The economics of a lease

Over the next week, I will be putting together a new class for ICSC’s John T Riordan School for Professional Development. The class will be offered as an elective for the Management, Marketing and Leasing tracks at the school which is being held September 23-27, 2018 in Minneapolis.

A previous version of the class focused primarily on discounted cash flow from the lease which I intend to incorporate into the class. However, I plan to also address:

  • The relationship of one lease and its impact on the balance of the property (and possibly the portfolio)
  • Premise by premise considerations for lease rates
  • Category by category considerations for lease rates
  • Building tenant improvement costs/allowances into the lease
  • How to protect yourself when you do give a sizable allowance (Security Deposits/Letters of Credit/Radius Restrictions)
  • Cotenancies
  • Termination rights (landlord and tenant)
  • Gross leases vs triple net vs modified gross leases
  • The cost of giving up certain standard lease clauses

If you have read this far, perhaps you were thinking another topic or two would be addressed in the class. Well, now is your chance to help shape the curriculum.

Please comment with any additional items you think you be valuable for inclusion.

Here is the link to the John T. Riordan School for Retail Real Estate Professionals. The School offers tracks for Leasing, Management, Marketing and Development, Design and Construction, as well as a new Leadership Institute.

Hope to see you there!

CAM, tax and insurance reconciliations during due diligence


More often than not, when acquiring a property or portfolio, prospective purchasers are focused on future cash flows. When it comes to CAM, taxes and insurance, it is future reconciliations that will have the most impact on the buyer’s cash flow.

However, when acquiring a property, it is critical to get as many years of CAM, tax and insurance reconciliations from the seller as possible. While a purchase and sales agreement may put the burden for retroactive adjustments on the seller, a tenant doesn’t care where the credits are coming from – seller or buyer.

But, often, there is another need for these historical reconciliations. If a tenant has a cap on any charge, a buyer may need to substantiate prior billings in order to justify current caps – especially in the case of a non-cumulative cap where you may need to show actual charges on a year to year basis.

Just this week, we had a tenant in a center that our client had acquired two years ago. CAM charges were fixed for this particular tenant. However, every five years, the fixed charge was to have been reset based upon the actual CAM charges for the prior five years.

Without the historical billing files, there would be no way to reset the tenant’s charge, leaving significant amounts of cash flow on the table.

So, whenever possible, even though you may do nothing with it, get as many years of historical reconciliations as possible!

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!

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