Poof! A $40M Value Swing Because of Lease Language

In prior posts, we have addressed why there are excluded areas defined for purposes of calculating prorata shares of taxes or CAM. In a nutshell, if a part of a property is not paying a full prorata share of expenses, any shortfall has to be absorbed by the landlord. For example, we have a fully occupied 1,000,000 regional mall with $1,000,000 in taxes. If everyone paid their full prorata share, all tenants would pay $1.00/sf. However, if a 100,000 sf anchor was not required to pay taxes, the landlord would absorb $100,000. However, if we define that anchor as an excluded area, the other tenants would pay $1,000,000/900,000 sf, or $1.11/sf. Then the landlord would have no absorption – we would have collected the full $1m.

This past week, we unfortunately had to deal with a property where the leases were not optimally structured/worded. A one level quasi-regional mall/entertainment center had a group of tenants with upper levels. The leases were worded in a way that the tenants paid additional charges on only the main level of their premises. In one case, the tenant had nearly 11,000 sf total, but only 1,000 sf on the main level. The tenant was required to pay additional charges on only the 1,000 sf. Therefore, unless the other leases were worded properly, the landlord would have to absorb the additional charges on the 10,000 sf.

Ideally, the other leases would have read that the tenants pay a prorate share of the additional expenses based upon the ground floor area of the center. This would have excluded any square footage above or below the ground floor from the denominator. This language did not exist. It could have read “excluding square footage above or below the main level” which would have included the square footage to begin with, but then defined that area to be excluded. The leases did not contain this language. The leases could have excluded “any tenant not paying a full prorate share” of additional expenses, but they did not.

Therefore, for the most part, the landlord is absorbing additional expenses on this upper level square footage. Prospectively, we may be able to use the “any premises not fronting on the enclosed mall” exclusion that exists in most of the leases by having two separate leases for the tenants with multiple levels – then we would have one premises fronting on the enclosed mall and another premises not fronting on the enclosed mall.

Why even bother with this? The total upper level square footage at the property is about 70,000 sf. Total additional expenses per square foot are nearly $40.00. That is currently $2.8m of absorption per year. Apply a 7% cap rate to that – that is $40m in value. Seriously, $40m in value! For lack of better lease language!

Think about the big picture when you are considering your lease language!

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