Who Pays When Operating Expenses Increase?
Expense escalations are relevant when the landlord is paying a base level of expenses and when the tenant is paying expenses. With a typical gross lease, the landlord pays all expenses and the tenant pays expenses in excess of a base level. (Gross leases are atypical for retail.) The base level is typically the operating expenses for the year the lease is signed. The "expense escalations", would be expenses in excess of this base level which the tenant is responsible for paying.
Caps on Increases?
Some leases also provide a cap on increases in expenses. To provide more certainty for the tenant's cost of occupancy, the tenant may request that property tax increases do not exceed 5% in any year. Property tax increases can be enormous in some states. For example, initial property tax assessments in Texas for retail buildings have increased by 20% to 100% for many retail building owners. In many cases, these large initial assessments have been successfully reduced to a level much closer to the prior year's value.
Cap Example
However, the property tax assessment process can be arbitrary at times. If the property taxes did increase by 20% or 100%, the landlord would be responsible for the increase in excess of 5% for the example given. There are also sometimes expense escalation caps for utilities, insurance, total expenses and other items.
Co-tenancy Termination Clause
A co-tenancy clause for retail defines a tenant's right to terminate the lease if another tenant ceases operations. For example, consider a grocery anchored neighborhood shopping center. Let's assume Kroger's, a nationally known grocery retailer, is the anchor. Bob's dry cleaner store decides to lease space in the center because it believes the Kroger versus will draw all a large volume of traffic. There's an agreement to pay rent commensurate with the traffic which should be generated by Kroger. However, five years after the center is built Kroger decides to "go dark".
Can You Terminate the Lease?
In other words, it ceases operations at this location. A co-tenancy clause would provide Bob an option to terminate his lease. There will typically be a defined period for terminating the lease based upon the co-tenancy clause.
Eminent Domain
Eminent domain is the right of government to take private property. Historically, eminent domain was limited to taking private property for public purposes. However, the US Supreme Court expanded eminent domain to include taking private property for private uses. In most cases, property owners are compensated for "takings" through eminent domain.
Eminent Domain Issues
Issues related to leasing retail space include who retains compensation for a leasehold estate, what happens if eminent domain takes an amount of parking which makes operation of the Senate set retail center impractical and are there any rent abatements during construction related to a partial taking of the retail center.
Leasehold Estate
A leasehold estate is a tenant's interest in real estate obtained through a lease. A leasehold estate becomes meaningful when contract rent is substantially lower than market rent. Having the right to use retail space for a payment well below market rent has value. In the event of a complete taking up (when the government takes the entire retail center) the lease needs to address proceeds of the tenant's leasehold estate. Do they belong to the tenant or to the landlord?
Partial Taking
In any "partial taking", the government only takes a portion of the retail center. This may or may not include any portion of the building. For the sake of discussion, let's assume a retail center with 10,000 ft. and 50 parking spaces. The 50 parking spaces are in two rows of 25. One row is along the street and one row is along the front of the building. The current amount of parking is just barely adequate. The condemnation will "take" the 25 parking spaces along the street. This leaves the property with only 25 parking spaces, or about half of what is necessary. The lease needs to define the rights and responsibilities of both the tenant and the landlord in event of a partial taking.
Pay Rent During Road Construction?
Consider addressing the payment of rent during road construction related to eminent domain. Most leases are silent on this point. In many cases, the loss of business due to construction is not compensated. The landlord must pay his expenses and mortgage payment during construction. The tenant's sales often decline precipitously during construction. There is no easy answer to equitably address this issue.
The Market Research and Consulting division of O'Connor & Associates provides information necessary to make decision to commercial real estate professionals. Occupancy and Rental Data, ownership and management information are routinely gathered for four major land uses multifamily, office, retail and industrial. This information allows investors to compare competitive properties, facilitate business decisions and track market and submarket performance.
Showing posts with label Retail. Show all posts
Showing posts with label Retail. Show all posts
Saturday, August 25, 2012
Tuesday, June 26, 2012
Leasing Retail Space - Foreclosures And Lease Cancellations
In Event of Foreclosure
Foreclosure of a mortgage typically extinguishes all claims to the property. In other words, if you've negotiated a lease and started a business, your right to use the retail space is terminated by foreclosure unless there is a separate agreement.
Will Lender Cancel?
In many cases, the lender has a defined period of time to reject leases or they are assumed to remain intact. Further, lenders often want to retain the leases and tenants to make the property more salable. However, if the rental rate for a lease is well below market rent, and the tenant is clearly successful, the lender would likely terminate the lease and require the tenant to negotiate a new lease at market rent.
Negotiating From a Position of Weakness
The tenants negotiating position is much weaker than it was when he first negotiated the lease. The tenant has a successful business at this location. Changing the location of the business may damage or destroy the business. The tenant's ability to bargain and negotiate lease terms is a weak.
Nondisturbance Clause
Tenants can avoid this dilemma by obtaining an agreement that the lease will not be terminated by foreclosure. This is termed a nondisturbance clause. Landlords are reluctant to grant this concession due to the limitation it imposes on the landlord when obtaining financing.
Maintenance Standards
The definition of maintenance standards is often vague. A typical clause may read that "the landlord will maintain the property in a manner consistent with local practice and a prudent owner".
Personal Guarantees
Landlords love personal guarantees since they substantially limit the tenant's ability to abandon operations at the retail space. Personal guarantees should be avoided by tenants whenever possible. It is reasonable that the tenant repay the unamortized portion of any tenant improvements and leasing commissions if the lease is terminated early. Further, it is reasonable for a tenant to guarantee a minimal level of performance on a building built to its specifications.
Different Rules for Second Generation Space?
However, for second-generation lease space, it is reasonable to request that the tenant not be personally or corporately responsible beyond paying the unamortized portion of tenant improvements and leasing commissions. Although this is reasonable, it may not be possible. The strength of the local rental market and local practice will dictate whether landlords can extract personal guarantees from tenants.
Purchase Option
For single tenant retail buildings, tenants often want a right to purchase the building at a predetermined price. Landlords prefer to avoid this. A compromise is providing the tenant a first right of refusal.
Sublease Issues
Landlords want the tenant to make rental payments throughout the lease term, but don't want the tenant to profit from subleasing the retail space. In some cases, the tenant has the right to sublease the space subject to the landlord's approval. There's often a clause that the landlord's approval shall not be withheld unreasonably. There's also often a clause limiting the types of businesses which can sublease from the tenant. Sublease payments in excess of payments on the primary lease can be an intensely negotiated item.
Minimum Hours of Operation
Some retail centers require fixed hours of operations for each tenant. The concept is great. If a shopper visits the mall, they know each store will be open from 9 a.m. until 9 p.m. (or whatever the hours of operation). However, assume you expect to get 90% of your business between 12 p.m. and 5 p.m. In some cases, the minimal hours of operations are nonnegotiable. You may need to consider the excess hours of operations part of your occupancy cost.
Dedicated Parking
Dedicated parking is another issue where interests almost always diverge. Tenants love to have parking dedicated to their customers and landlords hate having parking dedicated to any one store. Peak traffic for a store may occur in a short period of time. However, the parking spaces are typically dedicated 24 hours per day. A compromise is the right to put portable signs in front of parking spaces several hours per day consistent with the tenant's peak hours of business.
Expansion Options and First Right of Refusal
Expansion rights and first rights of refusal are less typical for retail than for office. However, assume you are opening a small restaurant in a highly vacant shopping center. You're initially taking 1000 square feet of space but hope to expand the restaurant to five or 10,000 square feet of space. Having the right to take additional space at a previously agreed-upon rental rate and to claim additional space through a first right of refusal can be invaluable. Once the restaurant is successful, negotiating rental rates at a favorable level will be difficult.
Example
For example, assume your restaurant has been operating successfully for two years and you expect to expand the restaurant during the next 12 months. Unfortunately, your landlord tells you he just leased the spaces on either side of you. A first right of refusal for additional space can allow you to avoid this problem. Consider whether the rental rate for the first right of refusal is the rate agreed upon by the landlord and the new tenant or a predetermined rate.
The Market Research and Consulting division of O'Connor & Associates provides information necessary to make decision to commercial real estate professionals. Occupancy and Rental Data, ownership and management information are routinely gathered for four major land uses multifamily, office, retail and industrial. This information allows investors to compare competitive properties, facilitate business decisions and track market and submarket performance.
Foreclosure of a mortgage typically extinguishes all claims to the property. In other words, if you've negotiated a lease and started a business, your right to use the retail space is terminated by foreclosure unless there is a separate agreement.
Will Lender Cancel?
In many cases, the lender has a defined period of time to reject leases or they are assumed to remain intact. Further, lenders often want to retain the leases and tenants to make the property more salable. However, if the rental rate for a lease is well below market rent, and the tenant is clearly successful, the lender would likely terminate the lease and require the tenant to negotiate a new lease at market rent.
Negotiating From a Position of Weakness
The tenants negotiating position is much weaker than it was when he first negotiated the lease. The tenant has a successful business at this location. Changing the location of the business may damage or destroy the business. The tenant's ability to bargain and negotiate lease terms is a weak.
Nondisturbance Clause
Tenants can avoid this dilemma by obtaining an agreement that the lease will not be terminated by foreclosure. This is termed a nondisturbance clause. Landlords are reluctant to grant this concession due to the limitation it imposes on the landlord when obtaining financing.
Maintenance Standards
The definition of maintenance standards is often vague. A typical clause may read that "the landlord will maintain the property in a manner consistent with local practice and a prudent owner".
Personal Guarantees
Landlords love personal guarantees since they substantially limit the tenant's ability to abandon operations at the retail space. Personal guarantees should be avoided by tenants whenever possible. It is reasonable that the tenant repay the unamortized portion of any tenant improvements and leasing commissions if the lease is terminated early. Further, it is reasonable for a tenant to guarantee a minimal level of performance on a building built to its specifications.
Different Rules for Second Generation Space?
However, for second-generation lease space, it is reasonable to request that the tenant not be personally or corporately responsible beyond paying the unamortized portion of tenant improvements and leasing commissions. Although this is reasonable, it may not be possible. The strength of the local rental market and local practice will dictate whether landlords can extract personal guarantees from tenants.
Purchase Option
For single tenant retail buildings, tenants often want a right to purchase the building at a predetermined price. Landlords prefer to avoid this. A compromise is providing the tenant a first right of refusal.
Sublease Issues
Landlords want the tenant to make rental payments throughout the lease term, but don't want the tenant to profit from subleasing the retail space. In some cases, the tenant has the right to sublease the space subject to the landlord's approval. There's often a clause that the landlord's approval shall not be withheld unreasonably. There's also often a clause limiting the types of businesses which can sublease from the tenant. Sublease payments in excess of payments on the primary lease can be an intensely negotiated item.
Minimum Hours of Operation
Some retail centers require fixed hours of operations for each tenant. The concept is great. If a shopper visits the mall, they know each store will be open from 9 a.m. until 9 p.m. (or whatever the hours of operation). However, assume you expect to get 90% of your business between 12 p.m. and 5 p.m. In some cases, the minimal hours of operations are nonnegotiable. You may need to consider the excess hours of operations part of your occupancy cost.
Dedicated Parking
Dedicated parking is another issue where interests almost always diverge. Tenants love to have parking dedicated to their customers and landlords hate having parking dedicated to any one store. Peak traffic for a store may occur in a short period of time. However, the parking spaces are typically dedicated 24 hours per day. A compromise is the right to put portable signs in front of parking spaces several hours per day consistent with the tenant's peak hours of business.
Expansion Options and First Right of Refusal
Expansion rights and first rights of refusal are less typical for retail than for office. However, assume you are opening a small restaurant in a highly vacant shopping center. You're initially taking 1000 square feet of space but hope to expand the restaurant to five or 10,000 square feet of space. Having the right to take additional space at a previously agreed-upon rental rate and to claim additional space through a first right of refusal can be invaluable. Once the restaurant is successful, negotiating rental rates at a favorable level will be difficult.
Example
For example, assume your restaurant has been operating successfully for two years and you expect to expand the restaurant during the next 12 months. Unfortunately, your landlord tells you he just leased the spaces on either side of you. A first right of refusal for additional space can allow you to avoid this problem. Consider whether the rental rate for the first right of refusal is the rate agreed upon by the landlord and the new tenant or a predetermined rate.
The Market Research and Consulting division of O'Connor & Associates provides information necessary to make decision to commercial real estate professionals. Occupancy and Rental Data, ownership and management information are routinely gathered for four major land uses multifamily, office, retail and industrial. This information allows investors to compare competitive properties, facilitate business decisions and track market and submarket performance.
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