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Why you should be at least slightly conversational in accounting, finance and lease administration

“Ambitious men do not ask questions for fear their infallibility will be challenged” – Washington (or John) Roebling

My apologies to David McCullough who wrote The Great Bridge about the building of the Brooklyn Bridge for not even knowing whether it was Washington or John Roebling who gave us that awesome quote above. But, whether father or son, he was lamenting some of the problems he was having with construction because certain supervisors would not ask questions that needed to be asked.

Since 1996, the International Council of Shopping Centers (ICSC) has offered finance and accounting classes for professionals in the industry that may not have to deal with finance, accounting or lease terms on a daily basis. Since you can’t teach finance and accounting in two days, my goal in teaching portions of the class has always been to get the students comfortable to learn enough to know what they don’t know, and be willing to ask questions – to help them understand that no one has all of the answers.

Why this blog today? Over the last week, I have seen a number of articles and press releases where I have thought, “Oooh! I wish they hadn’t presented it that way,” or, “I wonder if they checked with lease administration on that.”

One article related to a new source of parking revenues. We are always looking for ancillary revenues in our business, and a few companies promote ways to generate revenues from existing spaces. Any way to generate additional revenue from existing assets can be wonderful – provided you think through how the property may be affected. Will spaces assigned for revenue generation still be considered part of the parking ratios? Do some of the leases have prohibitions against charging for parking? Does the revenue need to be offset against CAM? If so, will it be the gross revenue or the landlord’s share of revenue?

Another article related to a company announcing new tenants coming to a property to backfill vacant anchors. The company is adding some “experiential” uses. I would be happy if they were coming to my local mall. However, the press release addressed “and other non-retail uses.”  Fuel for the fire. Shopping centers are going through another step in their evolution. What may never have been an acceptable use in a shopping center (think a brewery or distillery or a health club facility or even multi-family) is slowly becoming not only an acceptable use, but in some cases, a desirable use. While some of these “new” uses may not be retail, they are becoming shopping center uses. The press release reads “non-retail.” Many leases address a percentage of retail uses that must be located in the center, or a percentage of “traditional shopping center” tenants for cotenancy purposes.

These are just two from the week. But, you regularly see issues addressed that, if they had been run by multiple departments, may have been presented differently – expansions or additions that, if presented properly, might have warranted a minimum rent increase. Renovations or replacements that might be considered CAM. The list goes on.

There truly is value in knowing what you don’t know. (And, the next time ICSC offers the class, look into it. I will give you some good information, but the others that also teach are outstanding!)

Let’s eat, Grandma! Let’s eat Grandma!

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A comma can change the meaning of a sentence fairly drastically. And, for lease administration purposes, it can have an unexpected impact on cash flow. The clause below was from a center we worked on last week:

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“Tenant’s Proportionate Share” shall be equal to the number of rentable square feet included in the Premises divided by the total number of square feet included in the Building multiplied by ninety-five (95%) percent.

Yes. We do have the order of operation. If you were lucky or unlucky enough to have Sr. Julia Mary for seventh grade pre-algebra, you might have learned “Please Excuse My Dear Aunt Sally.” Parentheses – do what is in the parantheses first. Exponent – apply the exponents next. Then Multiply and Divide. Finally, Add and Subtract.

Why bring up Sr. Julia Mary (affectionately, by some, known as Scary Mary)? Because (1) if we take the premises divided by the center square footage and then multiply by 95%, we get a completely different answer than (2) taking the square footage divided by (the center square footage x 95). Take, for example, a 10,000 sf premises in a 100,000 sf shopping center. The straight prorate share would be 10,000/100,000 = 10%. But, we have a 95% factor to apply. In example 1 – we get 9.5% – 10,000/100,000 = 10%; 10% x 95% = 9.5%. In example 2, we get 10.53% – 100,000 x 95% = 95,000; 10,000/95,000 = 10.53%. That’s almost an 11% difference.

This one needs a letter agreement to correct it!

Leased vs. Leased and Occupied

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A few months ago, we had a blog that addressed a difference in lease language where an excluded area was defined as any premises greater than 15,000 sf vs any occupant greater than 15,000 sf – a subtle change in lease language having a material impact on a lease’s or even a property’s cash flow.

This week, we had a similar situation related to different wording. The expenses of the property were to be “grossed up” to what they would be if the property were 95% occupied. This gross up language is most commonly associated with office leases where a tenant’s prorate share is determined using the rentable area of the building. If the building has 100,000 sf and the tenant is 10,000 sf, their prorata share is 10%. That 10% may even be fixed in the lease. If the building was only 50% occupied, and janitorial in the office building was $50,000, without a gross up, the tenant would pay $50,000 x 10% = $5,000. However, a gross up recognizes that the $50,000 in expenses were attributable to a half full building. To keep it simple, if we “grossed up” expenses to what they might be if the building were 100% occupied, we would essentially calculate:

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So, using the grossed up share of $100,000 x 10%, the tenant’s share of the expense would be $10,000. So, if the 50,000 sf of occupied tenants all paid using the grossed up expenses, they would pay a total of $50,000, and the landlord would be whole. If the expenses were not grossed up, the tenants would have only paid $25,000, with the landlord absorbing the other $25,000 in expenses. (This example used straight prorate. In office, tenant’s shares are often couple wit base years as well, but I was trying to keep the example straightforward).

Simply, the purpose of the gross up is to make sure the tenants are paying their share of variable expenses based upon the square footage of the property occupied, really the square footage causing that expense. (Notice, only variable expenses get grossed up. If landscaping cost $25,000 per year, that expense would likely not vary if the property was 50% or 100% occupied so would not get grossed up.)

This week’s issue that caused some debate was the wording of an inline tenant’s lease in a retail property. As discussed, gross ups are typically associated with office leases. Therefore, office landlords are pretty detailed with the gross up language – they know what is needed. The tenant’s lease required the tenant to pay a prorata share of expenses based upon its square footage over the square footage of the center (there were some issues as to whether outparcels were included or excluded from the definition of the center, but that’s another story!). The expenses were also to have been grossed up to what the expenses would have been if the center had been 95% leased.

As the examples show, the purpose of a gross up is to determine what the expenses would have been had the center be 95% occupied. But, that’s not what the lease said. It said 95% leased. Subtleties! Subtleties!

In the property, there is a 25,000 sf premises which had been vacant for a number of years. In mid 2016, a lease was executed for that particular premises. The tenant took possession of that premises on the day the lease was executed. Because some approvals were needed from other tenants, the tenant received permits in March 2017.  The rent commencement dated was the earlier of open or permits + 180 days. As of March 2018, the tenant is still not open.

Based upon the “intent” of a gross up clause, we would treat the premises as un-occupied, and we would still be grossing up. However, based upon the terms of that particular lease, the Commencement Date of that lease was possession – mid 2016. Therefore, as of mid 2016, that particular premises was actually leased.

Two words often used interchangeably – occupied and leased – making a difference as to whether we have the ability to gross up expenses. The intent was clearly to gross up if the center was less than 95% occupied, but we are stuck with the word “leased.” The premises was, in fact, leased.

Pay attention to the language!

Same difference – more subtle changes in lease language

I grew up using the expression “same difference.” I think I used it when I said something that I believed was right, but someone pointed out something that was wrong about what I said – but it wasn’t important enough for me to care. I think today I would probably just say “whatever.”

There are a couple of things we came across this week that would surely generate a “same difference” response, but there are subtle differences that would generate different results. One is related to blending breakpoints for percentage rent and the other relates to the calculation of CPI (Consumer Price Index) increases (a measure of inflation).

When rents and percentage rent breakpoints changes during a lease year, you must “blend” them to determine what the breakpoint is for the current lease year. For example, the tenant’s pays 10% of sales over the breakpoint for the lease year ending 12/31. If the tenant’s breakpoint is $1,000,000 through 6/30/17 and then $1,200,000 effective 7/1/17, you would have to blend the two to determine the breakpoint for the lease year ending 12/31/17. In a “same difference” kind of way, the lease might require the breakpoint to be blended using number of months or number of days. In a months calculation, the breakpoint would be $1,100,000 ($1,000,000 x 6/12 + $1,200,000 x 6/12). In a days calculation, it would be $1,100,821.92 ($1,000,000 x 181/365 + $1,200,000 x 184/365). The difference is small – $821.92 – and would result in a smaller impact to cash flow ($82.19 in percentage rent – $821.92 x 10%), but it is real and is mandated under the lease. The days calculation would have been different in the event of a lease year (using 182/366 + 184/366). There would also be additional considerations in the event of a mid-month increase to rents and breakpoints (could be full months and then days during the month of increase. In certain cases, the month of increase could be the actual number of days in the month, while in others, days may be defined as 30).

The other item that might generate a “same difference” is which months’ CPI indices to use when calculating the increase in the CPI. Let’s say a lease commences on 9/1/17. Depending upon the wording of the lease language, if the lease states that a charge is to be increased each 1/1 by the increase in the index from commencement, there are a wide variety of indices that could be used. To start, if the lease says the base index is “for” the month of commencement, then we would use 9/17 as the base index. If the lease states that the index is published during the month of commencement, we would us 8/17 as the index, as the indices are published around the 15th of each month, and August would have been published around 9/15/17. Finally, if the lease states the base index is the index “at” commencement, we would use 7/17, as the last index would have been published around 8/15/17 would have been for July. These same subtleties exist for the current month to be used.

While for the most part, the variances created are immaterial, calculation must be performed in accordance with the lease. And, actually, sometimes they really do add up. We once worked on a 200,000 sf office lease that had a twenty year term. There was a two month swing in the base CPI and a two month swing in the current CPI to be used each year. That variance over the twenty year period was a little more than $300k.

All these seemingly irrelevant changes in lease language can add up to have a material impact on cash flow and value!

Give the people what they want (in retail)

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This weekend, my family had three experiences that really drove home one of the new realities of bricks and mortar retail that I keep reading about – that millennials like “Instagrammable” retail. My daughter, Maggie, and my wife, Kathy, accompanied a friend, Halle, to two separate wedding dress stores. At the first, there were separate rooms for each bride-to-be and her guests, set up for easy picture taking. The staff brought out mimosas and created a fun atmosphere. The second shop required phones to be turned off and allowed no pictures. In the second shop, only shop employees could assist with dressing the bride-to-be. The entire party loved the first shop and hated the second. She’s buying from the first.

The second experience was after picking up my son, Liam, from the airport yesterday. We decided to do some Christmas Shopping at Ponce City Market in Atlanta on the way home. PCM was an old Sears warehouse and distribution facility that was essentially derelict and abandoned for years before Jamestown, the owner, came in and converted the bottom two floors to retail and the rest of the building to beautiful, industrial office and residential. Whatever their formula (they own Chelsea Market in New York as well), you just want to be there. We had lunch at this great sandwich shop, El Super Pan, that looks like it’s been there for 50-60 years, but it is only a few years old. You just want to take a picture (above). You walk around the center at this time of year, and there are photo ops everywhere, from the rooftop deck with Atlanta skyline views, to quotes from popular Christmas movies, to the Grinch instead of Santa. Something completely different.

Finally, it was a conservation I had on Friday with a property manager, Raj Chandani at The Forum Carlsbad. It’s a beautiful open air center in California, and we were joking about Santa needing to be indoors in the California heat. But, at the center he manages, Santa is only in on the weekends. And, it’s not the chain Santa/picture package deal. It’s Santa and your own camera or phone. He talked about how much the people love it. Meanwhile, my wife and son are at a beautiful, local-to-me, mixed use property with our dog for pictures with Santa, where you can take a picture with your phone if your buy a picture package.

I am a behind-the-scenes lease administration person not involved in marketing in any way other than to make sure any assessments are being billed in accordance with the lease. However, from a consumer standpoint, it is so easy to see how giving people what they want makes for a much better experience, and makes me want to go back for more. And, it’s not just millennials that appreciate instagrammable retail!

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