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It’s just a couple of days

March 31, 2019

We will not complete the date fields in a lease abstract until we know which dates we are going to use as the Commencement Date and the Rent Commencement Date. That can be incredibly frustrating for anyone that has to deal with us.

Think about that. You’ve just executed a lease and you want a final abstract so you can start using the information to run a rent roll or do some  projections. You are confident it is going to open by February 1. Just use that date Jack!

But, if you have followed this blog at all, you know that a day here or there can make all of the difference in the world. Seriously?  All of the difference in the world?  Surely, you’re exaggerating? Maybe not quite that extreme, but it could mean the difference in the term by a year. It could make a difference in when a tenant has a right to terminate based upon sales. It could make a difference in the lease year end for percentage rent purposes. It could make a difference when a guaranty ends. It could make a difference in a tenant’s operating covenant. It could make a difference in when an exclusive expires. It could make a difference when a radius restriction expires. There are so many clauses in a lease that can be affected by just a couple of days. And, that is no exaggeration.

The three most common ways to define a Lease Year across all retail leases are: 1) Based upon a Calendar Year (where Calendar Year is 1/1-12/31), 2) A Lease Year ending January 31, and 3) 12 full months from the Rent Commencement Date. There are naturally endless variations of the definition of Lease Year, but those three cover 75%+ of all leases. Complicating the definition of Lease Year is the definition of Partial Lease Year. In some cases, a Partial Lease Year is a Lease Year. In most  cases, a Partial Lease Year is not a Lease Year because it is not a full 12 months. (There are qualifiers that you’ll see in leases regularly – something to the effect of “if a Partial Lease Year contains more than 6 full calendar months, it shall be considered a Lease Year.”)

You’re getting off track Jack! We were talking about a couple of days.

No. Not off track at all. All of these leases clauses are tied together and contingent on a couple of days. Think about a lease with a Term of five full Lease Years that defines Lease Year as ending January 31. You are confident that the lease is going to commence on February 1, 2019, so just use that date! But, let’s say that instead of the Rent Commencement Date being 2/1/19, it turned out to be 2/3/19. Two days. That’s it. In the case of 2/1/19, the first full Lease Year is 2/1/19-1/31/20. In the case of 2/3/19, the first full Lease Year is 2/1/20-1/31/21. Depending upon how that lease defines Rents (by Lease Year) and Term, the Term itself could end either 1/31/24 or 1/31/25 – a full year’s difference!

Or consider a ten Lease Year term with a right to terminate if sales for any 12 consecutive calendar months never exceed $350/sf through the end of the 5th Lease Year. Again, is the end of the 5th Lease Year 1/31/24 or 1/31/25?

Or an operating covenant that states a tenant has to operate as a _________ supermarket through the end of the 3rd Lease Year and as any supermarket through the end of the 10th Lease Year. Those dates could be contingent upon a couple of days.

Could you put in 2/1/19 and then go back and change all of the clauses if there is a change? Absolutely! But, history tells us that once that information is in the system, more often than not, it stays in the system. Yes, someone may think to change the expiration date (instead of 1/31/24 to 2/29/24) and the bump dates (from 2/1 to 3/1), but those may be (and likely are) wrong. And, rarely do the log codes (the non-financial clauses) get properly changed.

So, because the Commencement Date and the Rent Commencement Date have the potential to impact so many other clauses, we leave the definitions in the abstract as Lease Year One, Lease Year Two, etc. until we have a final date. In that way, because there are not absolute dates in the abstract, all of those dates are still open until they can be confirmed. Until that start date can truly be considered.

What’s the solution, then, if you need to run a rent roll or projections with that new lease’s rents? Use that 2/1/19 as the start date for rents, but absolutely, positively do not put other dates in to the abstracts so that those dates are still blatantly empty.

A couple of days do really matter.

(On a similar issue handled completely differently would be a start date for a lease that has commenced and is part of an acquisition. In a case where commencement may have been one or two sellers ago, you are forced to pick a date as the commencement because you know that you will never have a true absolute. You hate it, but sometimes that truly is the best you can do.)

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

Considering the proper treatment of tax abatements and incentives in your leases

March 17, 2019

I have the honor of serving on our city’s development authority. It is a recent appointment, so I cannot take any credit for the great things that have been done already. As part of the appointment, I was required to take a class that included a couple of hours on tax incentives and bond financings.
While I am a neophyte serving on an incentive granting authority, we have dealt with the aftermath of abatements and incentives on hundreds of properties over the years. Using the word “aftermath” is actually intentional because, so often, the true intended benefit for the intended recipients never actually comes to fruition. (And, because I am a lease language geek, the word “aftermath” is especially meaningful as the reason it often doesn’t come to fruition is because of what happens “after math”!)
There are numerous reasons for developers asking for and governments granting incentives, but most can be boiled down to two words – but for. The area would remain or become blighted “but for” the incentives. The employer might not consider locating here “but for” these incentives. It’s an oversimplification of a lengthy process, but it is fairly accurate.
One of the simplest forms of incentives is a tax abatement. There are countless numbers of ways the abatements can be structured – full and partial, of all taxes or of one or more categories of county, school or town/city/village and so on. But, the intent is often to provide some financial incentive to the developer to help with the costs of certain “but for” necessary improvements. Something to the effect of taxes being $100,000, and they are waived for a 10 year period. Or taxes are $100,000, and they are waived at 100% for the first year, reducing by 10% per year over a 10 year period. Or, taxes are $100,000, and they will remain at that level for a 10 year period despite the fact that the property is expected to increase in value by 5, 10, 20 times once the development work is completed. In our 10 year, $100,000 per year example, the intent is to get the $100,000 per year to the landlord.
In a typical lease, what would happen? The tenant is required to pay a prorata share of taxes. The landlord would get a tax bill for $0, and the tenants would then be billed a prorata share of $0. While you could argue that the landlord was able to get additional base rent during the abatement period because the tenant did not have to pay tax, the true $100,000 intended benefit may not have been realized.
However, if the landlord anticipated this tax abatement, the abatement itself could be addressed as a separate issue in the lease. Ultimately, the tenant would be required to pay a prorata share of taxes, with taxes defined to include what taxes would have been absent any abatement. In that case, the tenants would then be billed a prorata share of $100,000 (what taxes would have been absent any abatement), would collect the tenants’ prorata shares and then would retain those amounts because there is no tax bill.
Again, an oversimplification of the issues. However, incentives, including abatements, only really work if the intended benefit is received by the intended recipient. This can be done only by properly considering the lease language – before the lease is executed.

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

Be explicit – even fixed CAM can be tricky

March 10, 2019

There’s no doubt that prorata CAM, tax and insurance calculations can be tricky. You have to make sure the shopping center definition is correct, the expenses are correct, the method of calculating the leasable area is correct, the method of calculating vacancies is correct, the definition of excluded area is correct, the treatment of excluded area contributions is correct… Actually, as I write this, I am thinking of the dozens of other factors that go in to prorata calculations. So, the majority of leases on the mall side of our industry are fixed CAM calculations, and there is a material portion of leases in open air centers that use fixed CAM as well. It eliminates the complexity of administering CAM.

So, fixed CAM is simple, straightforward and can’t have any calculation issues, correct? We know that is not the case from previous blogs. One major culprit – the definition of “years,” and specifically when the first increase is going to be applied.

This past week, we were working on a beautiful mixed use property that, unfortunately, had opened in the middle of the great recession. It is doing well today, but, because of the conditions that existed at the time, could not be fully developed with its original timeframe. While the project opened with numerous freestanding restaurants, a few have come after the fact and are still being completed today. The existing outparcel tenants were all on a fixed CAM, all with comparable rates and comparable increase methods.

In 2014, one new lease was being negotiated. The then-current landlord did a great job being upfront with this future tenant of sharing the fixed CAM rate and increase method – $8.00/sf for 2014 with 3% increases annually. The lease was executed. The tenant opened. The tenant was billed its $8.00/sf with 3% annual increases – just the same as every other freestanding restaurant. Not really!

While the lease was being negotiated in 2014, it was finally executed in 2015. Ultimately, the tenant opened in November 2016. If you have followed these blogs for a while, I am hoping you can see where this is going. On the day the tenant opened, every other freestanding restaurant was at $8.49/sf. The tenant was at $8.00/sf. On 1/1/17, the other tenants bumped to $8.74/sf. The tenant stayed at $8.00/sf until 12/1/17.

$.72/sf per year; $5,400 in annual cash flow; $77,000 in value

Knowing the extended approval and development period existed, the lease could have addressed that the rate was $8.00/sf for 2014 (which it did), increasing every January 1, with the tenant’s rate at commencement to be the then-current rate. And, as addressed in the previous sentence, that January 1 reference is critical. As it was written, “annually” was not defined. Ultimately, because of the poor wording of the lease, the landlord has lost, on this particular tenant, $.72/sf (increasing by 3% per year). That $.72/sf is 2 years, 11 months’ worth of increases. FOR THE ENTIRE TERM!!!!

At 7,500 sf, that is $5,400 per year! At a 7% cap rate, that is $77,000 in value! This because the lease language did not match the former landlord’s intent.

Be explicit with your lease language. It absolutely translates into the property’s value!

Comments | Posted in Malls, Office Properties, Shopping Center, Uncategorized

Excluding tenants vs. excluding premises

March 3, 2019

When leases require tenants to pay a prorata share of expenses – real estate, taxes, CAM, insurance, in some cases utilities and marketing – landlords are hoping to get reimbursed for as close to 100% of those expenses as possible. You might think that with an administration fee of 15% (among the most common), a landlord would hope to get close to 115% of expenses. However, the reality is that landlords rarely achieve reimbursement ratios even approaching those percentages. Why? There are two primary factors – 1. It is rare than 100% of a commercial property’s leasable area is occupied for any entire year with no vacancies, and 2. The majority of leases have negotiated exceptions to a standard lease.  With vacancy, if a 100,000 sf property is at 100% occupancy at both the beginning and end of a year, but one 10,000 sf space became vacant in January, was leased in February, was built out March through July, and was once again occupied by a new tenant in August, we have 6 months of vacancy on that space. There is essentially 5,000 sf of space (10,000 x 6 months/12 months) that would not contribute to expenses.

Because of this vacancy issue, landlords hope to have tenant pay based upon the leased are of the center rather than on the leasable area of the center. If we had $100,000 of expenses and all tenants paid based upon the leasable area of the center, every tenant would pay $1.00/sf for the year. But, since we had 10,000 sf vacant for 6 months, the two tenants that were in that space (one for the month of January and one for August – December) would together pay $5,000 ($1.00/sf x 10,000 x (1 month + 5 months)/12 months). If tenants were billed based upon the leased area of the center, every tenant would pay $1.0526/sf ($100,000/95,000sf average occupancy for the year). The landlord would then be reimbursed a full $100,000 (90,000 sf occupied for the full year x $1.0526/sf = $94,736.84 + 10,000 sf occupied for 6 months = 5,000 sf x $1.0526 = $5,263.16).

And, as we have addressed in many other posts, most leases are negotiated to some extent. Let’s say of that $1.00/sf of expenses, 20% was attributable to a parking lot resurfacing, and one 25,000 sf tenant had negotiated that they do not pay for parking lot resurfacing more than one time in any 7 year period.  Then, if this was the second resurfacing, that particular tenant’s share would be calculated on $80,000 rather than $100,000.

shuffle

You’ve heard that reference to a deck of cards being shuffled and how, there are some many possible combinations, the combination you have just shuffled may never have been arranged that way  – ever. Well, a deck of cards has only 52 cards. Think of a shopping center with 52 tenants. Each one of those leases has hundreds of clauses and portions of clauses that can be negotiated. That’s what you are dealing with when administering leases.

So, landlords try to find certain commonalities. Which leases are likely to have exceptions to their leases causing the lowest rates per square foot in a center.  Those are the leases which will cause the landlord’s reimbursement ration to suffer.

We have addressed many of these commonalities in the past – tenants over a certain square footage, the anchors, are likely to be paying a lower arte per square foot; tenants that don’t front on the enclosed common area may not be paying for interior CAM expenses; theaters, or restaurants with exterior entrances can convince a landlord to bill a lower rate per square foot; there are dozens of ways to group these tenants.

And, now, to the point of this post. Did you see the language I used in that last paragraph? I sued the word “tenants” over and over. What does that imply? That implies that the “tenant” of the space is the excluded area, not the space itself. Semantics? Not in the least.

Semantics? Not in the least.

Sophisticated landlords and tenants focus heavily on the choice of words. Take a specific example of excluding a premises greater than 80,000 sf or a tenant greater than 80,000 sf. Let’s say we have an anchor tenant space of 100,000 sf.  Now let’s say that we lost our anchor. If the lease reads that any “premises > 80,000sf” is excluded, our denominator would be 100,000 sf (200,000 – the 100,000 sf premises). However, if the lease reads that “tenants > 80,000 sf” are excluded, since we do not have a tenant, the denominator is 200,000 sf.

That “semantic” combinatory of words will have a material impact of a tenant’s rate per square foot, and the landlord’s ultimate reimbursement ratio.

Tiny little, seemingly meaningless distinctions can really affect value.

Comments | Posted in Malls, Retail Leases, Shopping Center, Uncategorized

Unique remedy language in the event of a violation

February 10, 2019

The majority of national and regional tenant leases contain some sort of tenant-negotiated restriction. It may be an exclusive use, or a specific prohibited use in the center (no educational facilities), or a site line restriction, or a restriction against a type of use within x feet of the premises (no food uses within 200’ of the premises), and any of the other myriad restrictions that are important to tenants. Often times, if a restriction is violated, a remedy kicks in – tenant will pay the lesser of x% of sales or minimum rent, or 50% of minimum rent, or even no rent – until the condition is cured (and it may actually ultimately result in the right to terminate if the condition is not cured within x months).

This week, a novel remedy was included in one of the leases. If a violation is not cured within 90 days of notice to landlord of the violation, the tenant has the right to pay either 2% of Gross Sales, or “Minimum Rent … less the … rental paid by the tenants … using their premises for the Prohibited Use or Restricted Use for such period.. ”

“Minimum Rent … less the … rental paid by the tenants … using their premises for the Prohibited Use or Restricted Use for such period.. “

It really is a brilliant clause (for the tenant!). If a landlord allows a larger tenant to come in and violate the restricted or prohibited use, it is possible the tenant may not be required to pay any rent. If a smaller tenant comes in and violates it, they would see a proportionate reduction in rent.

While it may not be appropriate in every case, there really is no limit to leasing agents’ creativity.

Comments | Posted in Malls, Retail Leases, Shopping Center, Uncategorized

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