September 9, 2018
Last week, we covered minimum occupancies as a percentage of GLA for denominator purposes. But, sometimes we see another type of minimum – absolute minimum denominators. That is where you might see language to the effect of
“The tenant will pay its share of common area maintenance expenses based upon the leased area of the shopping center excluding tenants greater than 15,000 square feet. For purposes of calculating the denominator, the occupancy in the center shall never be less than 80%. Further, in no event shall the denominator ever be less than 225,000 sf.”
The 80% referenced above is the typical minimum occupancy – the minimum occupancy we addressed last week. However, the 225,000 sf referenced above is referred to as an absolute minimum denominator. Under no circumstance shall the denominator used to calculate the tenant’s prorate share ever fall below 225,000 sf.
Why would you have language like that? Consider the current state of regional malls where anchors or inline spaces are being demolished, or earlier periods where older malls were “de-malled.” Tenants wanted (and needed) assurances that if a landlord elected to reduce the GLA in a center, or re-configure the GLA in the center, the burden of those decisions would not fall on the tenant by increasing its ahre of CAM, taxes or insurance (typically, as the denominator goes down, the rate per square foot goes up. Not always, but typically).
However, in the spirits of earlier blogs where I have mentioned that you can never say “always” or “never” regarding certain lease language, even the word “absolute” may have qualifications.
This past week, we worked on a small center with a total GLA in the 47,000 sf range. One of the tenants had an absolute minimum denominator of just over 52,000 sf. Our client had bought this center, developed in the late 90s, just a few years ago. Sure enough, our client had diligently been using the absolute minimum denominator of 52,000 sf.
What does using that minimum denominator do to the center’s cash flow? By using a denominator higher than the actual denominator, the landlord is absorbing the tenant’s prorate share of this phantom square footage. If expenses are $470,000, if the denominator was 47,000 sf, the tenant would pay $10.00/sf. But, with a denominator of 52,000 sf, the tenant pays only $9.04/sf. If the center were fully occupied at 47,000 sf, and every tenant had this absolute minimum denominator, the landlord would eat $50,000. $50,000 at an 8% cap is $625,000 in value.
But, even though this is an “absolute minimum denominator,” there truly are no “absolutes” in real estate. There is typically a good reason for negotiating an “absolute minimum denominator” in a lease. Sometimes, it is a new center that has not been fully constructed. The tenant does not want to pay a prorata share of expenses for a center that will eventually be much larger, but is not there at commencement. So, we looked for that reason – and it was right there on the site plan/exhibit A. When the lease was executed, the center included two parcels that have since been sold off. Those two parcels contained that additional “phantom” 5,000 sf. So, while the center still technically included the additional 5,000 sf, the landlord’s expenses did not include the expenses attributable to that 5,000 sf.
In this scenario, the landlord should have gone to the tenant to amend the lease as those parcels were sold off. But, since they did not, there are two potential solutions. The first is to bill the tenant based upon landlord’s expenses and the actual square footage of the center – damn the absolute. This method represents the true expenses of the 47,000 sf. The spirit of the absolute minimum denominator is still intact. The tenant is not being billed expenses for 52,000 sf using a 47,000 sf denominator. The second method is to determine what the expenses are for that additional 5,000 sf that the landlord is not maintaining and then continue billing using the 52,000 sf denominator.
The latter scenario is fairly simple to administer for tax purposes – obtain the tax information from the local municipality. However, it is much more difficult to administer from a CAM and insurance perspective. The easiest way to do those is to “gross up” the expense to account for the additional 5,000 sf. Algebraically, this has the same exact impact as using the lesser denominator. Or, alternatively, you could approach the adjacent owners to get the true, actual expeses.
Personally, I would opt to approach the tenant to amend the lease to use a new “absolute minimum denominator reflecting the new “absolute.”
But, we know there are no “absolutes” in real estate!