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Could this be worse than a Most Favored Nations clause?

October 13, 2019

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We have addressed the Most Dreaded Lease Clause a few times over the past couple of years. We have also addressed another lease language concept – co-participation. But what happens when you combines the concepts? That combination was evident in an acquisition we were working on this week.

If you have time, take a minute to read those more detailed blogs, but briefly: A most favored nations clause states that a tenant will pay certain amounts (or could have certain restrictions on their occupancy) unless another tenant gets a better deal, in which case the tenant will get the other tenants deal. A co-participation clause states something similar – a tenant will pay, be subject to an increase or have restrictions as long as xx% of other tenants are similarly obligated.

Both clauses are fairly onerous and require some work to properly administer them. You must calculate or consider every other tenants’ obligations and then consider the specific tenant’s obligation.

This week, this was the beauty we came across in a big box lease:

“…provided that all in line tenants of the Shopping Center except (Shadow Anchor 1) and (Shadow Anchor 2) are obligated to pay an equivalent amount (on a per square foot basis) of such costs…”

The tenant was obligated to pay its share of CAM as defined in the lease “…provided that all in line tenants of the Shopping Center except (Shadow Anchor 1) and (Shadow Anchor 2) are obligated to pay an equivalent amount (on a per square foot basis) of such costs…”

The lease did not provide for any remedies if those parameters were not met. Therefore, it became an “I don’t have to pay at all if someone pays less” situation. Go back and read that language. It requires 100% participation from the inlines and an equivalent amount on a per square foot basis.

Consider the scenario: The tenant with this language in the lease is required to pay $4.00/sf. Another tenant is required to pay $3.25/sf. The other tenant is not paying an equivalent amount on a per square foot basis. Therefore, the “provided that” kicks in, and the tenant is no longer obligated to pay. It is not reduced to $3.25/sf as it might be in the case of a Most Favored Nations clause. We can’t argue “similar obligation” as we might in the case of a co-participation and state each is required to pay a prorata share, or a fixed share, or even just a share.

The fallout could be severe. As I mentioned, it was a big box. Figure 35,000 sf at $4.00/sf. $140,000 per year!!! Now apply a cap rate to that (as I also mentioned, it was an acquisition). At a 7% cap rate, that is $2,000,000 in value!!! That might be the worst case scenario (unless there was another most favored nations clause in the center which rarely ever happens). However, it could have other consequences (and be mitigated a bit) if the big box were a defined excluded area for other tenants in which case the other tenants might see an increase in their rates per square foot because that $140,000 contribution would be going away.

Two weeks ago, the blog was that Always and Never cannot exist in real estate. Perhaps I have to rethink my use of the word “Most” as in Most Dreaded Lease Clause from now on.

Comments | Posted in Commercial Real Estate, Malls, Office Properties, Retail Leases, Shopping Center, Uncategorized

Two words that STILL don’t exist in commercial real estate (this time related to sales reporting and percentage rent)

September 29, 2019

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Last year, upon returning from ICSC’s John T. Riordan School of Professional Development in Minneapolis, I felt the need to write a blog entry on the use of “ALWAYS” and “NEVER” when referring to commercial leases. In short, the only absolute that may exist in commercial real estate is that there are no absolutes.

This year, the JTR school was back in its former home in Scottsdale. There are tracks for Management I and II, Leasing I and II, Development, Marketing and Leadership. While the entire program is exceptional, one particular highlight is Case Study day. The students in the various disciplines are paired together with other disciplines to develop game plans for a particular property – grocery anchored for Level I and a more complex lifestyle center for Level II. The information provided to the students is thorough, with some of the most insightful geofenced data available for each property (provided by David Lobaugh of August Partners).

But, in the Level I program, we unfortunately did not provide tenant sales data. Wanting to determine how the tenants were performing, whether there might be percentage rent, and to help shape future rental rates, a few of the students asked if we could provide it.

The immediate response to the students was disappointing for two reasons. It used an absolute and it was incorrect. The students were told that tenants in grocery anchored centers NEVER report sales or pay percentage rent.

There are certain parts of the country where landlords are a little more likely to concede to tenants’ requests to delete percentage rent requirements. But, even in those areas, the landlord still makes every effort to keep the sales reporting requirements in the lease – perhaps not at the same monthly level, but quarterly or annually.

“Whether you have Percent-In-Lieu (Gross Deals), Early Termination Rights clauses, POP-Up Stores, Rent Relief, Specialty Leasing or other ‘Risk Sensitive’ leasing financial exposure, industry ‘Best Practices’ dictate you keep Sales Reporting and/or Percentage Rent requirements at a minimum.”

According to Ken Lamy, president and CEO of The Lamy Group, an international retail sales assessment and consulting firm, “Whether you have Percent-In-Lieu (Gross Deals), Early Termination Rights clauses, POP-Up Stores, Rent Relief, Specialty Leasing or other ‘Risk Sensitive’ leasing financial exposure, industry ‘Best Practices’ dictate you keep Sales Reporting and/or Percentage Rent requirements at a minimum.”

Lamy states that “These two provisions (percentage rent and sales reporting) currently appear in leases 65-70% in “Open-Air” properties and 99% in mall / outlet / lifestyle properties. As a 21st century industry professional, transparency along with quality data sharing is the norm.”

Even in those instances where the specific sales reporting requirement is deleted, there may be another useful clause buried elsewhere in the lease – Landlord’s right to request financial information. This clause requires the tenant to submit financials (income statements and balance sheets) upon request – often no more than once a year, or in conjunction with a sale or refinance of the center.

Because thorough sales data is critical to the health and operation of a center, landlords are firm in their resolve to keep the sales reporting clause in their leases.

And, to reiterate, always and never really do not exist in commercial real estate.

Comments | Posted in Commercial Real Estate, Malls, Office Properties, Retail Leases, Shopping Center, Uncategorized

The percentage rent unicorn revisited

August 27, 2019

A while back, we had addressed the “percentage rent unicorn” – that landlord dream within a dream (Hopefully, you are thinking The Princess Bride right now) – where landlords can bill percentage rent over a monthly breakpoint with no annual reconciliation. It is not something we see often, but when we do, it often leads to significant additional percentage rent.

However, the inverse of this clause happens frequently, especially with cotenancy provisions. “The tenant will pay, on a monthly basis, the lesser of minimum rent or x% of sales.” Typically, leases do not provide for an annual reconciliation when a tenant is on any sort of alternative rent. Can it be material? The lease I was just reviewing has the tenant pay the lesser of 2% of sales or minimum rent during the reduced rent period. Minimum rent runs $27k per month. In most months, alternative rent runs $20-$23k per month, which the tenant pays. However, in December, 2% of sales runs around $40k, but the tenant is only required to pay the “lesser of.”

Therefore, the fact that the tenant is not required to reconcile the 2% calculation on an annual basis causes the rent reduction to be $13k greater than it would be with an annual comparison, as reflected below:

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So, while there are unicorns for landlords, the tenants have unicorns too.

Comments | Posted in Commercial Real Estate, Malls, Retail Leases, Shopping Center, Uncategorized

John T Riordan School for Retail Real Estate Professionals

July 14, 2019

If you have followed this lease administration blog for the past couple of years, or even if you have just stumbled upon it because of a question you have had related to some lease related term, you are the type of person that would absolutely benefit from ICSC’s John T Riordan School for Retail Real Estate Professionals.

Classes run the gamut of disciplines within the shopping center industry – development, management, marketing, finance, leasing and leadership and are taught by some really incredible people that have years of experience and practical knowledge in all of these fields. These classes are outstanding preparation for the examination for ICSC’s CRRP designation (Certified Retail Real Estate Professional). And, quite honestly, the breaks, meals and other networking opportunities are almost as valuable as the classes themselves. The attendees are others like you that are making a long term commitment to the industry. I regularly reach out to other attendees or faculty for opinions or guidance on issues I see on a day-to-day basis. I can’t tell you the number of times this has saved me from reinventing the wheel.

This year’s School will be held September 22-26th in Scottsdale. You can find the link below:

https://www.icsc.com/attend-and-learn/events/details/john-t.-riordan-school-for-retail-real-estate-professionals6

Although I have been attending ICSC classes for 30 years and have been teaching for the past 23 years, I never fail to learn something new and valuable for my company and its clients. If you have any specific questions about the School or its classes, feel free to comment and I will answer or get you the answer.

Faith Cooper is ICSC’s Education Manager who handles the School. If you reach out to her via email (fcooper@ICSC.org), she actually has the ability to offer a 10% discount off of tuition for those referred by faculty.

Hope to see you in September.

 

Comments | Posted in Commercial Real Estate, Malls, Office Properties, Retail Leases, Shopping Center, Uncategorized

Premises trash and utilities vs. common area trash and utilities

June 9, 2019

It is not uncommon for a landlord to provide or arrange services for the actual tenant premises within a shopping center. Perhaps the tenants are provided water services to their spaces through one water main/meter, or the landlord arranges for trash removal from the premises rather than having each individual tenant arrange the service themselves. Or in some cases, there may even be electricity or HVAC provided by the landlord to the individual premises.

In the majority of leases, these services for the tenant’s own premises are addressed in a utilities section of the lease (with language that may read something to the effect of: “Tenant is responsible for all utilities consumed at the premises. If the landlord provides any of these services to the tenant, the tenant will purchase the same from the landlord at rates not greater than the tenant would be billed if the tenant were billed directly.”) Trash removal can sometimes be found in the utility section, the tenant maintenance, or even in the rules and regulations section/exhibit of the lease, containing similar responsibility language.

But this provision of services by the landlord can sometimes cause confusion, as it did three separate times this week. These services provided to the premises are NOT common area expenses. In most shopping centers, the landlord does provide water to the common areas of the center, and the cost of that water is absolutely CAM. However, water provided to the tenants for use within their premises is not CAM. It is a premises utility. The landlord’s removal of trash/emptying of common area trash receptacles is CAM, but the cost of removal of the trash from the individual tenant premises is a tenant expense. If the landlord happens to provide for or arrange the trash removal service, it is still a tenant expense, not CAM.

Often in attempt to simplify billings to the tenants, it is not uncommon for landlords to include these expenses in CAM and bill the same prorata shares used for CAM for these additional expenses. However, this attempt at simplification can cause some major errors.

One group of tenants to jump on this error in methodology is big boxes and supermarkets. So often, despite what is happening at the rest of the center, the big boxes do not participate in the landlord’s trash program and have also made the installation of separate meters for water or electricity a key component of their leases. Therefore, if the landlord were to bill trash or premises water through CAM, and those big boxes arrange and pay for their own trash removal and water directly, the landlord would be double dipping. Not that it doesn’t happen, but big boxes challenge this method regularly. (I don’t want to get off topic, but if the landlord gets one invoice for trash or water that covers premises trash removal and common area trash removal (or water), often the landlord and bid boxes will come to an agreement on an allocation of these invoices among premises and common areas (often 90/10 or 95/5 – so a $50,000 trash invoice might get allocated $5,000 as common area trash permitted to be included in CAM, and $45,000 as premises trash not permitted to be included in CAM).

This CAM inclusion method often causes tremendous amount of absorption by the landlord. If a tenant’s CAM method is leasable with no exclusions, a landlord might bill trash that way (by including it in CAM). However, in that center, if there was a major that provided its own trash removal and did not participate in the expense, and there was some vacancy, the landlord would be absorbing a significant portion of the expense. Take the following example:

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In our example, if the landlord bills the tenants premises trash using the CAM reimbursement method (GLA with no exclusions), the 30,000 sf of tenants that are provided with the trash removal service will have paid $7,500 (30,000 sf x the $.25/sf portion of the charge attributable to premises trash). The landlord will have absorbed $17,500 (major (60,000 sf) plus vacancy (10,000 sf) = 70,000 sf x $.25/sf. What does that mean? We as the landlord lose $17,500 per year, or, at an 8% cap rate $218,750 in value ($17,500/8%).

All because we tried to simplify the billing method.

In a specific example from this week, the tenant’s actual CAM charges were $3.70/sf, but CAM was capped at $3.47/sf. But over and above the $3.70/sf, the landlord was billing premises trash through CAM – another $.25/sf (reflected as $3.95/sf – $3.70 + $.25). The tenant expected all charges to be capped at $3.47/sf. But that $.25/sf was not CAM! So, ultimately, the tenant was responsible for $3.47 + $.25 = $3.72/sf. This was a 16,000 sf tenant. That difference was $4,000 per year. One lease, $4,000 per year.

It really does pay for you to know the difference between common area services and premises services!

Comments | Posted in Commercial Real Estate, Malls, Retail Leases, Shopping Center, Uncategorized

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