Strange things are afoot at the Circle K

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As underwriters of commercial real estate, we deal in facts. We read the leases, calculate all of the rents and reimbursements, examine the critical non-financial covenants, analyze the prior year cash flows and provide an analysis of the assumptions that our clients have made on vacancies and lease up and Tis and inflation and so on. However, we really do stick to the facts. If rents are currently $20 per square foot, and our client wants to assume renewal rents of $35. We use their numbers with the existing lease supported facts. We will let them know we think they are high, but it is up to them to interpret.

Again, we deal in facts.

Also, since we deal so heavily in acquisition due diligence, we are often bellwethers of larger scale trends. We can’t offer explanations as to why.

Fact – over the last 2-3 weeks, we are seeing a spike in the number of transactions in top tier properties (both office and retail) in second tier cities and their suburbs.

No interpretation – just facts.

We’ll be back to our standard lease administration blog post next week.

A couple of percentage rent/gross sales issues this week


This week, we were working on an acquisition of a property in the southeast. One tenant occupied the majority of the property, with a handful of other tenants accounting for about 10% of the leasable area, but about 20% of the income. There was a restaurant tenant that had a unique name that I had thought I recognized. I did a quick search and, sure enough, it had been featured on a popular food related show a couple of years back (my 19 year old son can watch those shows all day long when he is on break). The thousands of reviews of the place were out of this world, with descriptions of hours long waits at any time of the day. And, there were numerous photos of their many catering events on their website. Yet, while they were in percentage rent, the reported sales were mediocre. While the food did, the sales clearly did not pass the sniff test.

It really is incumbent upon a property manager to determine if sales as are being reported make sense. In this case, based upon average ticket, number of tables, number of turns and ancillary (catering revenues), sales being reported are likely 30-35% of actual. For $800-$1000, the seller could have done a sales audit and realized not only the additional revenue, but would have realized the additional value on the sale.

While discussing this internally, one of the guys in the office, Bob, was talking about a Greek restaurant that he had been to last weekend. While paying, the manager’s phone buzzed, the manager looked at it and then relayed to the kitchen an Uber Eats order that he had just received. Bob said that the order was relayed verbally and was not entered into the POS/register while he was there. It may have happened later, or it may have happened automatically, but he did not see what was likely a $30+ order recorded.

It used to be common for landlords to perform sales audits on 10-20% of their portfolios on an annual basis. Those percentages have been way down since the last recession. But, if you have tenants above, or at least within 5-10% of their breakpoint, you should at least be considering a three year rotation of that group of tenants for sales audits. Especially now, as technology changes delivery, and where sales “in, at, on or FROM the demised premises” are included in reported gross sales, there is additional percentage rent out there.

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!

Looking behind the retail curtain at the holiday


Way back when in high school, I was on stage crew for the school’s productions. What I realized was that after doing that for several years, whenever I went to a Broadway show or musical, I would be at least as interested in how the crew handled the sets and lighting and sound as I was with the show itself.

Similarly, at this time of year, as I walk around a mall or shopping center, I pay probably more attention to the centers’ operations as I do to the merchandise (that actually is part of the operations). What actually triggered this line of thought was an article this week on Business Insider:

“The end-of-the-year retail bump is a lie we’ve been told for decades”

It is worth a read, but, for those of us operating in this industry, there is no lie. Year after year. With the exception of a few retail categories that remain steady throughout the year, or some retail properties that are destinations at certain times of the year, we can consistently see that many of the mall and strip center “goods” type tenants experience this retail bump, doing 19+% of their annual sales in December and a little more than 12% of their sales in November. Throw in 8% for October, and you are pushing 40% for one quarter. If you do 40% in the 4th quarter, that leaves 60%, or an average of 20% per quarter for the other three quarters. Nearly a 100% increase over the other quarters is real, and critical.

But, what else do I think about as I walk through the malls and strips? That despite the fact that it may be the coldest part of the year, the HVAC units and central plants may be working their hardest as the heat generated by the sheer volume of people makes it work overtime. (Christmas shopping is not Christmas shopping for me without sweating in a mall because the HVAC can’t keep up and I have a winter jacket on!) And, speaking of overtime, what is happening with the additional hours that the centers operate? In the days when the majority of tenants were on prorata CAM in malls, the extra hours were paid prorata by the tenants. But, with the majority of mall tenants on fixed CAM, if the initial CAM did not consider the additional hours, the landlord will absorb the expenses. I think about the tenants that are opening late in the year and getting the benefit of a disproportionate amount of sales early on – how are they paying percentage rent. As we experienced the past two days here in Atlanta, I think about the costs of snow removal and whether it will be a disproportionate year. Do the properties leases allow, despite fixed CAM, a billing of snow related expenses for exceptional expense years? I think about the properties, mostly strips, that are still on prorata CAM and whether the holiday décor is defined as part of CAM, or whether it is purely a landlord expense, or whether they may be making a marketing contribution and it’s covered by that. I think about the Santa displays and the holiday village displays and where they are stored throughout the year, and whether the landlord owns the displays or leases them, or whether the temporary tenant that operates the Santa village owns the displays and that is part of their cost of doing business. I think about the gift cards being purchased, and that the sale of those gift cards is not a reportable sale until they are redeemed. But then, what portion are never redeemed, and does the tenant turn the unclaimed dollars over to the state as they may be required. And, I do think about the impact that online sales has on our industry – that the strongest properties will continue to get stronger and that the media will focus on the weakest properties that maybe should never have been built in the first place and their struggles supposedly indicating the death of retail.

In any event, you probably don’t want to go Christmas shopping with me because my mind will clearly be wondering. But as you go yourself, think about the time and effort the property managers and the marketing managers and the leasing staff and the temporary leasing staff have put in to making a great holiday shopping experience.

And, give a special shout out to the operations managers and HVAC engineers trying to keep you cool!

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