change in the definition of excluded area from greater than 15,000 sf to greater than 40,000 sf. A landlord can then respond with the addition of 「Notwithstanding anything in the lease to the contrary, the premises currently operated as a Barnes & Noble shall be an excluded area for purposes of calculating tenant’s share of CAM and taxes.」)

What that means is that you as the landlord have to put your best (most aggressive) foot forward in the standard lease form. Have the standard lease describe a monetary default as 0 days without notice. Specifically include items like parking lot resurfacing, roof replacement, management fees, manager’s compensation and admin fees in CAM. Included relocation rights and radius restrictions. Don’t give operating expense audit rights as part of the standard lease. Have the definition of excluded areas include any tenant not paying a full prorata share. Include an increase to minimum rent for the addition of an anchor or a renovation where the landlord spends more than $5m.

Remember, the lease language can be negotiated down, not up.

(While we tend to look at the industry from a landlord’s perspective, this same issue applies to department stores, supermarkets, big boxes and other tenants using their own form leases rather than the landlords. It doesn’t get better for you than your own standard, so make it as tenant- friendly as you can.)

Cotenancy and the importance of ‘Acceptable Replacement’ language

Lately, we have spent a fair amount of time focused on cotenancy provisions – specifically monetizing the impact of these clauses (think 「How much minimum rent will we lose in the first 12 months if Sears closes?」 What percentage of our tenants have the right to close if Sears closes.」). With the number of department stores announcing closures, analysts are quick to ask these questions.

Cotenancy provisions typically read 「If at any time during the term there are less than some number of department stores (Majors, anchors, etc) or less than some percentage of the gross leasable area (other than department stores) for more than X number of months, the tenant has the right to pay x% in lieu of minimum rent (or all rent). If the condition continues for x months, the tenant has the right to terminate.」 There are countless variations of these clauses – adding other requirements like 「and the tenant’s sales have dropped by more than x% over the same period,」 or 「the tenant has the right to terminate. If the tenant does not terminate, full rents resume.」

But, one of the most costly mistakes a landlord can make is not including a term – 「Acceptable Replacement.」 A department store or major may be defined in the lease as greater than a certain square footage, or it can sometimes be tenant name specific. In that case, the cotenancy provision will often read something to the effect of 「If Sears or its Acceptable Replacement,is not operating for more than 12 months, then tenant has the right to …」 If the lease reads only 「If Sears is not operating for more than 12 months,」 then we could have a Cotenancy provision that can never be cured.

Think about that – you have a mall. Sears closes. And, you replace the vacancy with a Nordstrom or a Macy’s or a Bloomingdales. Because it was name specific and because you do not have acceptable replacement language, a cotenancy failure will always exist.

So, make sure you include acceptable replacement language!

Feel free to comment if you have any thoughts or questions about cotenancy.

Who needs a blog about lease administration and lease language?

For the past 21 years, I have had the unique pleasure and responsibility of teaching a variety of courses for the International Council of Shopping Centers (ICSC). Most of the classes have been related to lease language, common area maintenance or accounting for non-accounting professionals. And, I probably get as much or more out of the classes as the students do, because the classes are always a conversation. I get to learn.

This past Monday, I spent the day leading two classes at ICSC’s University of Shopping Centers with a long-term friend and industry professional, Ken Lamy. The morning class was Finance and Accounting for Non-Accounting Shopping Center Professionals, and the afternoon class was a Case Study – where the students get to learn and apply that knowledge. So, you have brokers, marketing people, development professionals, some asset managers and even a few accountants just trying to learn the real estate terms. They come from both the landlord side and the tenant side, and are all trying their hands at a little bit of accounting and lease administration as groups of them develop an offer and a plan of action for a shopping center they 「want」 to acquire. 「Want,」 because not everyone would buy this center, but for purposes of the exercise, they do. And, in a little more than three hours, they realize they actually have learned some accounting and lease language!

But, what I try to get across in the classes is that every clause in a lease somehow affects cash flow, and cash flow affects value. So, what I will try to do with this blog is tackle parts of the lease and explain the impact on cash flow. Whether it is understanding the difference between true partial lease years, extended lease years and extended partial lease years, or why a 600 square foot hiking store can cost you a prospective tenant or millions of dollars, we will hit it.

We will address the cash flow and value of lease language! I intend to post weekly each Sunday.

(And a special thanks to Michael Beckerman from for sharing about the need for content as traditional media withers. Great session!)