Excluded areas – reducing or eliminating absorption
April 9, 2017
For purposes of prorata shares, leases will often define excluded areas as greater than some specified square footage. 「The tenant will pay a prorata share of real estate taxes based upon the leasable area of the center excluding premises (or occupants) greater than 25,000 square feet.」 You will see language like this in almost all regional malls and in many open air centers. Those areas that are excluded typically pay less than a full prorate share – whether it is taxes, CAM or insurance. By excluding them from the denominator, the landlord is able to reduce their own absorption of the shortfall and collect that shortfall from the other tenants in the center.
If you have a 1,000,000 square foot center and $1m in taxes, if the center was fully occupied and all tenants paid a full prorata share based upon the leasable area of the center, all tenants would be paying $1.00/sf. But imagine, as it typical, you have an anchor paying less than a full prorata share. A 200,000 square foot tenant is paying a fixed $.50/sf. In that case, we would have the balance of the center, 800,000 sf, paying $1.00/sf, and the anchor paying $100,000. Instead of having collected $1,000,000 from our tenants, we would have collected $900,000 (800,000 x $1.00 plus 200,000 x $.50). We as the landlord would absorb $100,000 not collected from the tenants. At a 7.5% cap rate, the $100,000 absorption costs us $1,333,333 in value ($100,000/.075). So, recognizing that not all tenants will pay a full prorate share, the landlord writes its standard lease to exclude premises (or occupants) greater than xx,xxx square feet.
With that type of language, the landlord then takes the $1,000,000 in takes, deducts the contribution from the anchor ($100,000) and allocates the net taxes ($900,000) over 800,000 square feet (the 1,000,000 square foot center less the 200,000 square foot anchor). The remaining tenants then pay $1.125/sf for their share of taxes ($900,000/800,000 sf). The landlord has then collected the full $1m in taxes (800,000 x $1.125 plus 200,000 x $.50/sf). No absorption. No $1,333,333 reduction in value.
This week’s blog was originally going to go down a path of excluding 「premises greater than 25,000 square feet」 vs. excluding 「occupants greater than 25,000 square feet,」 but that was a lot to hit for a short blog. But, imagine the 200,000 sf anchor in the above example closes. Use the comment section to take a shot at what happens to absorption and value if the lease reads occupant vs. premises. One word can be worth a lot!