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“…if the end of the world is imminent …”

Yes. This language exists in some leases. The language typically states that if the end of the world is imminent, the landlord has the right to accelerate rents for the remainder of the term.

There are still a few hours left to check your leases for this language before the eclipse arrives today.

Happy eclipse viewing today. And, good luck trying to collect with that clause!

We will be back to a regular lease administration post next week. Today, I am in Tennessee to see the eclipse!

Don’t overcomplicate the lease language

Every few weeks, someone in the office will let out a scream of frustration. The frustration comes from reading lease language that is so involved, but could have been accomplished with incredibly simple lease language.

For example, it is fairly common to see Consumer Price Index (CPI) increases applied to rents, or used as caps for certain reimbursable expenses in a lease. Applying a CPI increase is fairly simple and straightforward, but there are hundreds of variations of the CPI – for all Urban Consumers (CPI-U); for Urban Wage Earners and Clerical Workers and Wage Earners (CPI-W); either one of the using a 1982-84=100 base or a 1967=100 base, or even a 1957=100 base; any one of those for a specific city; any one of those for specific items, or excluding specific items. Along with those increases, it is common to have a negotiated cap on the increase – say 3%. Often, that cap is negotiated to be non-cumulative rather than cumulative. Sometimes there is language that states if the increase is greater than the cap in any given year, the amount over the cap can be carried forward to a future year when the increase is less than the cap. Sometimes, there are minimum increases applied in addition to the cap.

So, if you find yourself writing or negotiating a lease clause where

「the tenant pays a prorate share of CAM based upon the leased area of the shopping center, calculated on a weighted average basis, excluding major tenants greater than 25,000 sf and any tenant above or below ground level, where controllable costs are capped by 5% per year with any excess being carried forward to a future year, and where the first year CAM costs (including both controllable and uncontrollable costs) are capped at $2.00/sf, with the overall cap being increased by the CPI-W, 82-84=100 for New York, with a maximum increase of 3.5% and a minimum increase of 2.5%, also giving the tenant the right to audit CAM」

Do yourself (and your lease administration, lease accounting, asset management, billings and collections staff) a favor, and just simplify it to:

Tenant shall pay $2.00/sf for CAM, increased by 3% each 1/1 starting 1/1/18.

Think about what you are really trying to accomplish, and keep it as simple as possible.

Negotiate your leases wisely!

In any given year, we (my company, Meridian Realty Consultants) will read and abstract 8-10,000 leases. We get to see what landlords and tenants spend their time negotiating. It is not uncommon for someone in the office to say, 「Can you believe someone took the time to negotiate this?」 It might be something as simple as a tenant negotiating that common area maintenance expenses shall not include the cost of improvements to the leasable area of another tenant.

Why would we make that statement? Because excluding tenant improvements from CAM is a 「given.」 I am not saying it has never happened, but landlords do not include tenant improvement costs in CAM. Therefore, spending time negotiating that 「exclusion」 is a waste of time. It was going to have been excluded regardless of whether than negotiated language was included in the lease. It is amazing how many of these worthless (seriously) exclusions are negotiated. Is it really necessary to negotiate that the landlord shall not include in CAM a charge that has been recovered elsewhere in the lease? No. Again, it is a given.

At the same time, lease language that has a really material impact on expenses often is not as highly negotiated.

What has the single greatest impact on a tenant’s expenses? Is it the inclusion of roof repairs? Is it the inclusion of capital repairs or replacements? Is it the inclusion of seasonal décor? While they all impact a tenant’s rate, it is the METHOD used to bill CAM or taxes that has the most significant impact. If we have a 1,000,000 shopping center with four 200,000 sf anchor tenants each paying $2.00/sf for CAM and $5,000,000 in expenses, a tenant required to pay operating expenses based upon the leasable area of the shopping center would pay $5.00/sf ($5,000,000/1,000,000), while a tenant required to pay based upon the leasable area excluding anchors would pay $17.00/sf ($5,000,000 – $1,600,000 (4 anchors x 200,000 sf x $2.00/sf))/200,000 sf (1,000,000 sf – 4 anchors x 200,000 sf).

As we continue to show in out weekly review of lease language, it is imperative to understand how lease language and changes in lease language impact the cash flow from a property. So, if you are going to negotiate the lease language, spend the time negotiating language that will materially impact the cash flow.

“… the breakpoint shall likewise be abated…”

“… the breakpoint shall likewise be abated…”

This clause is almost a throwaway clause – one landlords and tenants give much consideration to – and it is the majority of retail leases.

So, what does it mean? If the tenant is struggling, and the landlord agrees to reduce minimum rent by 50%, then the 「breakpoint shall likewise be abated.」 To keep things simple, assume a tenant pays $100,000 per year in minimum rent and 10% of sales over a natural breakpoint ($100,000/10% = $1,000,000). If the landlord reduces minimum rent by 50% and 「the breakpoint is likewise abated,」 the tenant pays $50,000 in minimum rent and 10% of sales over $500,000. The intent is almost to ensure that the landlord doesn’t give too much.

But, its true impact is not always considered. Let’s consider a tenant with a lease commencing 10/1/17. They have the same $100,000 minimum rent and 10% of sales over the $1,000,000. They pay percentage rent on a 12/31 lease year end (including the true partial lease year*** ending 12/31/17). Now, let’s assume that in lieu of a tenant improvement allowance, the landlord gives a three month rent abatement. So, for October-December, 2017, the tenant pays no minimum rent. If that innocuous little statement (「the breakpoint shall likewise be abated」), the tenant is the required to pay 10% of sales over a 「likewise abated」 breakpoint, or $0. Therefore, the tenant pays 10% of all sales for 10/1-12/31/17.

The tenant was expecting essentially a $25,000 allowance as a three month rent abatement, but, it is possible, they actually got nothing because they end up paying the full amount in percentage rent.

This comes into play anytime there is a reduction is rent – a pure rent abatement, an abatement for a tenant improvement allowance, ant type of rent concession, alternate rent due to a cotenancy failure, alternate rent due to an exclusive violation and so on. Therefore, it is critical to understand this little bit of throwaway language and how it may impact a tenant’s percentage rent requirements.

*** – See a previous post on true partial lease years.

Office leases – Are taxes part of operating expenses?

The short answer? The lease should specifically address whether taxes are reconciled as part of operating expenses or are reconciled separately. But, why should this matter?

This week, we were working on an office tower acquisition in the southeast. The majority of the leases had the typical 「tenant pays a proportionate share in excess of the base year」 language. Both Operating Expenses and Real Estate Taxes (both capitalized) were defined very well by the leases. However, this was a situation where the leases were poorly written and rather than addressing a year end reconciliation of Operating Expenses as well as a year end reconciliation of Rea Estate Taxes, the leases addressed a reconciliation of Operating Expenses and Real Estate Taxes – so addressed only one time instead of two separate times.

The leases read, 「The tenant will pay its proportionate share of current year Operating Expenses and Real Estate Taxes over Base Year Operating Expenses and Real Estate Taxes.」 What made the scenario critical was that current year Operating Expenses were much higher than Base Year Operating Expenses, while current year Real Estate Taxes were much lower than Base Year Real Estate Taxes. Reconcile separately, the landlord bills excess for Operating Expenses and gets nothing for Real Estate Taxes. Reconcile together and the landlord leaves money on the table.

Take the following simple example:

  • Tenant’s proportionate share – 10%
  • Base Year Operating Expenses – $1,000,000
  • Base Year Real Estate Taxes – $1,000,000
  • Current Year Operating Expenses – $1,100,000
  • Current Year Real Estate Taxes – $900,000

combined

As you can see, there can be a real difference between reconciling together or separately. In the case of the acquisition, considering this scenario affected a number of tenants and has a material impact on cash flow, our client has requested that the seller obtain letter agreements from the tenants clarifying that the charges are reconciled separately. If the seller fails to obtain the letter agreements, cash flow for purposes of the purchase price will be reduced to reflect a combined reconciliation rather than two separate reconciliations.

Another example of somewhat innocuous lease language affecting the cash flow and value of a property.

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