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Advanced Lease Negotiation: Changed Conditions Clause

2011-12-08T19:42:10Z

The leasing market today is tough, no questions about that. Both tenants and landlords continue to seek ways to achieve optimum value and position in lease negotiations. Tenants want to use the current market conditions to lock in favourable rates and lease terms. Landlords want to fill their properties and do so without handicapping the future value of their investment.

One technique I’ve used on behalf of landlords is the “Changed Conditions” clause. This clause recognizes a number of things; first of which is that all business is cyclical. The second is that the lease is executory in nature over the term, generally meaning that it is not fixed at a point in time when the negotiation occurs.

The essence of the Changed Conditions clause is that the rent paid by the tenant will adjust at the time of some pre-negotiated meaningful event. Your first instinct in reading that sentence is that this clause doesn’t work in today’s environment. In fact, tenants use the concept all the time under the name of a co-tenancy clause. Tenants want downside protection. The landlord wants upside protection. The Changed Conditions clause is the corollary to the co-tenancy clause.

The clause can be included in the master lease form or inserted on a case by case basis, such as when a tenant asks for a co-tenancy clause.

One of the keys to the success of the clause is to tie it to a realistic and meaningful event that is expected to occur. These events can include:

Renovation or rehab
Expansion of the property
Addition of a major or anchor tenant
A significant increase in the average sales of the property, indicating a stronger property
Attainment of LEED or other sustainable certification (this is particularly useful in office buildings)
Addition of infrastructure positively affecting the property, such as a major transit stop or road realignment
Or a combination of any or all of these.

There are specifics that need to be considered concerning each of the events noted and these should be included in the clause wording. Another consideration is the determination of what occurs to the rent when the event happens and the clause is triggered. In each of these, there are very specific business related tactics and concepts that should be included. I can assist you with those. However, since I am not a lawyer nor am I offering legal advice, you should consult with your legal advisors in crafting the concepts into the lease.

Naturally, tenants in a strong negotiating position will want to remove this clause. As in all clauses, the landlord must decide for themselves how to deal with the particulars of each negotiation. The objective however, is to negotiate terms based upon today’s reality – providing comfort to the tenant; but acknowledge that a significant event, such as those above, may occur and be beneficial to the tenant during the term of the lease.

Improving returns and value is what we do best. Contact me to learn how to transform your investment returns in retail real estate.

Greenstead Group LLC

pmorris@beyond-the-building.com

Improving Operating Returns for Retail Property Owners

2011-10-31T20:30:12Z

By: Peter D. Morris SCLS, SCSM, SCMD

It doesn’t take a business degree to know that to improve operating returns at the corporate or property level means revenues must increase, expenses must decrease or a combination of the two. Aside from the obvious question of occupancy, we’ll explore some other aspects to improving returns.

At the company/enterprise level removing waste, eliminating redundancy and cost containment are all common sense ways to add value. As is a serious review of the debt structure and financing options. Another avenue to explore is to examine the company’s sacred cows – policies and processes that have been implemented over time. Some may no longer be needed or the methodology may be outdated. Challenging the status quo may reveal hidden opportunities. For example, I once challenged the way our service was delivered to our clients and their tenants. The end result was a realignment of some staff duties that resulted in a 15% decrease in our cost of serving our accounts. As an added bonus quality went up because we now had specialists properly aligned.

The way leases are structured and the mechanics of them can also improve value. In the early 1980’s Cadillac Fairview, a leading mall developer and owner, instituted an across the board HVAC basic charge. It was a sinking fund established to pay for the replacement of roof top units, air handlers, central plant equipment, etc. The concept was drafted into the company’s standard lease form and used for all future new leases. There are many other items in the way a lease is structured that can have a positive impact on returns; such as how renewal options are treated, how the space is used and measured, and how amortization costs are handled. These are just a few areas of more than a dozen lease refinements I’ve developed over the years.

One of the biggest lifts in return and value is to change the way lease rates are determined. Many owners and leasing agents still rely on comparable analysis. This is a mistake. Rent should be a function of sales – not to be confused with the concept of percentage rent. Using sales as the method for determining base or minimum rent I was able to create an incomparable market and increase the average rent for real estate under my direction to 35% more than ‘comparable’ properties. There is a specific methodology to achieve this. It starts by understanding the market potential in the trade area served and relies on obtaining sales information from each tenant, even if they do not pay percentage rent.

There are a number of opportunities at the property level too. For example, I’ve developed and implemented over 20 different ancillary income streams at the property level. Some produced significant revenues while others did not; but collectively the effect was the same as adding two or three rentable store spaces to the property– without the infrastructure costs.

An area of additional income from retail properties is through creative densification. The land-mass for retail properties, is very large as compared to the vertical nature of office buildings. Much of this is dictated by parking ratios mandated in zoning requirements. The typical 5 stalls per thousand square feet of GLA has been in use for more than 40 years, yet the nature of retail has changed dramatically over the same time. In the 1970’s evening shopping was usually confined to one or two nights a week and virtually no one shopped on Sundays. That parking ratio may have made sense then but does it make sense with the expanded shopping patterns of today?

I convinced a municipal council to adopt a new micro stall designation to accommodate the new ultra small cars, such as the Smart car. Decreasing the average stall size allows for more stalls on the same piece of land. Even with the existing stall ratio, the increase in the number of stalls permits further development on the site. In another program I was able to increase the site densification that resulted in an $8 Million lift in the property value with no additional infrastructure cost.

On the expense side of the ledger there are many opportunities to reduce expenses. One that is not widely practiced but that can pay significant dividends is lean maintenance, a concept borrowed from lean manufacturing practices. In lean maintenance there is an understanding that some common maintenance practices have diminished value through the lifecycle of the physical plant. Correcting this is the same as reducing the waste that was inherent in older manufacturing processes.

Repositioning and remodelling can have a positive impact on the revenue and expense of a property. Curb appeal determines customer attraction and what tenants perceive as a desirable location. So I never advocate trimming expenses to the point of harming the impression of the property. This includes capital expenses. However, the timing of a remodeling program is critical to obtain the best returns. It is also important to conduct a complete cost benefit analysis and judicious value engineering. Sometimes, just as in theatrical staging some inexpensive changes can have a dramatic impact on the look and perception of a property allowing for better quality tenants, more sales and higher rent.

Improving returns and value is what we do. Contact me to learn how to transform your investment returns in retail real estate.

pmorris@beyond-the-building.com

Lease Accounting Update October 2011

2011-10-28T22:25:25Z

The Financial Accounting Standards Board, FASB, and the International Accounting Standards Board, IASB, have signaled a modification to their approach on lease accounting rules for investment property owners/lessors. The Boards decided that a lessor of investment property would not be required to apply the proposed residual and receivable approach outlined in the initial Exposure Draft, if the lessor measures its investment properties at fair value by electing the fair value model under IAS 40, Investment Property.

This gives many real estate lessors the opportunity to continue to use operating lease accounting rules, effectively meaning no change to the existing methodology.

What does this mean for Lessees?

The Boards will likely receive requests to reconsider previous decisions on lessee accounting, such as requiring a single income statement recognition model for all leases, including leases of real estate.

Of course the proof is in the pudding so we should keep an eye out for the next official draft of the accounting rules expected first quarter of 2012.

Advanced Lease Management: Retail Use Clauses

2011-10-26T20:24:41Z

Some might suggest this article is more about lease negotiation than lease management. However, I believe proper lease management starts with the negotiation. Because the merchandising of a shopping center is such an important part of its success, the way use clauses are structured becomes an important management item. The use clause should be one of the most managed, non-financial aspects of the leases. After all, it outlines the merchandising and subsequent types of tenants an owner targets for their properties.

Use clauses also become important once any use restrictions, aka exclusivity clauses, are introduced by other tenants. [Please read the article concerning exclusives at advance.beyond-the-building.com]. Note too, that I am approaching this discussion from a business perspective and am not offering legal advice. Please consult a commercial real estate lawyer for any legal questions or direction.

I believe the way to construct a workable use clause is to segment the use into what the tenant is primarily offering and what is ancillary to its main offer. The primary use also gives a sense of the store’s overall concept. The trick is to work with the tenant so they have flexibility within the concept to adjust their merchandise inventory as time goes on, but still remain within the original concept.

The ancillary use should be reserved for uses that support the main use but that may also be common to other uses or could be another’s primary use. For example, consider a better quality hair salon primarily focused on women’s and men’s hair styling. As ancillary to that main concept they may sell hair care products, cut children’s hair and/or offer make-up or nail services. Scheduling all these as ancillary to the main concept allows the salon to provide these, but also gives the owner the option of providing a store that has nail care as its main concept, or a store selling cosmetics or a salon that specializes in children’s hair styling. The concept can then change which makes the management of the property uses more difficult.

If these ancillary uses were part of a general, all-in-one use clause it is conceivable that the original tenant could react to the introduction of a similar but not directly competing business by shifting its focus to meet the new offering head on. If this morphing occurs it has a number of consequences for the center owner:

The original concept for the tenant will have changed and perhaps lost.
The second shop will be upset with both the other tenant and the landlord, resulting in bad relations.
The ability to effectively merchandise the property will be blunted as valuable space and use- inventory will be duplicated, and
The landlord may have other problems if there are any exclusivity infractions as a result.

Since the primary use also provides the overall framework for the store’s concept it is important to cast a fence around what that means. There is, for example, a vast merchandising difference between a “woman’s apparel store” and, say, a “woman’s apparel store specializing in petite sizes.”

Whenever possible, my preference is to attempt to narrowly define the primary use as much as possible but give the tenant the latitude to come back to me to request merchandising changes during the term. This second look allows me to consider the ever evolving merchandise mix in the property at the time of the request and to review any potential conflicts. I prefer that to attempting to anticipate what may occur two or three years into the term.

The Greenstead Group LLC provides asset management and international consultancy services to real estate owners around the world. To learn more contact Peter Morris

Greenstead Group LLC

pmorris@beyond-the-building.com

What Does Sam Zell Know Now?

2011-10-03T20:35:24Z

By: Peter D. Morris SCLS, SCSM, SCMD

Legendary, billionaire real estate investor Sam Zell said he is entering the real estate markets in Colombia and India.

India has been on the economic radar screen as part of the BRIC countries for several years. BRIC is an acronym for the emerging economies of Brazil, Russia, India and China. However, as many real estate investors have found deals were hard to consummate and investor attention saturated those markets resulting in overall price escalation.

But what about Colombia? Forget about its drug related past. This is the new Colombia. While there are still rebel problems in the jungles and drug issues in poor suburbs, just as there are drug problems in any major city, Colombia is expanding.

The World Bank listed Colombia as one of the easiest countries in Latin America to do business. The culture of the country seems to be to move forward and move up with a relatively young population and a dynamic workforce. It is an economy coming of age and rich in oil reserves.

Recent free trade agreements with a number of countries, including Canada, and soon to be signed agreements with countries, such as the USA, are pumping the economy.

Colombia is part of the next wave of emerging markets called CIVETS, that hold prospect of returns greater than can be found in developed nations. And Colombia holds a preferred position even in this group. CIVETS stands for Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa. The recent turmoil in Egypt has all but excluded it as an emerging market for investors. Colombia is the closest geographically to North American investors, is politically more stable than some of the other CIVETS countries and is better understood.

There is something else about Colombia that is attractive to commercial real estate investors. In fact, there are three things:

1. The ability to reap short term returns based on the county’s prevalent real estate business model,

2. A change in the native real estate practices is on the horizon, and

New investment vehicles.

The Current Practice

As I wrote about in another article, Colombia went through a credit crisis over a decade ago. At the time it was difficult to obtain financing for any large scale project. The market adapted and ‘constructors’ came to the fore with a real estate model of ‘sell, build.’ As a result, almost all new developments - even today – are pre-sold condo projects, irrespective of land use. Investors can buy individual offices or entire floors, individual retail shop space in regional malls or blocks of space, etc.

Financing these types of development projects can produce a nice return in a short term as the project is pre-sold prior to the dirt being turned.

There are specific issues with investing in individual new units however; such as a phenomenon known as dead on arrival projects. If you would like more information about this costly issue and the things you can do about it, please contact me.

A Change on the Horizon

We predict the issues associated with the sell, build model coupled with international interest in the country will propel a new real estate model for the country. We expect to see a return of the ‘developer’ who owns the entire project and leases individual space, rather than the constructor who is out of the project once it is sold and built.

There are several reasons in our view why this will come to pass, including: foreign financing accustomed to lending for long term holding projects, foreign pension fund investment that seeks consistent long term returns rather than project by project returns and multi location tenants (particularly in retail) that wish rapid market entry to capitalize on the opportunity to become a leader. It is easier for them to deal with a few developer/owners rather than hundreds of private investor owners.

This change will come about as single investors take down entire projects; or consolidate, and then expand, majority ownership stakes in distressed projects. We also expect to see single owner new project developers enter the market.

New Investment Vehicles

Ten new real estate investment trusts were created in Colombia in 2010 alone, although a few have since disappeared because they couldn’t complete the types of deals their charters stated. The Colombian form of REIT is a relatively new investment vehicle. Because of their recent introduction to the market, some may be high risk so a complete due diligence is required before investing. That said, coupled with the prospect of single entity long term leased space ownership we see these funds as powerful new players in the years to come.

Irrespective of the type of investing above, it is important to know the market and have strong existing relationships. That is where we come in. We have worked in Colombia. We have strong relationships with key influencers in the commercial real estate industry, who in turn have their finger on the pulse, trends and market movements. We would be pleased to assist you in exploring an investment in the Colombian real estate market so contact us at pmorris@beyond-the-building.com

Advanced Lease Management: Exclusive Use Restriction

2011-09-27T22:11:38Z

By: Peter D. Morris SCLS, SCSM, SCMD

In an ideal situation the landlord should never provide a retail tenant with an exclusive right to sell a category of merchandise, or specific product or service. There are a lot of reasons for this, some of which will become apparent in my comments below.

But when the tenant requires an exclusive use right to close the deal, the landlord can also insert reasonable expectations to provide the tenant with this benefit.

Two caveats as we begin. First, I am not offering legal advice. You should always seek out a competent lawyer with experience in commercial leases to provide that advice and draft the required clauses. The second one is that each and every deal is different. Below I present the ‘full meal deal’ as to a desired landlord’s position, but you may not be able to accomplish all of this on each and every negotiation. Some items I personally consider to be more important than others. I’ll tell you why I think these are important. You may have different points and/or points that are more important to your specific situation and the negotiation. So let’s begin.

I believe that all ‘rights’ granted should be conditioned, so the right remains available only so long as the conditions granted in exchange for the right are met. Again, there are a lot of business and legal reasons for this; not the least of which is the right holder’s unilateral benefit to the right. While some may say the offset to the right is the rent received, I don’t concur. For example, I’ve rarely seen a tenant back away from an exclusive use clause for a reduction in rent.

Here are the conditions I think should be in an exclusive use clause:

The exclusive use clause should only be proprietary to the specifically named tenant. The main reason for this is that this specific tenant requested the right and has the leverage to obtain it, presumably because it is a highly desirable tenant with a good sales record and excellent covenant.

The right extends to the tenant only so long as they actually occupy the whole of the premises. No one wants to provide a tenant with a say over the landlord’s merchandising if they aren’t even in the property to benefit from the right. Yes, I’ve seen situations when the tenant went dark, opened across the street and still retained the exclusive rights to the former property, effectively locking out competition (without the landlord going to considerable expense to remedy the situation).

The tenant must be operating in accordance with the lease and must not be in default at any time. This allows the landlord to claw back this clause, with the appropriate default clause wording. And it follows that a bad tenant shouldn’t receive a one sided benefit.

There should be a performance provision, such as a sales volume achieved or percent rent being paid. Naturally, a tenant will argue that they need the exclusive to reach the sales volume and ask the questions: “What happens until I reach the threshold? Does that mean I don’t have the right I bargained for?” Ask your lawyer about wording that removes the restriction when sales volume decreases by X percent over Y period of time. Or having the tenant within A% of the break point. This can be ramped up over the term of the lease.

The restriction should be that the landlord will not “lease” another premises to a tenant with the prohibited use; and not that the landlord will not allow another tenant to ‘use’ their premises for the prohibited use. A lot of legal reasons for this I am sure. But, from a business perspective the landlord is in the business of leasing not monitoring product assortment and how the individual premises are used.

The restriction should only apply to the primary or principal use of another tenant and not generally. For example, it is entirely different to limit the number of, say, coffee shops (primary use concept) vs. restricting the sale of coffee, which could affect every food outlet in the property as well as grocery, drug and dollar stores selling coffee by the pound.

Don’t use generic terms to describe restricted uses (ie: coffee shops). Be specific, as suggested below.

The restriction should be written to be as specific and narrow as possible to address the tenant’s concern; but to also provide merchandising flexibility throughout the term. For example, consider the morphing of the merchandise mix in Target, a chain that now has a significant grocery department. Or grocery stores that now offer prepared, ready to eat hot meals; furniture; clothing and electronic departments and even their own branded in-store banks!

The restriction should only apply to and affect leasing entered into after the commencement date of the requesting tenant’s lease. Therefore it shouldn’t apply to existing tenants (heirs, assigns, etc.). Unfortunately, I have seen issues when this obvious matter wasn’t covered, particularly when the wording also includes the ‘use’ issue noted in #5 above.

The restriction should specifically exclude any anchor spaces at all times. No landlord wants to face a mountain of restricted, conflicting uses if they are attempting to backfill an anchor, or sub-anchor space.

The landlord should ask if the exclusivity provision should apply to the entire property. The tenant may be happy to limit the total number of similar uses or where they can (or cannot) be located.

Likewise, if the restriction is on a single product line rather than an entire category (think patio furniture vs. coffee shops) consider my suggestion in number 6 as well as delineating the percentage of the primary use in the other lease. For example, a restriction might convey that the landlord won’t lease to another store selling patio furniture as part of its primary use if the patio furniture constitutes more than X% of the selling area. However, don’t get caught in the trap of a merchant requesting a laundry list of these types of product restrictions. The administration of that type of merchandising logistics would be unmanageable.

The landlord should also ask if the restriction can be time limited. A tenant may only need the comfort of the clause to kick start sales; such as during the first, say, 5 years of the initial term (my standard default position whenever possible).

Your lawyer will also want to include wording that nullifies the restriction if it found to contravene any laws or regulations, or changes to them over the term.

A retail property’s merchandising mix determines the property’s success overall and on an individual store basis. The owner (or asset manager) must maintain the ability to competitively merchandise their property at all times. Exclusive use rights can inhibit that ability. You now have some ideas on how to meet the merchant’s needs while retaining as much merchandising ability as possible.

Greenstead Group LLC

pmorris@beyond-the-building.com

Do You Use HID Fixtures in Your Parking Lot?

2011-09-20T18:50:04Z

Until recently HIDs were the most cost effective lighting choice. Then came LED lighting but these were cost prohibitive and problematic for high wattage needs. Induction fixtures have been around for a long time but until recently their capital cost made little sense and there were issues with EMC interference, lumen depreciation, ability to dim and a useful range of voltages.

On the flip side of the coin, Induction fixtures operate without filaments and electrodes. This results in a lamp of unmatched life. Lasting up to 100,000 hours or approximately 25 years, this system can outlast 100 incandescent, five HID, or five typical fluorescent lamp changes.

400w Induction fixtures are now available that will replace 1,000 watt HID fixtures in parking lots and large interior spaces. This solution will reduce your 1,095 (input) watt parking lot lighting down to 430 watts!

In addition, the increased lighting quality delivered at a CRI of 85 or higher. This makes color more brilliant and defined. CRI is the Color Rendering Index and describes how a light source makes the color of an object appear to human eyes and how well variations in color shades are revealed.

Induction lighting is “instant on” needing no re-strike time which enables the use of sensors to

instantly deliver light when needed. The long 60,000-100,000hr life will drastically reduce the need

for costly bucket truck service to replace lamps outlast and HID by 4 to 5 times.

The combination of reduced consumption coupled with exceptionally low maintenance costs, as compared to other fixtures warrants consideration for new and retrofit projects.

What Does Sam Zell Know Now?

2011-09-02T17:55:18Z

By: Peter D. Morris SCLS, SCSM, SCMD

Legendary, billionaire real estate investor Sam Zell said he is entering the real estate markets in Colombia and India.

Recent free trade agreements with a number of countries, including Canada, and soon to be signed agreements with countries, such as the USA, are pumping the economy.

There is something else about Colombia that is attractive to commercial real estate investors. In fact, there are three things:

1. The ability to reap short term returns based on the county’s prevalent real estate business model,

2. A change in the native real estate practices is on the horizon, and

3. New investment vehicles.

The Current Practice

Financing these types of development projects can produce a nice return in a short term as the project is pre-sold prior to the dirt being turned.

A Change on the Horizon

New Investment Vehicles