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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!

Phantom Square Footage

stopsayingthat

I would have to guess that we may have annoyed a client this week because we would not drop an issue. Their leases required the inclusion of licensee square footage in Gross Leasable Area (GLA). Generally, most standard leases today define licensees as exclusions when calculating prorata shares. (Licensees themselves are typically defined as short term agreements less than 12, 18 or 24 months.) So, if you have a 1,000 square foot premises that is occupied by a temporary tenant, that 1,000 square feet would come out of the denominator when calculating the prorata share for tenants where licensees are excludable.

But, licensees are not in just inline space. In retail, most cart (retail merchandising units, or RMUs) are license agreements. With this particular client, because of the wording that required license agreements to be included in GLA, as they added a cart to the center, they were required to add the square footage to GLA. Without considering the consequences, the instead of adding 32 square feet when adding a 4’ x 8’ cart, they actually added 192 square feet which accounted for a 4’ perimeter all around the cart (4’ plus 4’ on either side (12’) x 8’ plus 4’ on either side (16’). In this case, 160’ more than actually existed. So, we saw that going in to a denominator with no reimbursement. If CAM and taxes total $20 per square foot, by including that additional square footage, they were absorbing $3,200.

But, on top of that, once the square footage was added to the center, it remained there – in total GLA. If the cart was used 6 weeks per year, the 192 square feet was included year round. One issue was what they did with the carts and other RMUs when they were not in use. The casual answer was that they were left in the common area and used by other tenants for advertising. The answer we were looking for was that they were stored elsewhere (so that we could take them out of GLA).

Why was that so important? For two reasons. The first is that absorption factor. Believe it or not, there was 4,000 square feet of what we considered phantom square footage being carried on the rent roll. 4,000 square feet at $20 per square foot = $80,000 of absorption!!!!! $80,000!!!!! The second reason was that a number of tenants in the center have cotenancy provisions in their leases based upon the occupancy of the inline GLA. Think about this – If you have 200,000 square feet of inline GLA and 20,000 square feet of inline GLA vacancy, you are at 90% occupancy. But, if you are also have 4,000 square feet of “phantom” license square footage that is vacant, you are at 88.23% occupancy (180,000 sf of occupied inline / 204,000 sf). If you have tenants that have 90% cotenancy requirements, that 4,000 square feet of phantom square footage cause a cotenancy violation.

So, we got the answer, and we asked again. And again. And pointed out that the rent roll carried 35+ vacant RMUs. In reality, there were three vacant RMUs in the common area, but the rent roll have never been “cleaned up.”

It’s worth taking a look at your rent roll, compare it to the lease plan and account for all of your square footage. There truly are both financial and non-financial consequences if you don’t.

(The gif comes from what some (at least me!) miht say is the greatest movie of all time, The Princess Bride, in honor of the 30th anniversary of its release this month. You’re welcome!)

Intelligent People Will Argue

I have mentioned in prior blogs that one of the things I love about lease administration is that everything you need to know about the lease is right there in 40-50 pages of the lease (sometimes as few as 2-3 pages, but sometimes as many as 500+). But, unless there are outside rules specifically addressed in the lease (such as “in accordance with Generally Accepted Accounting Principles” or “measured in accordance with BOMA standards”), the lease language is the only thing that matters (as well as laws and ordinances).

It’s beautiful. It’s all there … except when it’s not.

It can be extremely frustrating when a situation arises that was never considered by the lease. Much more often than not, stones are not left unturned. Even record stores in the 1970s or the pager stores in the 1980s and 1990s addressed “the technological evolution of their permitted uses” in both their use clauses and exclusive use clauses. But, twice this week, we had situations arise that had not been considered – or at least not addressed properly.

The first was a new lease with the tenant’s expected opening in March, 2018. The lease language addressing CAM was clear and concise. For 2018, CAM would be $x.xx per square foot, increasing by 5% each January 1. But, the lease did not consider that opening might be accelerated a few months into 2017. As the title of the blog suggests, intelligent people will argue. Since you have to live within the terms of the lease, what will the CAM charge be for 2017. Is it the $x.xx per square foot quoted for 2018? Is it $x.xx per square foot for 2018 divided by 1.05 (which would cause it to increase to $x.xx per square foot after applying a 5% increase)? Or, is it possible there is no charge for CAM for 2017 since the lease specifically addresses 2018 forward? (Ultimately, because the word “through” was buried in a CAM related section, the $x.xx per square foot rate for 2018 applied to 2017 as well.)

The second situation related to an extension of the term. A lease had naturally expired 1/31/17 and the tenant had been holding over as new terms were negotiated. Rather than execute a new lease, an amendment extending the term was executed. And, rather than making the extension retroactive to 2/1/17, a “New (uppercase “n”) Rent Commencement Date” was addressed, with a five year extension term with rents addressed by “Lease Year” (uppercase “L” and “Y”). With a new Rent Commencement Date of 8/1/17 and a new expiration date of 7/31/22, it was clear what the intent was – rent bumps each 8/1. However, the “Lease Year” definition, which was based upon the original “Rent Commencement Date,” would not have changed. And, if it did, the lease as amended never considered what would happen to the partial lease year (2/1/17-7/31/17) percentage rent that would now be occurring mid-term. Again, intelligent people will argue. (This one actually needs a letter agreement to specifically correct the Lease Year definition and the partial year percentage rent.

While it would be impossible to consider every potential scenario to be covered by a lease as new situations arise every day, the two situations will be used by the respective landlords to help their standard leases evolve. Ensuring that the “through” language is addressed in the “recitals” (terms) portion of the lease and is more prominently featured in any fixed CAM clause will take care of the early opening issue. And, while the mid-term partial lease year would likely never need to be addressed in the standard lease form, the landlord will now surely recognize the impact of a potential change in lease year definitions prospectively.

In any event, intelligent people will continue to argue.

Poof! A $40M Value Swing Because of Lease Language

In prior posts, we have addressed why there are excluded areas defined for purposes of calculating prorata shares of taxes or CAM. In a nutshell, if a part of a property is not paying a full prorata share of expenses, any shortfall has to be absorbed by the landlord. For example, we have a fully occupied 1,000,000 regional mall with $1,000,000 in taxes. If everyone paid their full prorata share, all tenants would pay $1.00/sf. However, if a 100,000 sf anchor was not required to pay taxes, the landlord would absorb $100,000. However, if we define that anchor as an excluded area, the other tenants would pay $1,000,000/900,000 sf, or $1.11/sf. Then the landlord would have no absorption – we would have collected the full $1m.

This past week, we unfortunately had to deal with a property where the leases were not optimally structured/worded. A one level quasi-regional mall/entertainment center had a group of tenants with upper levels. The leases were worded in a way that the tenants paid additional charges on only the main level of their premises. In one case, the tenant had nearly 11,000 sf total, but only 1,000 sf on the main level. The tenant was required to pay additional charges on only the 1,000 sf. Therefore, unless the other leases were worded properly, the landlord would have to absorb the additional charges on the 10,000 sf.

Ideally, the other leases would have read that the tenants pay a prorate share of the additional expenses based upon the ground floor area of the center. This would have excluded any square footage above or below the ground floor from the denominator. This language did not exist. It could have read “excluding square footage above or below the main level” which would have included the square footage to begin with, but then defined that area to be excluded. The leases did not contain this language. The leases could have excluded “any tenant not paying a full prorate share” of additional expenses, but they did not.

Therefore, for the most part, the landlord is absorbing additional expenses on this upper level square footage. Prospectively, we may be able to use the “any premises not fronting on the enclosed mall” exclusion that exists in most of the leases by having two separate leases for the tenants with multiple levels – then we would have one premises fronting on the enclosed mall and another premises not fronting on the enclosed mall.

Why even bother with this? The total upper level square footage at the property is about 70,000 sf. Total additional expenses per square foot are nearly $40.00. That is currently $2.8m of absorption per year. Apply a 7% cap rate to that – that is $40m in value. Seriously, $40m in value! For lack of better lease language!

Think about the big picture when you are considering your lease language!

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)!

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