January 6, 2018
I grew up using the expression “same difference.” I think I used it when I said something that I believed was right, but someone pointed out something that was wrong about what I said – but it wasn’t important enough for me to care. I think today I would probably just say “whatever.”
There are a couple of things we came across this week that would surely generate a “same difference” response, but there are subtle differences that would generate different results. One is related to blending breakpoints for percentage rent and the other relates to the calculation of CPI (Consumer Price Index) increases (a measure of inflation).
When rents and percentage rent breakpoints changes during a lease year, you must “blend” them to determine what the breakpoint is for the current lease year. For example, the tenant’s pays 10% of sales over the breakpoint for the lease year ending 12/31. If the tenant’s breakpoint is $1,000,000 through 6/30/17 and then $1,200,000 effective 7/1/17, you would have to blend the two to determine the breakpoint for the lease year ending 12/31/17. In a “same difference” kind of way, the lease might require the breakpoint to be blended using number of months or number of days. In a months calculation, the breakpoint would be $1,100,000 ($1,000,000 x 6/12 + $1,200,000 x 6/12). In a days calculation, it would be $1,100,821.92 ($1,000,000 x 181/365 + $1,200,000 x 184/365). The difference is small – $821.92 – and would result in a smaller impact to cash flow ($82.19 in percentage rent – $821.92 x 10%), but it is real and is mandated under the lease. The days calculation would have been different in the event of a lease year (using 182/366 + 184/366). There would also be additional considerations in the event of a mid-month increase to rents and breakpoints (could be full months and then days during the month of increase. In certain cases, the month of increase could be the actual number of days in the month, while in others, days may be defined as 30).
The other item that might generate a “same difference” is which months’ CPI indices to use when calculating the increase in the CPI. Let’s say a lease commences on 9/1/17. Depending upon the wording of the lease language, if the lease states that a charge is to be increased each 1/1 by the increase in the index from commencement, there are a wide variety of indices that could be used. To start, if the lease says the base index is “for” the month of commencement, then we would use 9/17 as the base index. If the lease states that the index is published during the month of commencement, we would us 8/17 as the index, as the indices are published around the 15th of each month, and August would have been published around 9/15/17. Finally, if the lease states the base index is the index “at” commencement, we would use 7/17, as the last index would have been published around 8/15/17 would have been for July. These same subtleties exist for the current month to be used.
While for the most part, the variances created are immaterial, calculation must be performed in accordance with the lease. And, actually, sometimes they really do add up. We once worked on a 200,000 sf office lease that had a twenty year term. There was a two month swing in the base CPI and a two month swing in the current CPI to be used each year. That variance over the twenty year period was a little more than $300k.
All these seemingly irrelevant changes in lease language can add up to have a material impact on cash flow and value!