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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.

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

A few more issues related to excluded area contributions

January 27, 2019

Last week we addressed a few of the issues to consider related to excluded area contributions, but two properties that we worked on this week made me realize I missed discussing two very significant issues – refunds/credits and recaptures as they relate to excluded area tenants.

At one of the properties, an excluded area tenant audited its CAM and tax charges for several years. While the landlord had tried to bill everything in accordance with the terms of the leases, the tenant was entitled to credits of just over $75,000. While painful to issue such a significant credit, since the credit was issued to an excluded area tenant, this actually should have triggered other adjustments. Every tenant in the center with a lease that defined that particular tenant as an excluded area had previously had its CAM and taxes calculated based upon the original contributions. As the credits were issued reducing those contributions, the other tenants were underbilled.

Often, it is impractical to go back to bill the other tenants for their respective share of what may have been $25,000 per year for three years. The typical application of this would be to apply the credit in the ensuing year, without applying the same credit to those tenants who were not there in the years the credits applied.

(This is a bit more advanced, so skip it if you need to. The method just addressed may have a negative impact if some of the tenants have caps that would be affected by a material reduction in any given year. In that case, even though it would be an administrative burden, it would be best to go year by year so as not to set the caps artificially low for any given year.)

The second property had a standard lease for that specifically addressed deducting contributions from majors (definition varied tenant to tenant) where the major did not have the right to “recapture” the contribution against other charges. I will do a blog in the future to specifically address recaptures. But briefly, some tenants (typically majors or the most desired tenants) have requirements to pay a share of CAM or taxes, but then have a right to offset these payments against percentage rent or some other charge. As an example, if a tenant was required to pay $100,000 in taxes, but had $65,000 in percentage rent due, and then tenant was allowed to offset taxes paid against percentage rent, then, with this clause in a lease, instead of a $100,000 contribution from the excluded area tenant reducing allocable taxes, the contribution used would be $35,000 ($100,000 paid less $65,000 “recaptured”).

We usually see tenants granted recapture language perhaps one time out of every three to four retail properties (so maybe .5-1% of leases). In this case, while the standard lease does address recapture language, none of the current majors have recapture rights (we haven’t completed the outparcels which could potentially have recapture rights). Therefore, at this property, it may not even apply.

These two issues are a little more convoluted. Feel free to comment if you have any specific issues needing clarification.

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

Excluded area contributions

January 20, 2019

When a tenant pays a prorata share of taxes or CAM, there are often defined excluded areas. Most typically, those defined excluded areas are either directly assessed, self-maintaining or insured, or are paying at a rate significantly less than full prorata. By defining those areas as “excluded areas,” the landlord reduces it absorption of CAM or taxes not paid by those areas. And, again, most typically, the contributions made by those defined excluded areas are deducted from the total allocable expenses prior to calculating the specific tenant’s share of CAM or taxes.

Most typically.

However, there are instances where a lease will read “without deducting contributions from excluded areas” (this is most often seen in the northeast part of the country and Florida). This specific language allows the rare “double dip” by the landlord. It happens infrequently but it does happen.

Occasionally, we’ll see the opposite. Where the previous example includes very specific language that does state “without deducting,” the opposite is often an error. A lease will read something to the effect of “after deducting contributions from Majors,” but the lease does not allow the same Majors’ square footage to de excluded from the denominator. This gives opportunity for the rare “double dip” by the tenant.

One not uncommon issue is where a lease requires Majors or some other defined excluded excluded area to be excluded from the denominator, but subject to a cap on how much square footage may be deducted, or to some certain number of tenants that may be considered excluded areas. For example, a lease may read that “the denominator used to allocate CAM shall be the Gross Leasable Area of the center excluding any tenant greater than 15,000 sf. However, in no event shall the denominator ever be less than 200,000 sf.” In this scenario, if the denominator would have been 175,000 sf after deducting all excluded areas, the landlord would still be required to use 200,000 sf as the denominator. But often, the landlord would have deducted the contributions from all tenants that would have otherwise taken then down to 175,000 sf. In that particular (again, not so uncommon) instance, the landlord would have “overdeducted” contributions.

Our very insightful client recognized that, if not considered, the balance of the tenants would be getting a contribution from an anchor for taxes that they, themselves, were not required to pay.

Why this issue this week? We worked on a property this week where a portion of the property was subject to a material tax abatement. Two of the anchor tenants were required to pay taxes based upon what they would have been absent 50% or 75% of the abatement. So, in this instance, the two tenants were paying on taxes greater than total taxes billed. However, the balance of the tenants did not have the same requirement and were being billed based upon actual taxes. Our very insightful client recognized that, if not considered, the balance of the tenants would be getting a contribution from an anchor for taxes that they, themselves, were not required to pay.

While excluded area contributions are usually straightforward, this is clear evidence that they are not always so!

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