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CAM, tax and insurance reconciliations during due diligence

storage

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!

The “new” reality

Crystal-Ball

In 1995, there were approximately 1,800 regional malls in the US. At that time, ICSC (the International Council of Shopping Centers) published articles and held sessions at conferences addressing the then-current predictions that 25% of those regional malls would close, and there was a need to find alternative uses for regional malls. A few years earlier, at either the ICSC Spring Convention (now ReCon) or the Fall Management and Marketing Conference, one of the speakers (I believe it was Dr. Peter Linneman) made the statement that the regional mall development business (and to a certain extent even the open air shopping center development business) was a one generation business – the generation of Herb and Mel Simon, Ernest Hahn, Eddie DeBartolo Sr., the Bucksbaums, Henry Faison, Leo Eisenberg, Mal Riley, Norm Kranzdorf and so many others who made their names and fortunes (and sometimes lost and made them again).

That was 23 years ago, and there was already discussion of alternative uses for regional malls and vacant department stores. Last week, I read a story that another traditional regional mall would never be built in the US. “Never” is a mighty long time. But, as those 23 year old stories prove, this is not “breaking news.” The industry has been expecting this, and has been preparing for this, for over 20 years (it may actually be pushing 30 years as articles about “de-malling” and converting department stores to data center and other uses started appearing in the late 1980s).

Today, depending upon how you classify them, we have somewhere between 1,200 and 1,300 regional malls. Just about 25% of those 1995-era 1,800 malls no longer with us in their original form. And, today, the experts predict that 25% of today’s population of regional malls will no longer exist over the next 10+ years. But, really, while some will go away completely, most will continue to exist, just in an evolved format.

The ICSC and the leaders in this industry have had their eyes wide open for years. Leasing, asset management, development and the other disciplines have been adapting their long term plans, changing lease language, anticipating and planning for what the future will bring. It is because they are the ones bringing the future. The mall and open air shopping center development business may have been a one generation business, but that next generation of David Simons and Stephen Lebovitzes and their contemporaries are finding and creating even more value in the evolution of regional malls and open air centers.

Maintaining and enhancing value has always been what our industry is about. It may look a little bit different, but that is the future of the industry too!

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 –

https://www.icsc.org/news-and-views/icsc-exchange/tenants-should-include-more-internet-returns-in-reported-sales-simon-says

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.

The “backdoored” exclusive

sneakytom

Exclusives, kickouts and cotenancies are typically the big three non-financial covenants that have to be confirmed on an acquisition because, along with the cash flow of the property, they have such an impact on value.

More often than not, these provisions are fairly obvious in a lease, But, sometimes they are buried. This past week, we were working on a property that a new client had acquired. As you will sometimes see in leases, most of the standard leases at this property contained the exhaustive list of all restrictions and exclusives for all tenants at the property. In one particular lease, the tenant did not have an exclusive contained within the body of the lease. Had there not been a line by line review of the exhaustive exhibit containing all of the exclusives for the property, the tenant’s own exclusive might have been missed. It was a “backdoor” exclusive – not addressed in the body of the but added, not by special stipulation, but by inclusion in that exhibit.

Sneaky? Yes. But the tenant got its exclusive. Fortunately, while our client was not previously aware of the exclusive, they had not unintentionally violated it.

There’s another clause you will sometimes see in a lease – “heading and captions.” In essence, it says that the headings and captions within the lease may not always properly address what’s in the clause. It’s there for a reason. There’s always something hidden in leases!

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