Strange things are afoot at the Circle K

circle k

As underwriters of commercial real estate, we deal in facts. We read the leases, calculate all of the rents and reimbursements, examine the critical non-financial covenants, analyze the prior year cash flows and provide an analysis of the assumptions that our clients have made on vacancies and lease up and Tis and inflation and so on. However, we really do stick to the facts. If rents are currently $20 per square foot, and our client wants to assume renewal rents of $35. We use their numbers with the existing lease supported facts. We will let them know we think they are high, but it is up to them to interpret.

Again, we deal in facts.

Also, since we deal so heavily in acquisition due diligence, we are often bellwethers of larger scale trends. We can’t offer explanations as to why.

Fact – over the last 2-3 weeks, we are seeing a spike in the number of transactions in top tier properties (both office and retail) in second tier cities and their suburbs.

No interpretation – just facts.

We’ll be back to our standard lease administration blog post next week.

A couple of percentage rent/gross sales issues this week


This week, we were working on an acquisition of a property in the southeast. One tenant occupied the majority of the property, with a handful of other tenants accounting for about 10% of the leasable area, but about 20% of the income. There was a restaurant tenant that had a unique name that I had thought I recognized. I did a quick search and, sure enough, it had been featured on a popular food related show a couple of years back (my 19 year old son can watch those shows all day long when he is on break). The thousands of reviews of the place were out of this world, with descriptions of hours long waits at any time of the day. And, there were numerous photos of their many catering events on their website. Yet, while they were in percentage rent, the reported sales were mediocre. While the food did, the sales clearly did not pass the sniff test.

It really is incumbent upon a property manager to determine if sales as are being reported make sense. In this case, based upon average ticket, number of tables, number of turns and ancillary (catering revenues), sales being reported are likely 30-35% of actual. For $800-$1000, the seller could have done a sales audit and realized not only the additional revenue, but would have realized the additional value on the sale.

While discussing this internally, one of the guys in the office, Bob, was talking about a Greek restaurant that he had been to last weekend. While paying, the manager’s phone buzzed, the manager looked at it and then relayed to the kitchen an Uber Eats order that he had just received. Bob said that the order was relayed verbally and was not entered into the POS/register while he was there. It may have happened later, or it may have happened automatically, but he did not see what was likely a $30+ order recorded.

It used to be common for landlords to perform sales audits on 10-20% of their portfolios on an annual basis. Those percentages have been way down since the last recession. But, if you have tenants above, or at least within 5-10% of their breakpoint, you should at least be considering a three year rotation of that group of tenants for sales audits. Especially now, as technology changes delivery, and where sales “in, at, on or FROM the demised premises” are included in reported gross sales, there is additional percentage rent out there.

Same difference – more subtle changes in lease language

I grew up using the expression “same difference.” I think I used it when I said something that I believed was right, but someone pointed out something that was wrong about what I said – but it wasn’t important enough for me to care. I think today I would probably just say “whatever.”

There are a couple of things we came across this week that would surely generate a “same difference” response, but there are subtle differences that would generate different results. One is related to blending breakpoints for percentage rent and the other relates to the calculation of CPI (Consumer Price Index) increases (a measure of inflation).

When rents and percentage rent breakpoints changes during a lease year, you must “blend” them to determine what the breakpoint is for the current lease year. For example, the tenant’s pays 10% of sales over the breakpoint for the lease year ending 12/31. If the tenant’s breakpoint is $1,000,000 through 6/30/17 and then $1,200,000 effective 7/1/17, you would have to blend the two to determine the breakpoint for the lease year ending 12/31/17. In a “same difference” kind of way, the lease might require the breakpoint to be blended using number of months or number of days. In a months calculation, the breakpoint would be $1,100,000 ($1,000,000 x 6/12 + $1,200,000 x 6/12). In a days calculation, it would be $1,100,821.92 ($1,000,000 x 181/365 + $1,200,000 x 184/365). The difference is small – $821.92 – and would result in a smaller impact to cash flow ($82.19 in percentage rent – $821.92 x 10%), but it is real and is mandated under the lease. The days calculation would have been different in the event of a lease year (using 182/366 + 184/366). There would also be additional considerations in the event of a mid-month increase to rents and breakpoints (could be full months and then days during the month of increase. In certain cases, the month of increase could be the actual number of days in the month, while in others, days may be defined as 30).

The other item that might generate a “same difference” is which months’ CPI indices to use when calculating the increase in the CPI. Let’s say a lease commences on 9/1/17. Depending upon the wording of the lease language, if the lease states that a charge is to be increased each 1/1 by the increase in the index from commencement, there are a wide variety of indices that could be used. To start, if the lease says the base index is “for” the month of commencement, then we would use 9/17 as the base index. If the lease states that the index is published during the month of commencement, we would us 8/17 as the index, as the indices are published around the 15th of each month, and August would have been published around 9/15/17. Finally, if the lease states the base index is the index “at” commencement, we would use 7/17, as the last index would have been published around 8/15/17 would have been for July. These same subtleties exist for the current month to be used.

While for the most part, the variances created are immaterial, calculation must be performed in accordance with the lease. And, actually, sometimes they really do add up. We once worked on a 200,000 sf office lease that had a twenty year term. There was a two month swing in the base CPI and a two month swing in the current CPI to be used each year. That variance over the twenty year period was a little more than $300k.

All these seemingly irrelevant changes in lease language can add up to have a material impact on cash flow and value!