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Experiential retail as a consumer

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We are always considering retail from the landlord perspective, and there is so much to consider as retailers and landlords emphasize the experience. But, over the past two weeks, I have been on the other side of the equation – feeling the impact of showrooming and experiential retail as a consumer.

Two weeks ago, I was at Mall of America. Two stores that caught my attention were UnTuckIt and Indochino. I seem to get inundated with emails from these two companies and have always though that I would like to give them a shot. Both etailers had physical locations at Mall of America where I was able to see the product up close and, in the case of UnTuckIt, try the product on. That showroom experience converted me. Honestly, had it not been for the physical presence, I don’t know that I would have ever made the leap.

And, this past weekend, I had a different kind of “experiental” retail experience. My wife and I made a road trip to meet old friends in Louisville. There, we visited more than a handful of distilleries. While I have always enjoyed a mule or two, I didn’t know much about bourbon. But, I truly believe this was experiential retail at its finest. Similar to leaving the World of Coke in Atlanta, you feel as if it is now your responsibility to be a champion of their product. There is now a connection that will stay with me. And, Total Wine will be the ultimate beneficiary.

On one lease language related subject, distilleries and breweries are often specifically prohibited in shopping centers’ “Rule and Regulations” or in other prohibited uses. But, as the industry changes, this is just one of many formerly important restrictions that may need to be reconsidered.

Why look at a municipality’s tax maps or GIS data?

Often in retail, tenants will be required to pay their share of taxes using the square footage of the tax parcel of which they are apart. In other cases, they will be required to pay based upon the leasable area of the shopping center excluding separately assessed premises. Sometimes, just looking at the tax map or the graphical information system (GIS) data for a shopping center will allow you to “see” that adjustments may exist.

The three most common types of adjustments that we are able to “see” from this information are:

  1. A tax parcel is a building footprint only. Sometimes a department store, supermarket or outparcel occupies a tax parcel that includes only the land under the building. A 4,000 sf building sits on a 4,000 sf tax parcel. In those cases, we can “see” that the tenant’s parcel does not include any common areas or any supporting parking areas. In those cases, there may be an opportunity to bill additional land taxes.
  2. There are numerous parcels for one shopping center. In many leases, the lease will allow (“at landlord’s option”) the tenant to be billed based upon the square footage of the parcel on which the tenant resides. Often, there can be a wide range of rates per square foot when looking parcel to parcel. This past week, we worked on two centers where the rates per square foot varied by nearly 400% from the main parcel to a multi-tenant outparcel ($1.50/sf on the main parcel to $6.00/sf on one of the multi-tenant outparcels). Carefully considering the landlord’s lease required/allowed billing options can greatly affect a tenant’s rate per square foot.
  3. Occasionally, we will see that there are just a couple of tax parcels for a center, but as we dig into the municipality’s records, there is detail of the assessment for a single parcel BY BUILDING. In those cases, while it may initially appear that there are not separate assessments, there truly are, creating the opportunity addressed in #2.

You may not fully understand all of the information that you are looking at when you pull up the tax maps or the GIS data for a property, but, odds are, you may recognize when an issue exists – enough to ask the right questions. Those questions may lead to additional value!

Two words that cannot exist in commercial real estate

This past week, I was in Minneapolis with about 175 other shopping center professionals for ICSC’s John T. Riordan School of Professional Development. If you have not been, it is a tremendous experience, with tracks for leasing, management, marketing, development and leadership, with electives for finance, at levels for both newer and more experienced professionals.
While there, I heard two words that I do not expect to hear when describing commercial real estate – “always” and “never.” If you’ll look back over a year and a half of these blogs, you will see that I have been very careful to qualify lease clauses. In many cases, I am tempted to use those two words. But, week after week, as I review hundreds of new leases, I realize that always and never do not exist.
There were two “nevers” that stick out this week. One was a student adamantly stating that supermarket leases NEVER contain percentage rent clauses. And, in his particular corner of the country, in the asset class in which he operates, percentage rent clauses in grocery store leases are fewer and further between. But, as a whole, it is much more common than not to have a percentage rent requirement in a supermarket lease. Because of lower rents and lower percentage rent rates, the clause may have little impact because the tenant may be unlikely to reach the breakpoint, but it is still there.
The second “never” (actually a set of “nevers”) was used by fellow faculty members suggesting that students could not sell off portions of a shopping center in a case study because the center was REIT owned, and “REITs never sell off” parts of a shopping center. Also, you would “never” change the physical components of a center to cover previously open areas. Both of these scenarios, while infrequent, are actually not uncommon – just not in the smaller subset of the commercial real estate universe that each speaker operates in.
For every supposed absolute of “always” or “never,” there are likely (again, I am qualifying) many examples of properties or leases that contradict those absolutes. So, when you think you have learned or seen everything in commercial real estate, look again!

A need for a holistic approach to leases

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When coming up with a blog topic for the week, I typically reflect back on one issue that stood out for the week. My guess is that it almost appears as if each of the issues are stand alone. But, this is never the case. Within one lease, you can have hundreds of potential changes, and then multiply that by the number of tenants in a property, and the combinations are exponential.

However, there are certain types of lease related issues that you truly only expect to see once every 5/10/15 properties. But, this week, we had a “perfect storm” – one property that had so many of these one off type issues.

This was a power center with two smaller specialty centers actually incorporated into the center, giving almost the feel of a lifestyle center. When the property was originally developed, the parcel for one of the two specialty centers was sold off and developed by another owner. They did a beautiful job on this 40,000 sf portion of the entire development. One of the big issues was that there is not an REA/OEA for the entire development. Therefore, the restrictions that apply to the balance of the center – exclusives, prohibited use, signage, height – do not apply to that center. Which makes the opposite true as well. Any time a property is going to be operated as one integrated center, there really needs to be an overall declaration.

One tenant at the center had co-participation language. They were only required to pay taxes if 90% of the other tenants were similarly obligated. You might imagine that we immediately had to focus on that particular lease’s definition of the shopping center. It was an “as reflected on Exhibit A,” with the Exhibit reflecting the entire development, including the separately developed center which the master landlord had absolutely no control over.

Then, there were two absolute minimum denominators. We had talked about this over the last couple of weeks. The denominator for prorata shares could never be less than xxx,xxx sf. However, a few portions of the development, including the separate center, were separately maintained. And, a few more parts of the center were being sold off (to realize some immediate value).

These were just a few of those big ticket lease clauses (or documents in the case of the Declaration) that exist at this particular property. While it is very easy to focus on the particular lease that you are working on/negotiating at the moment, it is critical that we take a holistic approach – looking at the property (and even in some cases, the entire portfolio) as a whole.

Why might it go beyond the property? It is a great topic for another week. However, one really quick example. Another client put a small grocery anchored center under contract this week. What makes this small acquisition unique is that it is immediately adjacent to another of their own centers. The first item we tackled was not a lease on the new acquisition, but the list of restrictions and exclusives on the existing center, and whether there might be landlord radius restrictions. (While radius restrictions exclude “then-existing” more often than not, there are those that are the exception.)

Bottom line, there are consequences/impacts to every change made to a lease – often going beyond that single landlord/tenant relationship.

building vs. Building

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No. It’s not a fight in the ring between two skyscrapers. It’s one of those capitalized/non-capitalized issues that can have a material impact on the cash flow of a property.

Though many tenants may beg to differ, the majority of landlords do actually consider the financial health of their tenants. I cannot tell you the number of times that I have heard “We did not bill that because the tenants do not have the ability to absorb it.” Specific inclusions in CAM or taxes, or, in a few cases, even a CPI increase on a minimum rent charge (this did happen multiple times during the last and previous recessions). For their own long term financial health, landlords want their tenants to succeed and often make decisions toward that goal.

There is also this “conscience” thing that landlords have. And, every organization has one – the vast majority are good. But, there have been a handful… One of the most obvious, recurring examples of the landlord conscience relates to management fees as part of CAM. Not admin fees, but management fees. Back when most mall leases were still on prorata CAM, landlords were starting to include management fees in the definition of CAM expenses. Not all were billing them, but they were including them in defined expenses. However, it had always been much more common for management fees to be included in CAM expenses for open air centers – many times specifically called out, and other times grouped together as the “cost of managing, repairing, replacing, maintaining, operating,…” the common areas or shopping centers. But where that conscience has kicked in is when management fees have actually been permitted to be and have been billed through CAM, it is not uncommon for a landlord to exclude those fees when calculating the required admin fee.

I know. I know. My tenant brethren are up in arms. You can’t have both. Actually, if the lease is negotiated with both, you can absolutely have both. We all have to live with (and properly administer) the terms of an executed lease.

In any event, back to the building vs. Building conscience and the ultimate financial ramifications. The past week, we worked on an open air center that had two distinct sets of prorata CAM requirements. The tenants were to pay a prorata share of “Center” expenses and a prorata share of “Building” expenses, with the sole difference between the two being a freestanding, self-maintaing, self-insuring, separately assessed supermarket. For example purposes, we  will say the denominator for Center expenses is 125,000 sf with the supermarket and 55,000 sf for Building expenses. Personally, I liked the set up and the clarity of the definitions.

However, where the issue came up was that the 55,000 sf of Building square footage was actually two separate buildings (notice the lower case “b”) – for example purposes, one 30,000 sf and one 25,000 sf. There was a significant repair (truly a repair, not a capitalizable expense) of $100,000 to the 30,000 sf building. And here is where the conscience kicked in. The landlord billed the expense only to the tenants in the 30,000 sf building where the expense actually applied, but used the lease required Building denominator of 55,000 sf. This caused the landlord to absorb a full 46%, or, in our example, $46,000 of this expense.

You can understand the conscience issue here – bill it only to those affected. But, to truly and properly reflect the expense, the amount should have been allocated over just the 30,000 sf in the building (again, lower case “b”), but the landlord did not have that option.

Surely, the landlord would have done the same if another expense been on the 25,000 sf building – once again causing material absorption, in that case of 55% of the expense.

While they tried to do the “right” thing, they really hurt themselves and had set themselves up for future failure. The proper direction was (and is) to administer the leases in accordance with the terms of the respective leases – specifically as negotiated. It eliminates any question whatsoever with how to administer the leases.

One final thought. Had this been a recurring annual expense administered “in good conscience” rather than as required by the lease, that $46k that was absorbed would equate to well over $500k in value.

As we have discussed many times, it is imperative to understand the value of a change proposed to a lease before agreeing to it. Once executed, both parties must live with the outcome.

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