Distorted sales and sales audits

Over the past 2 months, there have been a number of stories about tenants “distorting” sales including this one in Shopping Centers Today –

It is almost presented as a “breaking news” type item, but this issue, including internet returns and its technological predecessor, catalog returns, has been an issue as long as tenants have been reporting sales and consumers have been returning items ordered outside of a store location. The issue occurs when a consumer makes a purchase that was not made in the store where they are returning the item. It that particular location was either over its breakpoint or approaching its breakpoint, a $150 return could mean a $9 loss in percentage rent (at 6%).

Just this past week, while doing a cotenancy analysis, we came across a cellular provider in a center that had reported sales of $600k for 2015, $625k for 2016 and then just over $150k for 2017. Something was off. We reviewed the lease language specifically to determine if cellular contracts were excepted/excluded from reported gross sales. They were not. The breakpoint was just $650k.

Landlords have been aware of these and other issues and trying to combat them for years. Just a few things that keep companies like The Lamy Group Ltd. and Freed and Associates busy – firms providing tenant sales audits to ensure that tenants are fully reporting sales made at the premises. And, while you may think that the sole purpose of these audits is to generate additional percentage rent, there are many other reasons. One example is that a tenant’s lease is set to expire within the next 18 months and you will soon be negotiating a renewal. Knowing the tenant’s true sales will help you set rents for the renewal or extension term (using an occupancy cost ratio). Another would be that the tenant has requested rent relief and a sales audit helps to create an accurate picture of true sales. Or perhaps, you have provided a significant tenant allowance and the tenant’s lease provides a sales kickout/termination. A sales audit will help determine the risk of the exercise of the kickout, or whether you should devote marketing dollars to promote the tenant to protect your own investment.

While a headline of “Internet returns being used to distort sales reports” might make for good clickbait, the “issue” is not a new one and has always been part of the impetus behind a strong sales audit program.

This should bother you

We were working on a property this week that had a newer 20,000 sf fitness center on a gross lease at an incredibly low rate per square foot. It wasn’t the rate per square foot that bothered me – it was at the back of the center not fronting on the main parking lot. It might have otherwise been non-leasable area. It wasn’t the fact that it was a gross deal with no CAM, tax or insurance contributions.
Two things bothered me. The first was that there were quite a few tenants at the center with leases requiring them to pay based upon the leased area, not the leasable area. Therefore, because the space was leased rather than vacant, the landlord truly was absorbing the CAM, tax and insurance on this 20,000 sf space (whereas, if it were vacant, other tenants would be picking up a portion of the charges).
But, the second, more troubling issue, was that the tenant’s lease read that the tenant would “operate a minimum of 12 hours per day.” Not a big deal – but the tenant is operating 24 hours per day. AND THERE IS NO PROVISION FOR THE BILLING OF AFTER HOURS EXPENSES TO THE TENANT.
Therefore, the tenant not only is not paying any CAM charges at all, they are causing an increase to all other tenants’ CAM. Granted, the right thing to do would be to keep after hours expenses separate from CAM and bill those only to those tenants operating after hours. But, since there are no true set operating hours in this lease (or, more importantly, in most of the other leases), there are not “after hours” expenses based upon a literal application of the lease terms.
Make sure you consider the impact of a gross lease on other tenant!