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Excluding tenants vs. excluding premises

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.

shuffle

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.

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