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Applying the K.I.S.S. method in leases

October 27, 2019

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“Keep it simple, stupid!” That hits home so often as I am reading leases.

I have taught classes for ICSC for nearly 25 years. One of my favorite example has been base rents or fixed CAM charges increased by the CPI. That in and of itself is pretty simple. But, you often see caps on these increases, and in many cases where there are caps there are also floors. So the lease might read something to the effect of:

Minimum rent as reflected in Section x.x will be adjusted at the beginning of each Lease Year by the increase in the Consumer Price Index (CPI) from Index published as of the Commencement Date through the Index in effect as of the adjustment date. The increase applied shall never be less than 2% nor more than 4%. The Index shall be the CPI, Clerical Workers and Wage Earners, 1982-84=100 for the SMSA of which the property is apart.

This adjustment is not difficult to calculate, but it has so many different factors to consider.

  • What is the Commencement Date? You might hone in on the Rent Commencement Date, but the Commencement Date might defined elsewhere as the Date of the Lease.
  • What is the definition of Lease Year? Is it from the Commencement Date? Is it from the Rent Commencement Date? Is it 1/1-12/31? Is it 2/1-1/31?
  • What is my SMSA? A property is midway between Philadelphia and DC? Do I go with Philly or DC? Do I go with Eastern Region?
  • What is the “as of date”? It may sound silly, but “as of” Commencement Date is different that “for” the month of Commencement, which is different that Published “during” the month of Commencement. The possibility of three different months. And, the right index could change if the lease commenced on the 10th or 20th of the month (the Index is usually published mid-month, but it can be the 13th-17th).
  • Are my floors (minimums) or cap (maximums) cumulative or non-cumulative?

Honestly, there are a handful of additional considerations.

However, with the idea of K.I.S.S., you can ask, what are we hoping to accomplish? Your minimum is 2%. Your maximum is 4%. Do we think maybe both parties are shooting for 3%? Is it possible they both have an idea of when each year they would like the increase to be applied?

So, instead of each year having to do the drawn out computation, it can be eliminated with:

Minimum rent will be increased by 3% each January 1 of the term, with the first increase effective 1/1/20.

No arguing of any component of a computation. Simple. Straightforward.

Why this post this week?

We are working on a portfolio acquisition and the seller has created some of the most complicated pools for one of these open air centers that I have ever seen. Grocery and discount store anchored. 11 different groupings for allocations. A similar number of pools within these  groupings. Multiple denominators within each of these groupings. Caps. A Most Favored Nations clause or two.

And, there was one particular pool, with one particular denominator that had been created for one particular tenant. The total allocable expense in that pool? $158. Seriously, $158. The incremental pickup of creating the separate pool and the unique denominator? $1.30. That is not $1.30/sf. That is $1.30 total.

My life, and the lives of the professionals in our company (Meridian Realty Consultants), is about making sure that landlords do not leave any cash flow on the table. I can appreciate efforts to reduce a landlord’s absorption. But, the number of factors going in to that calculation – the expense coding, the allocation among the groupings, the denominators within the pools, the explanations necessary – all for $1.30?

I have a really bad tendency to associate scenes from movies or lyrics from songs to my current situation. As I wrote that $1.30, it brought back a scene from a movie I haven’t even thought about in probably 35 years. https://www.youtube.com/watch?v=e9mf3Bypyk8

Focus on what matters. And, K.I.S.S.

Comments | Posted in Commercial Real Estate, Malls, Office Properties, Retail Leases, Shopping Center, Uncategorized

Could this be worse than a Most Favored Nations clause?

October 13, 2019

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We have addressed the Most Dreaded Lease Clause a few times over the past couple of years. We have also addressed another lease language concept – co-participation. But what happens when you combines the concepts? That combination was evident in an acquisition we were working on this week.

If you have time, take a minute to read those more detailed blogs, but briefly: A most favored nations clause states that a tenant will pay certain amounts (or could have certain restrictions on their occupancy) unless another tenant gets a better deal, in which case the tenant will get the other tenants deal. A co-participation clause states something similar – a tenant will pay, be subject to an increase or have restrictions as long as xx% of other tenants are similarly obligated.

Both clauses are fairly onerous and require some work to properly administer them. You must calculate or consider every other tenants’ obligations and then consider the specific tenant’s obligation.

This week, this was the beauty we came across in a big box lease:

“…provided that all in line tenants of the Shopping Center except (Shadow Anchor 1) and (Shadow Anchor 2) are obligated to pay an equivalent amount (on a per square foot basis) of such costs…”

The tenant was obligated to pay its share of CAM as defined in the lease “…provided that all in line tenants of the Shopping Center except (Shadow Anchor 1) and (Shadow Anchor 2) are obligated to pay an equivalent amount (on a per square foot basis) of such costs…”

The lease did not provide for any remedies if those parameters were not met. Therefore, it became an “I don’t have to pay at all if someone pays less” situation. Go back and read that language. It requires 100% participation from the inlines and an equivalent amount on a per square foot basis.

Consider the scenario: The tenant with this language in the lease is required to pay $4.00/sf. Another tenant is required to pay $3.25/sf. The other tenant is not paying an equivalent amount on a per square foot basis. Therefore, the “provided that” kicks in, and the tenant is no longer obligated to pay. It is not reduced to $3.25/sf as it might be in the case of a Most Favored Nations clause. We can’t argue “similar obligation” as we might in the case of a co-participation and state each is required to pay a prorata share, or a fixed share, or even just a share.

The fallout could be severe. As I mentioned, it was a big box. Figure 35,000 sf at $4.00/sf. $140,000 per year!!! Now apply a cap rate to that (as I also mentioned, it was an acquisition). At a 7% cap rate, that is $2,000,000 in value!!! That might be the worst case scenario (unless there was another most favored nations clause in the center which rarely ever happens). However, it could have other consequences (and be mitigated a bit) if the big box were a defined excluded area for other tenants in which case the other tenants might see an increase in their rates per square foot because that $140,000 contribution would be going away.

Two weeks ago, the blog was that Always and Never cannot exist in real estate. Perhaps I have to rethink my use of the word “Most” as in Most Dreaded Lease Clause from now on.

Comments | Posted in Commercial Real Estate, Malls, Office Properties, Retail Leases, Shopping Center, Uncategorized

Two words that STILL don’t exist in commercial real estate (this time related to sales reporting and percentage rent)

September 29, 2019

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Last year, upon returning from ICSC’s John T. Riordan School of Professional Development in Minneapolis, I felt the need to write a blog entry on the use of “ALWAYS” and “NEVER” when referring to commercial leases. In short, the only absolute that may exist in commercial real estate is that there are no absolutes.

This year, the JTR school was back in its former home in Scottsdale. There are tracks for Management I and II, Leasing I and II, Development, Marketing and Leadership. While the entire program is exceptional, one particular highlight is Case Study day. The students in the various disciplines are paired together with other disciplines to develop game plans for a particular property – grocery anchored for Level I and a more complex lifestyle center for Level II. The information provided to the students is thorough, with some of the most insightful geofenced data available for each property (provided by David Lobaugh of August Partners).

But, in the Level I program, we unfortunately did not provide tenant sales data. Wanting to determine how the tenants were performing, whether there might be percentage rent, and to help shape future rental rates, a few of the students asked if we could provide it.

The immediate response to the students was disappointing for two reasons. It used an absolute and it was incorrect. The students were told that tenants in grocery anchored centers NEVER report sales or pay percentage rent.

There are certain parts of the country where landlords are a little more likely to concede to tenants’ requests to delete percentage rent requirements. But, even in those areas, the landlord still makes every effort to keep the sales reporting requirements in the lease – perhaps not at the same monthly level, but quarterly or annually.

“Whether you have Percent-In-Lieu (Gross Deals), Early Termination Rights clauses, POP-Up Stores, Rent Relief, Specialty Leasing or other ‘Risk Sensitive’ leasing financial exposure, industry ‘Best Practices’ dictate you keep Sales Reporting and/or Percentage Rent requirements at a minimum.”

According to Ken Lamy, president and CEO of The Lamy Group, an international retail sales assessment and consulting firm, “Whether you have Percent-In-Lieu (Gross Deals), Early Termination Rights clauses, POP-Up Stores, Rent Relief, Specialty Leasing or other ‘Risk Sensitive’ leasing financial exposure, industry ‘Best Practices’ dictate you keep Sales Reporting and/or Percentage Rent requirements at a minimum.”

Lamy states that “These two provisions (percentage rent and sales reporting) currently appear in leases 65-70% in “Open-Air” properties and 99% in mall / outlet / lifestyle properties. As a 21st century industry professional, transparency along with quality data sharing is the norm.”

Even in those instances where the specific sales reporting requirement is deleted, there may be another useful clause buried elsewhere in the lease – Landlord’s right to request financial information. This clause requires the tenant to submit financials (income statements and balance sheets) upon request – often no more than once a year, or in conjunction with a sale or refinance of the center.

Because thorough sales data is critical to the health and operation of a center, landlords are firm in their resolve to keep the sales reporting clause in their leases.

And, to reiterate, always and never really do not exist in commercial real estate.

Comments | Posted in Commercial Real Estate, Malls, Office Properties, Retail Leases, Shopping Center, Uncategorized

The percentage rent unicorn revisited

August 27, 2019

A while back, we had addressed the “percentage rent unicorn” – that landlord dream within a dream (Hopefully, you are thinking The Princess Bride right now) – where landlords can bill percentage rent over a monthly breakpoint with no annual reconciliation. It is not something we see often, but when we do, it often leads to significant additional percentage rent.

However, the inverse of this clause happens frequently, especially with cotenancy provisions. “The tenant will pay, on a monthly basis, the lesser of minimum rent or x% of sales.” Typically, leases do not provide for an annual reconciliation when a tenant is on any sort of alternative rent. Can it be material? The lease I was just reviewing has the tenant pay the lesser of 2% of sales or minimum rent during the reduced rent period. Minimum rent runs $27k per month. In most months, alternative rent runs $20-$23k per month, which the tenant pays. However, in December, 2% of sales runs around $40k, but the tenant is only required to pay the “lesser of.”

Therefore, the fact that the tenant is not required to reconcile the 2% calculation on an annual basis causes the rent reduction to be $13k greater than it would be with an annual comparison, as reflected below:

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So, while there are unicorns for landlords, the tenants have unicorns too.

Comments | Posted in Commercial Real Estate, Malls, Retail Leases, Shopping Center, Uncategorized

John T Riordan School for Retail Real Estate Professionals

July 14, 2019

If you have followed this lease administration blog for the past couple of years, or even if you have just stumbled upon it because of a question you have had related to some lease related term, you are the type of person that would absolutely benefit from ICSC’s John T Riordan School for Retail Real Estate Professionals.

Classes run the gamut of disciplines within the shopping center industry – development, management, marketing, finance, leasing and leadership and are taught by some really incredible people that have years of experience and practical knowledge in all of these fields. These classes are outstanding preparation for the examination for ICSC’s CRRP designation (Certified Retail Real Estate Professional). And, quite honestly, the breaks, meals and other networking opportunities are almost as valuable as the classes themselves. The attendees are others like you that are making a long term commitment to the industry. I regularly reach out to other attendees or faculty for opinions or guidance on issues I see on a day-to-day basis. I can’t tell you the number of times this has saved me from reinventing the wheel.

This year’s School will be held September 22-26th in Scottsdale. You can find the link below:

https://www.icsc.com/attend-and-learn/events/details/john-t.-riordan-school-for-retail-real-estate-professionals6

Although I have been attending ICSC classes for 30 years and have been teaching for the past 23 years, I never fail to learn something new and valuable for my company and its clients. If you have any specific questions about the School or its classes, feel free to comment and I will answer or get you the answer.

Faith Cooper is ICSC’s Education Manager who handles the School. If you reach out to her via email (fcooper@ICSC.org), she actually has the ability to offer a 10% discount off of tuition for those referred by faculty.

Hope to see you in September.

 

Comments | Posted in Commercial Real Estate, Malls, Office Properties, Retail Leases, Shopping Center, Uncategorized

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