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How many expense pools are required?

Over the years, we have worked on 150+ tenant regional malls where the sellesr had been using 3-4 expense pools per prorata expense category, and we have also worked on 20 tenant open air centers where the seller had been using 20 different expense pools.

What’s right?

As new variables are introduced into leases, the number of pools required grows. For example, your standard lease requires the tenant to pay a prorata share of taxes based upon the leased area of the shopping center excluding tenants greater than 15,000 sf. If every tenant comes in and agrees to that methodology, you may have one pool. But another tenant comes in and changes the definition to 20,000 sf, and yet another, 25,000 sf. All other things being equal, you now have three pools. Other tenants come in, and rather than leased, they negotiate leasable. With no other variables, you could possibly have 3 additional pools, for a total of 6 (leased less 15k, leased less 20k, leased less 25k, leasable less 15k, leasable less 20k, leasable less 25k). Part of it will also be determined by how you have set up your property management software and you cash flow analysis software. Now suppose you develop an outparcel and you want that outparcel to be excluded, so you change your standard lease to leased less tenants greater than 15,000 sf and outparcels. All of the sudden, there are the possibility of 6 more. Then you have tenants request (and your leasing people agree to) minimum occupancies (ex. Leased less tenants > 15k sf, with the denominator never less than 80% of the leasable area excluding tenants > 15k). The number of possibilities grew again. Consider that the property is sold and the new owner’s standard lease includes personal property taxes in the tax definition whereas the original lease did not.

Seriously, as variables are added, the number of pools grows. We have worked on properties that on the day they have opened, there have been nearly the number of pools as there are tenants.

Why this post this week? Working on a regional mall this week with about 140 tenants, I had just reviewed the owners set up of taxes. There were about 12 methods while about 20/21 were needed. Then I got to CAM. They had nearly 40 methods set up for CAM, many with changes in the inclusions or exclusions from expenses (before even considering changes in methodologies). I settled in for the long haul, but soon found that all but one tenant was on fixed CAM. Still not sure why they had not cleaned up the CAM pools.

So, how many expense pools are required? Unfortunately, as many as necessary. Trying to use too few pools to ease the administrative burden will lead to numerous errors, which can often lead to money left on the table. No one wants that!

Excluded Areas – Premises vs. Occupants

In defining excluded areas, a lease will often read:

“the tenant will pays its prorate share of the charges based upon the gross leasable area of the center excluding premises greater than 15,000 sf…”

Others may read:

“the tenant will pays its prorate share of the charges based upon the gross leasable area of the center excluding occupants (or tenants) greater than 15,000 sf…”

When you are setting up your reconciliations in your property management system, you focus on “15,000.” Both include the 15,000. However, one is “premises” and the other is “occupant” (or tenant).

When the language reads “premises,” it does not matter whether the premises is occupied or vacant. The space itself is the excluded area. When the language reads “occupant” (or tenant), it is an excluded area only when that space is occupied.

You may think to yourself that it does not matter in your leases because your standard lease requires the tenants to pay based upon leased an occupied area rather than leasable area – so if the space is not excludable as a premises, it is excluded as a vacancy, and that may very well be the case. However, if any tenants have negotiated minimum occupancies, your exclusion of the space as a vacancy may be limited.

Bottom line – make sure your leases read “excluding premises greater than xx,xxx sf.” You will save yourself a tremendous amount of aggravation (and cash flow)!

Hurricane Harvey, flooding and your lease obligations

A friend emailed me a suggested topic for this coming Sunday’s blog post. 「So with the events in Houston, is it time for a blog on Rent Abatements in Damage and Destruction clauses?」

Clearly, it is. And, as landlords and tenants are not going to wait to start paperwork for claims until Sunday, it is time for a Thursday blog.

Harveyfloodcenter

Photo from American Urban Radio Networks (aurn.com)

It is rare to see too much negotiation around 「Damage and Destruction」 or 「Reconstruction」 or the portion of the 「Utilities」 clause related to the unavailability of utilities, or to 「Business Interruption Insurance.」 And, honestly, when landlords summarize their lease requirements in an abstract, most of these clauses are not captured because, for the most part, the clauses rarely come into play. But, in the coming weeks, they will be front and center for property owners and tenants alike.

There is only one 「pat」 answer for who is responsible for what in terms of reconstruction, the payment or abatement of rent, damage-related terminations or so on, and that answer is that the responsibility is defined by each individual lease.

Typically, the damage and destruction section of the lease will define whether it is the landlord or tenant that is responsible for the reconstruction of the premises, and, more often than not, the party responsible for obtaining the property insurance on the building itself (as opposed to the contents), will be responsible for the repair/reconstruction.

The leases will also address whether or not the tenant is responsible for the payment of rent during the reconstruction period. Again, with the 「more often than not」 comment, there will be an abatement of rent during the period of reconstruction. But, it is not unusual for the tenant’s rent responsibility to continue. You will find that when it is the tenant responsible for rebuilding, it will be more common for the tenant being required to continue to pay rent during the reconstruction period.

Often buried in the lease is a requirement for the landlord or tenant to carry business interruption insurance. Again, it would be more common for a tenant responsible for reconstruction and for the payment of rent during reconstruction to have also been responsible for carrying business interruption insurance. The business interruption clause typically will address the prior the landlord or tenant the insurance is required to cover – often 12-18 months. It will often follow that if the landlord is required to reconstruct, and the tenant gets an abatement during the repair/reconstruction, then the landlord would have been required to carry the insurance covering the period. (The tenant likely paid either a prorata share of the insurance, or paid for it as part of a fixed CAM/operating charge.) The opposite is likewise true. If the tenant is required to repair and pay rent during the down time, they would have been required to carry the insurance. That being said, I just pulled a lease for a national sandwich shop at a property outside of Houston where the standard lease included business interruption insurance as part of the landlord’s responsibility with the tenant paying a prorata share. But, the requirement was stricken from the lease by the tenant.

Another issue to consider is that leases often include language giving the landlord and/or tenant the right to terminate the lease if the damage/destruction occurs in the last x months or years of the term. Over the years, we have seen damage destruction in a transitioning area being used to clear out a property to make way for a completely different tenant mix.

Also to be considered an issue addressed in an earlier blog – 「when minimum rent is abated, the breakpoint shall likewise be abated.」 Keeping it simple, if a tenant’s annual breakpoint is $1,200,000 for the year and they have a 12/31 lease year end, a Houston tenant will pay percentage rent for 2017 based upon sales through 8/31 over a denominator of $800,000 ($1,200,000 x 8/12. I am oversimplifying the other variables). Then let’s say it takes 12 months to restore the property. For 2018, the tenant will pay percentage rent using sales for the year (just 9/1-12/31) and a breakpoint of just $400,000. Knowing how sales typically fall, they may end up paying no percentage rent for 2017, but a disproportionate amount for 2018 (and since it will not really be considered a partial year in either case, any extended or extended partial lease year language (addressed in yet another earlier blog) will not be there to protect the tenant.

And, just when you think you may not have issues because your property was not damaged, in many cases, even though it is beyond the landlord’s control, if utilities are not available at the property and the tenant cannot operate, there may be related rent abatements. It never ends!

I wish there were better, more universal answers that I could give. But, yet again, the answers lie in the leases.

“…if the end of the world is imminent …”

Yes. This language exists in some leases. The language typically states that if the end of the world is imminent, the landlord has the right to accelerate rents for the remainder of the term.

There are still a few hours left to check your leases for this language before the eclipse arrives today.

Happy eclipse viewing today. And, good luck trying to collect with that clause!

We will be back to a regular lease administration post next week. Today, I am in Tennessee to see the eclipse!

Don’t overcomplicate the lease language

Every few weeks, someone in the office will let out a scream of frustration. The frustration comes from reading lease language that is so involved, but could have been accomplished with incredibly simple lease language.

For example, it is fairly common to see Consumer Price Index (CPI) increases applied to rents, or used as caps for certain reimbursable expenses in a lease. Applying a CPI increase is fairly simple and straightforward, but there are hundreds of variations of the CPI – for all Urban Consumers (CPI-U); for Urban Wage Earners and Clerical Workers and Wage Earners (CPI-W); either one of the using a 1982-84=100 base or a 1967=100 base, or even a 1957=100 base; any one of those for a specific city; any one of those for specific items, or excluding specific items. Along with those increases, it is common to have a negotiated cap on the increase – say 3%. Often, that cap is negotiated to be non-cumulative rather than cumulative. Sometimes there is language that states if the increase is greater than the cap in any given year, the amount over the cap can be carried forward to a future year when the increase is less than the cap. Sometimes, there are minimum increases applied in addition to the cap.

So, if you find yourself writing or negotiating a lease clause where

「the tenant pays a prorate share of CAM based upon the leased area of the shopping center, calculated on a weighted average basis, excluding major tenants greater than 25,000 sf and any tenant above or below ground level, where controllable costs are capped by 5% per year with any excess being carried forward to a future year, and where the first year CAM costs (including both controllable and uncontrollable costs) are capped at $2.00/sf, with the overall cap being increased by the CPI-W, 82-84=100 for New York, with a maximum increase of 3.5% and a minimum increase of 2.5%, also giving the tenant the right to audit CAM」

Do yourself (and your lease administration, lease accounting, asset management, billings and collections staff) a favor, and just simplify it to:

Tenant shall pay $2.00/sf for CAM, increased by 3% each 1/1 starting 1/1/18.

Think about what you are really trying to accomplish, and keep it as simple as possible.

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