Squeeze another 353 sf out of that space!

This past week, we had a call with a long term client to review the results of a lease audit. Typically, it is the accounting people, perhaps some accounts receivable people and occasionally asset management. We review additional historical billings and expected increases to cash flow. But, this week was a little different, it was a group that, in addition to property and asset management, also included leasing. It was outstanding to be able to get all of the disciplines on the same page.

The following day, it really hit me just how valuable that approach was to an owner of shopping centers.

As you know, cotenancy is becoming more and more of a hot topic as the industry evolves. We regularly perform analyses to determine the immediate and long term impact of changes to the anchor and tenant mixes in a center – what is the one year financial impact, what percentage of square footage will have a right to terminate, do the leases also require a sales drop for cotenancy to kick in, can we replace a department store with a hotel? A theater? A restaurant/video/bowling combination? A health club?

On one of the properties we were analyzing this week, the landlord was able to bring in a health club to take some vacant inline space – just under 19,650 sf. It is actually a great addition to the center. But, unlike the first client that pulled all disciplines together, this one did not have the same level of communication. Therefore, when the deal was approved, no one considered that an additional 353 sf would have gotten that particular premises over the “major” definition for a number of tenants at the property. 20,000 sf was the magic number that would have made the health club count as an additional major – that would have provided an additional level of insurance against a cotenancy condition kicking in for a group of tenants that also happened to include two tenants that also fell in to the “major” category themselves.

That additional 353 sf would have … provided an additional level of insurance against a cotenancy condition kicking in …

The cotenancy condition at the property is currently not an issue. However, a meeting of minds across disciplines within the organization would have allowed someone to say “too bad it’s not 20,000 sf,” and another person to say “well, could we add 353 sf to the lease and just not charge them for it?”

As our industry evolves, it is more critical than ever to involve all disciplines within an organization to ensure that all aspects of a deal are considered.

Time for an interdepartmental group hug!

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!

The “backdoored” exclusive


Exclusives, kickouts and cotenancies are typically the big three non-financial covenants that have to be confirmed on an acquisition because, along with the cash flow of the property, they have such an impact on value.

More often than not, these provisions are fairly obvious in a lease, But, sometimes they are buried. This past week, we were working on a property that a new client had acquired. As you will sometimes see in leases, most of the standard leases at this property contained the exhaustive list of all restrictions and exclusives for all tenants at the property. In one particular lease, the tenant did not have an exclusive contained within the body of the lease. Had there not been a line by line review of the exhaustive exhibit containing all of the exclusives for the property, the tenant’s own exclusive might have been missed. It was a “backdoor” exclusive – not addressed in the body of the but added, not by special stipulation, but by inclusion in that exhibit.

Sneaky? Yes. But the tenant got its exclusive. Fortunately, while our client was not previously aware of the exclusive, they had not unintentionally violated it.

There’s another clause you will sometimes see in a lease – “heading and captions.” In essence, it says that the headings and captions within the lease may not always properly address what’s in the clause. It’s there for a reason. There’s always something hidden in leases!

The physical embodiment of the last real estate recession is now gone … and it is kind of sad.


(A little non-lease administration but still real estate related blog for this week)

Having been in retail real estate since 1987, I have seen my shares of ups and downs. However, in the early through mid 2000s, transaction volumes were through the roof, and I had forgotten the rule about what goes up also goes down. But, late 2007 to late 2009 was as rough as I had ever experienced. Having lived as if the party of the early 2000s would continue forever, it was time to batten down the hatches.

Quickly becoming a Dave Ramsey fan, the Lexus and BMW gave way to a fairly nice used Hyundai Veracruz for my wife, and, a 1998 Jeep Cherokee for me (which my family somewhat affectionately (not really!) referred to as “the steaming metal box”). Steaming because the A/C worked intermittently, then not at all. Metal box because it started as mostly slate blue with a slight Cherokee acidy paint fade to a most acidy paint fade with some remaining vestiges of blue.

It is a humbling but powerful learning experience to move from a BMW to a used Jeep with 160k miles on it at purchase. In an area where teenagers drive cars as nice (or nicer) than the parents, it was almost a forced sociological experiment. You no longer even got the steering wheel hand wave in the neighborhood.

By the time the industry started to recover in 2010, I had embraced that Jeep and wasn’t about to give it up. I became a fan of not worrying about a new scratch. It was actually liberating. In 2014, I finally caved and bought a new car. But, that physical embodiment of the recession – that steaming metal box – had become a family member. It was not going anywhere.

My son absolutely loved that car and proudly drove it to a high school with a fair share of Mercedes, and BMWs, and Maseratis and Range Rovers. Ultimately, likely as a joke, his cross country team voted his car as favorite vehicle during their goofy year end awards. He loved the designation.

At the start of his sophomore year of college last fall, we drove the Jeep the 700+ miles from Atlanta to South Bend. Well, not all of the way. It decided it need some work in Indianapolis, so made it about a week later. And, it served him well, starting without a hitch after sitting for over a month during winter break on many sub zero days.

But, it came to its final resting place on the drive home yesterday in Austin, Indiana, just 70 miles shy of 240,000 miles, as the transmission gave way and we, fortunately, were able to glide about ¾ of a mile off of I-65 around corners and even up a slight hill into a parking space in a Fuel Mart gas station.

With great fondness, I say goodbye to that symbol of the Great Recession. I will never forget the lessons learned. The next time you see an old Cherokee on the road, use it to remind yourself that commercial real estate is cyclical, and that you need to plan for both good and bad times.

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