For a landlord, escalations can be a legal and ethical method of recovering some, or sometimes all, of a property's operating expenses. But escalations can also be the biggest operational headache a landlord has to contend with during a tenant's tenure.
And from a tenant's standpoint, escalations can be the single most defining issue that determines if the landlord is trustworthy.
Escalations are frequently the cause of misunderstandings with tenants.
When not handled well, these misunderstandings can easily escalate into disputes and then into very serious legal proceedings between landlords and tenants.
Follow these 5 rules to dramatically reduce the chances of getting into escalation disputes and audits. In order of importance:
Rule # 1 – Be consistent.
Escalations are not just a function of accounting. 2 other disciplines are also involved: legal and property management. Legal is represented by the lease document. Property management is represented by operational contracts and practical processes for expense-gathering activities provided by managers and engineers.
Unlike accounting, the legal and property management concepts are sometimes based on interpretation rather than quantifiable numbers.
Being consistent is sometimes more important than being accurate. The main point is that the same methodology should be used for each year throughout the term of a lease.
Rule # 2 – Don't forget Rule # 1
Is consistency important enough to warrant being both Rule # 1 and Rule # 2? Even if you make a calculation mistake or an error of judgment about a key assumption in a base year (which benefits the tenant), the odds are reasonably good that making the same mistake in subsequent years (which benefits the landlord) will cancel out that error. What should a property manager or accountant do when he or she finds an error in a tenant's past escalation charge? The odds are reasonably good that the same mistake in subsequent years will cancel out a previous error. Not absolutely certain, so the door remains open to the possibility that 2 wrongs do not make it right. When the error benefits both the tenant and the landlord in equal measure, we will generally leave the mistake alone until a lease expires before correcting it.
However, if a mistake clearly and solely benefits the landlord, we suggest throwing consistency aside, admitting the error, recalculating the escalation charge and establishing new methodology for the remainder of the lease term. Why? Because honesty is good business. It is also a key to minimizing escalation disputes and audits.
Rule # 3 – Start with the end in mind (an audit)
Tenants don't like paying escalations any more than they like paying for parking, so plan on being questioned or challenged by a tenant or an auditor. Keep escalation records at least one year past the expiration of every lease.
Rule # 4 – Communicate effectively
Letters to tenants about escalation charges should be concise. They should include explanations for any significant expense changes (plus or minus). Brevity is of great value with this type of communication.
When you do get audited, follow the same rule and commit to doing your homework so you can communicate effectively with them. Return phone calls from tenants and auditors immediately, even if it's to tell them you are collecting the information they requested. Accept that managing the communications is as important as what is being communicated.
Rule # 5 – Use industry standardized methodology
Very little published information exists that establishes standardized methodology, other than BOMA (Building Owners and Manager's
Association) International's handbook and software. Some real estate companies continue to use home-grown logic and in-house spreadsheets developed in years past to calculate escalation charges.
But switching to industry-endorsed methodology would help those landlords avoid escalation audits, and also better prepare them to manage the audit process.
It's even easier to avoid escalation disputes or manage audits than you imagined. To recap the Escalation Rules again:
1. Be consistent.
2. Assume that your tenants will audit your records, so
store them in a safe place.
3. Communicate clearly and effectively about
escalations.
4. Use industry-accepted methodology so your
calculations are trusted."
rom Office & Commercial Real Estate Magazine, Summer 2005 . For more inforamtion contact www.houstonrealtyadvisors.net
Thursday, February 22, 2007
Wednesday, February 21, 2007
Life Style Center will Continue to be Hot
"The traditional lifestyle center as defined by ICSC (International Council of Shopping Centers) is between 150,000 sf and 500,000 square feet. They are open-air, usually in upscale locations and have many of the same fashion and restaurant tenants. But the definition and parameters are becoming more fluid as developers build more of these centers and shoppers get to know them.
When putting them together, developers also need to keep in mind what tenants go where. The biggest flaws we see are in the site plans.
You can't put a Cheesecake Factory in the middle of a street. As much parking as we can provide them, they'll eat it all up.
Some of the more innovative, earlier lifestyle centers introduced larger sidewalks than a typical strip center, allowing more people to congregate. However, that can also be overdone. A sea of concrete is really not very friendly.
Panelists agree that adding other real estate components to lifestyle centers and making them mixed-use is the wave of the future for these developments, but that might not always be a good thing. As land becomes more expensive and in shorter supply, mixed-use properties are rapidly becoming the project of choice for most developers. And while having the right mix of uses is vital to a project's success, it's just as imperative to have the right mix of retailers.
Retail is an important part of mixed-use from an economic point of view. It also gives a project character, so the types of retailers that occupy a project can have a significant impact on its overall image. This kind of format is conducive to a blend of retailers that would not normally come together under one roof.
Mixed-use enables mall mainstays to coexist with typical open-air or lifestyle tenants, offering a wide range of merchandise. A key component to a successful development is food and entertainment.
Restaurants are critical to a mixed-use project. Most of them are the anchor tenants and drive the sales volume that we need to make projects work. They also help to make it a daytime/nighttime destination.
Mixed-use clearly has its benefits. Chief among them are that municipalities and zoning entities are likely to look more favorably on mixed-use as a smart-growth-type initiative than they would a straight-forward retail project. A successful mixed-use complex is more sustainable, less susceptible to competition. Mixed-use projects tend to be costly and need higher rents in order to make fiscal sense.
CAMs (Common Area Maintenance) tend to be much more for a mixed-use asset, because of things like parking and security. CAMs for mixed- use can be between 30% and 35% more than suburban centers.
The discussion also touched on issues such as parking and the competition for prominent positioning among the various components of a project. All the uses — hotel, retail, office, residential - want that prime corner. Therefore, it is important for the developer to to create a place where they each have visibility and identity."
When putting them together, developers also need to keep in mind what tenants go where. The biggest flaws we see are in the site plans.
You can't put a Cheesecake Factory in the middle of a street. As much parking as we can provide them, they'll eat it all up.
Some of the more innovative, earlier lifestyle centers introduced larger sidewalks than a typical strip center, allowing more people to congregate. However, that can also be overdone. A sea of concrete is really not very friendly.
Panelists agree that adding other real estate components to lifestyle centers and making them mixed-use is the wave of the future for these developments, but that might not always be a good thing. As land becomes more expensive and in shorter supply, mixed-use properties are rapidly becoming the project of choice for most developers. And while having the right mix of uses is vital to a project's success, it's just as imperative to have the right mix of retailers.
Retail is an important part of mixed-use from an economic point of view. It also gives a project character, so the types of retailers that occupy a project can have a significant impact on its overall image. This kind of format is conducive to a blend of retailers that would not normally come together under one roof.
Mixed-use enables mall mainstays to coexist with typical open-air or lifestyle tenants, offering a wide range of merchandise. A key component to a successful development is food and entertainment.
Restaurants are critical to a mixed-use project. Most of them are the anchor tenants and drive the sales volume that we need to make projects work. They also help to make it a daytime/nighttime destination.
Mixed-use clearly has its benefits. Chief among them are that municipalities and zoning entities are likely to look more favorably on mixed-use as a smart-growth-type initiative than they would a straight-forward retail project. A successful mixed-use complex is more sustainable, less susceptible to competition. Mixed-use projects tend to be costly and need higher rents in order to make fiscal sense.
CAMs (Common Area Maintenance) tend to be much more for a mixed-use asset, because of things like parking and security. CAMs for mixed- use can be between 30% and 35% more than suburban centers.
The discussion also touched on issues such as parking and the competition for prominent positioning among the various components of a project. All the uses — hotel, retail, office, residential - want that prime corner. Therefore, it is important for the developer to to create a place where they each have visibility and identity."
Thursday, February 15, 2007
'Prenegotiated' Leases, with Built-in Compromises.
Any method of negotiation may be fairly judged by three criteria:
1. It should produce a wise agreement if agreement is possible.
2. It should be efficient.
3. And it should improve or at least not damage the relationship between the parties."
So say Roger Fisher and William Ury in Getting to Yes 4 (2d ed.
1991).
In the classic method of lease negotiation, the landlord submits its standard form, often in excess of 60 pages, regardless of the size of the relevant premises or the term of the relevant lease; the tenant reviews the proffered form; and the negotiations proceed from there.
In the case of national retail tenants, the tenant submits its standard form, but this article will assume the process starts with the landlord's submission.
This method, usually more often than not, complies with the first criterion above: It produces a wise agreement. This method, usually more often than not, complies with the third criterion: It does not damage the relationship between the parties. However, much more often than not this method fails the second criterion-and fails it
miserably: It is not by any means efficient.
This lack of efficiency is a direct result of landlords time and time again proffering to prospective tenants forms that contain numerous provisions that do not address the tenant's needs. And landlords do this knowing many tenants will complain about these clauses, and also knowing that if a prospective tenant requests that these provisions be changed, the landlord will capitulate. Although there always will be variations in individual situations, often it is the same clauses about which a tenant will complain, only to receive the landlord's standard response, followed by the standard arguments by counsel and, ultimately, the standard compromised result. This not only fails to meet the criterion of efficiency, it is a case study in inefficiency. Worse, it is inefficiency coupled with unnecessary expense in terms of legal fees incurred to negotiate the same provisions over and over again.
But there is an alternative method available that undeniably better serves criterion 2 in that it is more efficient, and arguably better serves criteria 1 and 3 as well. Although not known by any official doctrinal title, the method is for the landlord to create a standard form and proffer in the first instance what one might call a `prenegotiated' lease-that is, a lease where the landlord has built into the form as many of the conventional compromises as it finds acceptable. This serves the cause of efficiency in two ways:
a. It avoids the time and energy wasted on negotiations over clauses about which the landlord is willing to compromise.
b. It helps send the message that the likelihood of the landlord being flexible on various other clauses is not great. If the landlord was willing to be flexible on those scores, the lease form would already reflect that flexibility.
This approach results in shorter, easier negotiations, increasing efficiency, thus saving the landlord and tenant money. It probably results in wiser agreements and better tenant relations as well. And the best part is that this result is achieved without the landlord giving away any position about which it actually cares.
There is no universal list of the provisions in a lease that should be prenegotiated. There is no universal right way these provisions should come out. The individual needs (or quirks) of the particular landlord, the accepted practices in the region, the size of the relevant structure, the prototype size of any individual premises, the landlord's practices concerning the necessary level of credit- worthiness of prospective tenants and the statutory or common law of the relevant jurisdiction are but some of the factors that might affect any of the provisions to be discussed.
Here are some of the conventional compromises to which landlords and tenants often agree. In using as many of these compromised positions as a landlord finds acceptable in its standard lease form, the landlord has prenegotiated the lease and created efficiency not only by including the acceptable provisions, but by thinking through and rejecting the other provisions. Having thought through these positions in advance and deciding to reject same, the landlord will be able to respond immediately to the inevitable tenant requests to modify these particular provisions with rational arguments.
ALTERATIONS
Virtually every tenant is going to want to know its initial build-out is acceptable and that thereafter it has some level of freedom to make alterations. A landlord should consider including in the form permission, without consent, to make nonstructural alterations that do not materially harm building systems, perhaps subject to a dollar cap. If a cap is included, it should not be so low as to forestall the possibility of any meaningful work being permitted. A landlord should consider allowing alterations that do not require consent to remain at lease expiration. The landlord would also be obligated to inform the tenant at the time of granting approval (as to alterations that require approval) whether the relevant approved alteration may remain at lease expiration.
ASSIGNMENT & SUBLETTING
Affiliates, mergers and consolidations, asset sales, public companies, estate planning-does a tenant's need for some flexibility in these provisions without requiring consent, or being subject to recapture or a rent hike or a landlord review fee, come as a shock to anyone? A landlord should consider what is acceptable-and consider volunteering it in the lease form.
ASSIGNMENT OF EXTENSION & EXPANSION OPTIONS Is this part of the bargain for which the tenant is paying, and accordingly assignable whenever the lease is assignable, or personal to the named tenant? Traditionally, on the East Coast the right was the tenant's to assign. On the West Coast, these rights traditionally have been viewed as personal to the named tenant. A landlord might consider allowing the rights to be transferred, but only to any person to whom the lease can be transferred without consent.
CAPITAL EXPENDITURES & CAM
The landlord often starts with the position that any penny spent on anything is properly included in Common Area Maintenance (CAM), and often, but not always, provides for some type of amortization of capital items. The tenant often starts with the position that it should have no responsibility for capital items, as it has no equity in the building. A prenegotiated compromise to consider is to include in CAM only capital expenditures incurred to replace existing building equipment or reduce building operating costs (as compared to lobby renovations, art work or other changes mostly designed to attract new tenants). Such expenditures would be amortized over the useful life of the improvement (without an artificially short absolute maximum period of reimbursement), and without an interest factor (the tenant is not financing a purchase; it is paying an annual use charge).
LEASE AUDIT RIGHTS
A landlord should consider providing this right. If it does, the landlord should further consider not mandating that the tenant provide specific information as to the details of the complaint in advance of the audit. If the tenant knew the details, an audit wouldn't be needed. And the landlord should consider not mandating that the auditor be a Big 4 firm or even a certified public accountant; the required professional fees might be enough to cause the tenant to forgo the audit. A landlord should consider as well not mandating that the auditor refrain from working on a contingency fee or from contacting other tenants, although these last two points are ones landlords might be loath to relinquish.
DAMAGE BY FIRE
Leases almost invariably provide landlords tremendous flexibility while very often providing tenants none. A landlord might consider providing tenants a right to terminate, especially as the term draws to a close, and might also consider granting this right if parking or access is affected even if there is no direct damage to the premises.
ENVIRONMENTAL
A landlord should consider allowing de minimis amounts of cleaning and other toxic products to be maintained in offices in the ordinary course, and consider making compliance with law, as compared to compliance with the landlord's subjective decisions, the standard of required behavior. The lease should make clear that the tenant has no responsibility for pre-existing conditions.
INTERRUPTION of SERVICES
Absent a 9/11- or Katrina-type disaster, how often are services interrupted for extended periods of time? A landlord should consider volunteering rent abatement if services are disrupted for more than a relatively short period-maybe 72 hours.
HOLDOVER
A kick-up of basic rent is de rigeur. But a landlord should consider dropping both multipliers of CAM and broad-stroke indemnities against any and all damages, and protect itself from problems with new tenants in the delivery section of that tenant's lease.
HVAC OVERTIME
A landlord should consider volunteering that multiple tenants in the same zone will divide the hourly rate, rather than each paying in full.
NOTICE of MONETARY DEFAULTS
How many thousands of times has this topic been discussed? And how many times has a landlord terminated a lease without demanding the overdue rent be paid-not once but multiple times? Landlords do not desire evictions or empty spaces-they want the cash flow. Almost invariably, notice of nonpayment is delivered. So a landlord should think about putting it in the form. And it does not have to be all or nothing-perhaps on the third monetary default in any consecutive 12-month period the landlord can proceed without notice. And landlords should also consider whether requiring credit and payment history reports on prospective tenants might be a better tool to guard against nonpayment than preserving the lease clause entitling the landlord to evict without notice.
REMEDIES
A landlord should consider whether the form, if it includes the right to accelerate rents, should also include a fair market value credit for the then-remaining value of the space upon such acceleration of rents.
MITIGATION of DAMAGES
A landlord should contemplate whether its purposes are not better served by acknowledging that it has an obligation to mitigate, while also objectively defining what steps will be deemed to satisfy this obligation.
ESTOPPEL
Rather than simply mandating that the tenant, on demand, deliver an estoppel-a document in which the tenant is asked to make certain representations-a landlord should consider volunteering to deliver one when requested by the tenant. Given the possible volume of requests, a landlord might also contemplate including an appropriate administrative fee to be charged in connection with processing such a request.
There is no one perfect lease that works for every landlord in every setting. But if the time and effort is invested to prenegotiate a lease form, and to simply trim its length as well, the effort will be rewarded in savings of time and money, without loss of meaningful rights."
from The National Law Journal, October 3, 2005 for more information go to: www.houstonrealtyadvisors.net
1. It should produce a wise agreement if agreement is possible.
2. It should be efficient.
3. And it should improve or at least not damage the relationship between the parties."
So say Roger Fisher and William Ury in Getting to Yes 4 (2d ed.
1991).
In the classic method of lease negotiation, the landlord submits its standard form, often in excess of 60 pages, regardless of the size of the relevant premises or the term of the relevant lease; the tenant reviews the proffered form; and the negotiations proceed from there.
In the case of national retail tenants, the tenant submits its standard form, but this article will assume the process starts with the landlord's submission.
This method, usually more often than not, complies with the first criterion above: It produces a wise agreement. This method, usually more often than not, complies with the third criterion: It does not damage the relationship between the parties. However, much more often than not this method fails the second criterion-and fails it
miserably: It is not by any means efficient.
This lack of efficiency is a direct result of landlords time and time again proffering to prospective tenants forms that contain numerous provisions that do not address the tenant's needs. And landlords do this knowing many tenants will complain about these clauses, and also knowing that if a prospective tenant requests that these provisions be changed, the landlord will capitulate. Although there always will be variations in individual situations, often it is the same clauses about which a tenant will complain, only to receive the landlord's standard response, followed by the standard arguments by counsel and, ultimately, the standard compromised result. This not only fails to meet the criterion of efficiency, it is a case study in inefficiency. Worse, it is inefficiency coupled with unnecessary expense in terms of legal fees incurred to negotiate the same provisions over and over again.
But there is an alternative method available that undeniably better serves criterion 2 in that it is more efficient, and arguably better serves criteria 1 and 3 as well. Although not known by any official doctrinal title, the method is for the landlord to create a standard form and proffer in the first instance what one might call a `prenegotiated' lease-that is, a lease where the landlord has built into the form as many of the conventional compromises as it finds acceptable. This serves the cause of efficiency in two ways:
a. It avoids the time and energy wasted on negotiations over clauses about which the landlord is willing to compromise.
b. It helps send the message that the likelihood of the landlord being flexible on various other clauses is not great. If the landlord was willing to be flexible on those scores, the lease form would already reflect that flexibility.
This approach results in shorter, easier negotiations, increasing efficiency, thus saving the landlord and tenant money. It probably results in wiser agreements and better tenant relations as well. And the best part is that this result is achieved without the landlord giving away any position about which it actually cares.
There is no universal list of the provisions in a lease that should be prenegotiated. There is no universal right way these provisions should come out. The individual needs (or quirks) of the particular landlord, the accepted practices in the region, the size of the relevant structure, the prototype size of any individual premises, the landlord's practices concerning the necessary level of credit- worthiness of prospective tenants and the statutory or common law of the relevant jurisdiction are but some of the factors that might affect any of the provisions to be discussed.
Here are some of the conventional compromises to which landlords and tenants often agree. In using as many of these compromised positions as a landlord finds acceptable in its standard lease form, the landlord has prenegotiated the lease and created efficiency not only by including the acceptable provisions, but by thinking through and rejecting the other provisions. Having thought through these positions in advance and deciding to reject same, the landlord will be able to respond immediately to the inevitable tenant requests to modify these particular provisions with rational arguments.
ALTERATIONS
Virtually every tenant is going to want to know its initial build-out is acceptable and that thereafter it has some level of freedom to make alterations. A landlord should consider including in the form permission, without consent, to make nonstructural alterations that do not materially harm building systems, perhaps subject to a dollar cap. If a cap is included, it should not be so low as to forestall the possibility of any meaningful work being permitted. A landlord should consider allowing alterations that do not require consent to remain at lease expiration. The landlord would also be obligated to inform the tenant at the time of granting approval (as to alterations that require approval) whether the relevant approved alteration may remain at lease expiration.
ASSIGNMENT & SUBLETTING
Affiliates, mergers and consolidations, asset sales, public companies, estate planning-does a tenant's need for some flexibility in these provisions without requiring consent, or being subject to recapture or a rent hike or a landlord review fee, come as a shock to anyone? A landlord should consider what is acceptable-and consider volunteering it in the lease form.
ASSIGNMENT OF EXTENSION & EXPANSION OPTIONS Is this part of the bargain for which the tenant is paying, and accordingly assignable whenever the lease is assignable, or personal to the named tenant? Traditionally, on the East Coast the right was the tenant's to assign. On the West Coast, these rights traditionally have been viewed as personal to the named tenant. A landlord might consider allowing the rights to be transferred, but only to any person to whom the lease can be transferred without consent.
CAPITAL EXPENDITURES & CAM
The landlord often starts with the position that any penny spent on anything is properly included in Common Area Maintenance (CAM), and often, but not always, provides for some type of amortization of capital items. The tenant often starts with the position that it should have no responsibility for capital items, as it has no equity in the building. A prenegotiated compromise to consider is to include in CAM only capital expenditures incurred to replace existing building equipment or reduce building operating costs (as compared to lobby renovations, art work or other changes mostly designed to attract new tenants). Such expenditures would be amortized over the useful life of the improvement (without an artificially short absolute maximum period of reimbursement), and without an interest factor (the tenant is not financing a purchase; it is paying an annual use charge).
LEASE AUDIT RIGHTS
A landlord should consider providing this right. If it does, the landlord should further consider not mandating that the tenant provide specific information as to the details of the complaint in advance of the audit. If the tenant knew the details, an audit wouldn't be needed. And the landlord should consider not mandating that the auditor be a Big 4 firm or even a certified public accountant; the required professional fees might be enough to cause the tenant to forgo the audit. A landlord should consider as well not mandating that the auditor refrain from working on a contingency fee or from contacting other tenants, although these last two points are ones landlords might be loath to relinquish.
DAMAGE BY FIRE
Leases almost invariably provide landlords tremendous flexibility while very often providing tenants none. A landlord might consider providing tenants a right to terminate, especially as the term draws to a close, and might also consider granting this right if parking or access is affected even if there is no direct damage to the premises.
ENVIRONMENTAL
A landlord should consider allowing de minimis amounts of cleaning and other toxic products to be maintained in offices in the ordinary course, and consider making compliance with law, as compared to compliance with the landlord's subjective decisions, the standard of required behavior. The lease should make clear that the tenant has no responsibility for pre-existing conditions.
INTERRUPTION of SERVICES
Absent a 9/11- or Katrina-type disaster, how often are services interrupted for extended periods of time? A landlord should consider volunteering rent abatement if services are disrupted for more than a relatively short period-maybe 72 hours.
HOLDOVER
A kick-up of basic rent is de rigeur. But a landlord should consider dropping both multipliers of CAM and broad-stroke indemnities against any and all damages, and protect itself from problems with new tenants in the delivery section of that tenant's lease.
HVAC OVERTIME
A landlord should consider volunteering that multiple tenants in the same zone will divide the hourly rate, rather than each paying in full.
NOTICE of MONETARY DEFAULTS
How many thousands of times has this topic been discussed? And how many times has a landlord terminated a lease without demanding the overdue rent be paid-not once but multiple times? Landlords do not desire evictions or empty spaces-they want the cash flow. Almost invariably, notice of nonpayment is delivered. So a landlord should think about putting it in the form. And it does not have to be all or nothing-perhaps on the third monetary default in any consecutive 12-month period the landlord can proceed without notice. And landlords should also consider whether requiring credit and payment history reports on prospective tenants might be a better tool to guard against nonpayment than preserving the lease clause entitling the landlord to evict without notice.
REMEDIES
A landlord should consider whether the form, if it includes the right to accelerate rents, should also include a fair market value credit for the then-remaining value of the space upon such acceleration of rents.
MITIGATION of DAMAGES
A landlord should contemplate whether its purposes are not better served by acknowledging that it has an obligation to mitigate, while also objectively defining what steps will be deemed to satisfy this obligation.
ESTOPPEL
Rather than simply mandating that the tenant, on demand, deliver an estoppel-a document in which the tenant is asked to make certain representations-a landlord should consider volunteering to deliver one when requested by the tenant. Given the possible volume of requests, a landlord might also contemplate including an appropriate administrative fee to be charged in connection with processing such a request.
There is no one perfect lease that works for every landlord in every setting. But if the time and effort is invested to prenegotiate a lease form, and to simply trim its length as well, the effort will be rewarded in savings of time and money, without loss of meaningful rights."
from The National Law Journal, October 3, 2005 for more information go to: www.houstonrealtyadvisors.net
Tuesday, February 13, 2007
Negotiating Common Area Costs
Typical mall or shopping center customers expect certain things in their shopping experience. They certainly expect clean floors, a safe environment, plowed and maintained parking lots, holiday cheer in the form of decorations and the like. For those who negotiate shopping center leases, we know these basic requirements present significant issues in any lease negotiation.
The expenses for these and other aspects of making the shopping center an attractive and safe destination fall into a general category called common area maintenance (CAM). Determining what is included in CAM and who pays for it can be among the most important and challenging aspects of any lease negotiation.
The respective goals of the landlord and tenants regarding CAM seem fairly obvious — the landlord wants to pass every possible expense through to tenants, while tenants want to pay as little as possible for CAM so that available cash can be invested in inventory, sales labor and other revenue-generating uses. But taking these extreme stands can result in undesired consequences. When CAM is too expensive for tenants, they will look elsewhere for space so they do not suffer cash flow problems. And when the landlord carries an excessive share of the CAM burden, important maintenance initiatives may be delayed or neglected.
Because neither party benefits in these extreme situations, the negotiation process to arrive at a fair and reasonable distribution of CAM costs is a delicate and essential component of the landlord-tenant relationship. The negotiation of the CAM clause will typically touch on several key topics that determine the composition of CAM, its distribution among tenants, and how these costs increase over time.
Is it CAM or isn't it?
In basic terms, CAM should be based upon the landlord's actual and reasonable net costs in repairing and maintaining the common areas of the shopping center. Typical components of CAM include, but are not limited to, expenses related to cleaning, operating, managing, equipping, decorating, policing, lighting and repairing the shopping facility and parking areas as well as taxes and assessments on those facilities. Utilities, landscaping, insurance, wages and benefits of personnel and depreciation of equipment are also included. An administrative fee may also be added to CAM, often as a percentage of the CAM amount.
The tenant may seek to limit the term common area to include only parking areas and enclosed areas meant for customer use, not areas such as adjacent parcels and outdoor areas used only for certain tenants or the landlord. Some tenants seek specific exclusions. For instance, some refuse to pay any costs associated with structural, roof or exterior repairs. Many tenants take the position that common area expenses should not include capital expenditures of any kind as these are investments that add value to the landlord's property.
Landlords may argue that tenants, too, benefit from capital expenditures, such as the replacement of a deteriorated parking lot.
Other common exclusions sought by tenants are original construction and improvement costs, mortgage interest, some taxes, improvements made to tenant spaces and special services for individual tenants. Costs for attracting and signing new tenants, any reimbursed costs such as through insurance coverage, landlord executive salaries and the cost of correcting code violations are also excluded in many cases. Clearly, the final negotiated list of exclusions can have a significant impact on the actual CAM charge incurred by the tenant.
What is a fair share of CAM?
CAM costs are most often distributed on a pro rata basis among tenants of the shopping center or mall. The formula for that distribution is generally based on the tenant's square footage as a percentage of total leasable retail space. However, several variables can dramatically affect the final calculation.
The tenant's square footage must first be determined. Issues may arise regarding mechanical or non-selling space, or unusable space such as a large basement with more area than is reasonably required or desired by the tenant.
Calculation of the total square footage within the center may exclude significant portions of actual area. For instance, department stores and/or anchor stores often contribute to CAM on some basis other than square footage, so the space of those stores is not counted in the proration. Exclusion can be based on the size, classification or use of the space, so the definitions used in the CAM clause must be carefully examined. For instance, if major stores of at least 50,000 square feet are excluded from the CAM denominator, does a 60,000-square-foot cinema qualify as well? Is a cinema really a major store? Is a major store defined in the lease other than by size?
Because the result of these exemptions is essentially a subsidy of the large stores' CAM costs by smaller tenants, negotiation on this topic can be particularly contentious.
What about fees?
Most CAM clauses include administrative fees or management fees, or both. The lease may stipulate that the tenant shall pay an administrative fee in the range of 5 percent to 18 percent of the total cost of operating and maintaining the center. This fee, in essence, compensates the landlord for tending, on behalf of the tenants, to all of the important matters that make the center run smoothly. While this is a fairly standard fee, an additional management fee is less universal. From the tenant's perspective, the two fees essentially pay for the same thing and constitute unnecessary double dipping by the landlord. The landlord, however, may seek the management fee to pay for a third-party management company hired to manage the center.
Sophisticated clients may seek to limit which cost items are used in calculating the administrative fee. For instance, big ticket items such as utilities and insurance, over which the landlord may not really administer or manage, may be excluded.
How quickly will CAM costs rise?
Predictability of costs is one of many desirable characteristics that a retailer looks for in a location. As such, the use of CAM caps has become more common in the community center, strip center and lifestyle center world. These caps limit the amount by which the tenant's CAM cost will increase year to year.
Caps can be structured in a variety of ways. The simplest is a first year cap, which essentially pegs the initial year's CAM at a specific not-to-exceed amount that is set by the leasing agent when the deal is made. An ongoing CAM cap protects the tenant through subsequent years. This cap specifies that CAM cannot rise by more than a specified percentage over the previous year, with that percentage often tied to an index such as the Consumer Price Index.
Caps can be cumulative or non-cumulative. A cumulative cap allows the landlord to carry forward unused increases when actual CAM costs rise at uneven rates. For instance, if a CAM cap is 5 percent, but actual costs rise only 3 percent in the first year, the additional 2 percent could be applied to the second year so that if actual costs rose by 7 percent in that second year, the landlord could recover the entire increase. A non-cumulative cap would limit the increase to 5 percent per year.
Landlords typically insist that CAM caps exclude certain types of costs, often referred to uncontrollables. Expenses such as utility costs, snow removal and security may be excluded so that the landlord is not saddled with the full burden of unexpectedly high cost increases. Typically, a tenant will accept this uncontrollable exclusion from a CAM cap because the landlord truly has no control over these costs and allocating that risk solely to the landlord is an inappropriate distribution of responsibility.
Do the numbers add up?
A CAM clause may include an array of definitions, limits, calculations, exclusions and exceptions. All of these specifications open the possibility for errors, misinterpretations or disagreement on appropriate CAM costs for each tenant. With this in mind, tenants frequently negotiate for the right to audit the landlord's books and records to verify that only permitted costs are included in CAM and that the tenant's specific charge has been properly calculated.
These audit provisions typically designate how often audits can be initiated, how the process will be conducted, and how any discrepancies uncovered in the audit will be resolved. Landlords will seek a variety of limits on audits, including confidentiality. From the landlord's perspective, it is not appropriate for tenants to share audit information. Each lease is different and an issue discovered in a CAM audit for one tenant may or may not be relevant to a different tenant's lease.
Is there a better way?
CAM clauses are complex, the negotiations required to create them may be lengthy and their terms may cause friction between the landlord and tenant through the entire lease period. Given these truths, a fixed or flat CAM has some appeal. Pyramid introduced the concept to its portfolio in the early 1990s and some other owners have since followed suit. A fixed CAM may be based on several methods, all setting an initial CAM amount and a predetermined annual rate of increase.
A fixed CAM rises by the designated rate of increase, regardless of actual costs, so these figures will be negotiated carefully, as well the rate of increase. Setting the CAM too low results in the landlord subsidizing tenant CAM costs. Fixing the CAM too high means that the tenant overpays for the various CAM services. Larger developers with a significant national track record may be better positioned to set a realistic CAM amount than new or more regional players. A national landlord can balance CAM costs over an entire portfolio so it may be better positioned to absorb the costs associated with an unusually snowy winter, for example.
While tenants may feel they will benefit if the landlord underestimates the actual CAM costs and sets a low fixed number, the benefit may be short-lived. If the landlord cannot recoup its costs, it will be strongly motivated to cut expenses. Disputes may arise about whether minimum maintenance standards are being met and patronage at the center may decline as the center begins to show its age without necessary or important upkeep. One solution to this problem is to periodically reset the fixed number based on actual costs. However, for tenants, the reset concept is somewhat unappealing because it diminishes the fixed nature of the tenant's costs.
With a fixed CAM, landlords typically demand that tenants forgo the right to audit CAM costs as CAM essentially becomes additional rent that is not based on actual incurred costs. Administration of CAM is also simplified with fixed charges. Also, because fewer CAM details must be negotiated, closing a lease deal can generally be accomplished more quickly under this arrangement.
A difficult issue
CAM continues to be a difficult issue for both landlords and tenants.
While fixed CAM initially appeared to be the answer to so many problems from lease negotiation to lease administration, in all but the largest portfolios, it carries substantial risk for the landlord. Since we do not have a crystal ball and cannot predict exactly what will happen with costs in the future, the landlord assumes a great deal of risk in the fixed CAM situation. Therefore, pro rata CAM continues to be the most common method for payment of these expenses. Landlords and tenants need to adopt the long term view of their relationship to insure that the landlord is fully reimbursed for its costs and the tenant is receiving for its CAM investment what it bargained for - a well maintained and managed shopping center from which it can grow its business."
from Shopping Cemter Business, May 2006 for more information call 713 782-0260 or check our web site: www.houstonrealtyadvisors.net
The expenses for these and other aspects of making the shopping center an attractive and safe destination fall into a general category called common area maintenance (CAM). Determining what is included in CAM and who pays for it can be among the most important and challenging aspects of any lease negotiation.
The respective goals of the landlord and tenants regarding CAM seem fairly obvious — the landlord wants to pass every possible expense through to tenants, while tenants want to pay as little as possible for CAM so that available cash can be invested in inventory, sales labor and other revenue-generating uses. But taking these extreme stands can result in undesired consequences. When CAM is too expensive for tenants, they will look elsewhere for space so they do not suffer cash flow problems. And when the landlord carries an excessive share of the CAM burden, important maintenance initiatives may be delayed or neglected.
Because neither party benefits in these extreme situations, the negotiation process to arrive at a fair and reasonable distribution of CAM costs is a delicate and essential component of the landlord-tenant relationship. The negotiation of the CAM clause will typically touch on several key topics that determine the composition of CAM, its distribution among tenants, and how these costs increase over time.
Is it CAM or isn't it?
In basic terms, CAM should be based upon the landlord's actual and reasonable net costs in repairing and maintaining the common areas of the shopping center. Typical components of CAM include, but are not limited to, expenses related to cleaning, operating, managing, equipping, decorating, policing, lighting and repairing the shopping facility and parking areas as well as taxes and assessments on those facilities. Utilities, landscaping, insurance, wages and benefits of personnel and depreciation of equipment are also included. An administrative fee may also be added to CAM, often as a percentage of the CAM amount.
The tenant may seek to limit the term common area to include only parking areas and enclosed areas meant for customer use, not areas such as adjacent parcels and outdoor areas used only for certain tenants or the landlord. Some tenants seek specific exclusions. For instance, some refuse to pay any costs associated with structural, roof or exterior repairs. Many tenants take the position that common area expenses should not include capital expenditures of any kind as these are investments that add value to the landlord's property.
Landlords may argue that tenants, too, benefit from capital expenditures, such as the replacement of a deteriorated parking lot.
Other common exclusions sought by tenants are original construction and improvement costs, mortgage interest, some taxes, improvements made to tenant spaces and special services for individual tenants. Costs for attracting and signing new tenants, any reimbursed costs such as through insurance coverage, landlord executive salaries and the cost of correcting code violations are also excluded in many cases. Clearly, the final negotiated list of exclusions can have a significant impact on the actual CAM charge incurred by the tenant.
What is a fair share of CAM?
CAM costs are most often distributed on a pro rata basis among tenants of the shopping center or mall. The formula for that distribution is generally based on the tenant's square footage as a percentage of total leasable retail space. However, several variables can dramatically affect the final calculation.
The tenant's square footage must first be determined. Issues may arise regarding mechanical or non-selling space, or unusable space such as a large basement with more area than is reasonably required or desired by the tenant.
Calculation of the total square footage within the center may exclude significant portions of actual area. For instance, department stores and/or anchor stores often contribute to CAM on some basis other than square footage, so the space of those stores is not counted in the proration. Exclusion can be based on the size, classification or use of the space, so the definitions used in the CAM clause must be carefully examined. For instance, if major stores of at least 50,000 square feet are excluded from the CAM denominator, does a 60,000-square-foot cinema qualify as well? Is a cinema really a major store? Is a major store defined in the lease other than by size?
Because the result of these exemptions is essentially a subsidy of the large stores' CAM costs by smaller tenants, negotiation on this topic can be particularly contentious.
What about fees?
Most CAM clauses include administrative fees or management fees, or both. The lease may stipulate that the tenant shall pay an administrative fee in the range of 5 percent to 18 percent of the total cost of operating and maintaining the center. This fee, in essence, compensates the landlord for tending, on behalf of the tenants, to all of the important matters that make the center run smoothly. While this is a fairly standard fee, an additional management fee is less universal. From the tenant's perspective, the two fees essentially pay for the same thing and constitute unnecessary double dipping by the landlord. The landlord, however, may seek the management fee to pay for a third-party management company hired to manage the center.
Sophisticated clients may seek to limit which cost items are used in calculating the administrative fee. For instance, big ticket items such as utilities and insurance, over which the landlord may not really administer or manage, may be excluded.
How quickly will CAM costs rise?
Predictability of costs is one of many desirable characteristics that a retailer looks for in a location. As such, the use of CAM caps has become more common in the community center, strip center and lifestyle center world. These caps limit the amount by which the tenant's CAM cost will increase year to year.
Caps can be structured in a variety of ways. The simplest is a first year cap, which essentially pegs the initial year's CAM at a specific not-to-exceed amount that is set by the leasing agent when the deal is made. An ongoing CAM cap protects the tenant through subsequent years. This cap specifies that CAM cannot rise by more than a specified percentage over the previous year, with that percentage often tied to an index such as the Consumer Price Index.
Caps can be cumulative or non-cumulative. A cumulative cap allows the landlord to carry forward unused increases when actual CAM costs rise at uneven rates. For instance, if a CAM cap is 5 percent, but actual costs rise only 3 percent in the first year, the additional 2 percent could be applied to the second year so that if actual costs rose by 7 percent in that second year, the landlord could recover the entire increase. A non-cumulative cap would limit the increase to 5 percent per year.
Landlords typically insist that CAM caps exclude certain types of costs, often referred to uncontrollables. Expenses such as utility costs, snow removal and security may be excluded so that the landlord is not saddled with the full burden of unexpectedly high cost increases. Typically, a tenant will accept this uncontrollable exclusion from a CAM cap because the landlord truly has no control over these costs and allocating that risk solely to the landlord is an inappropriate distribution of responsibility.
Do the numbers add up?
A CAM clause may include an array of definitions, limits, calculations, exclusions and exceptions. All of these specifications open the possibility for errors, misinterpretations or disagreement on appropriate CAM costs for each tenant. With this in mind, tenants frequently negotiate for the right to audit the landlord's books and records to verify that only permitted costs are included in CAM and that the tenant's specific charge has been properly calculated.
These audit provisions typically designate how often audits can be initiated, how the process will be conducted, and how any discrepancies uncovered in the audit will be resolved. Landlords will seek a variety of limits on audits, including confidentiality. From the landlord's perspective, it is not appropriate for tenants to share audit information. Each lease is different and an issue discovered in a CAM audit for one tenant may or may not be relevant to a different tenant's lease.
Is there a better way?
CAM clauses are complex, the negotiations required to create them may be lengthy and their terms may cause friction between the landlord and tenant through the entire lease period. Given these truths, a fixed or flat CAM has some appeal. Pyramid introduced the concept to its portfolio in the early 1990s and some other owners have since followed suit. A fixed CAM may be based on several methods, all setting an initial CAM amount and a predetermined annual rate of increase.
A fixed CAM rises by the designated rate of increase, regardless of actual costs, so these figures will be negotiated carefully, as well the rate of increase. Setting the CAM too low results in the landlord subsidizing tenant CAM costs. Fixing the CAM too high means that the tenant overpays for the various CAM services. Larger developers with a significant national track record may be better positioned to set a realistic CAM amount than new or more regional players. A national landlord can balance CAM costs over an entire portfolio so it may be better positioned to absorb the costs associated with an unusually snowy winter, for example.
While tenants may feel they will benefit if the landlord underestimates the actual CAM costs and sets a low fixed number, the benefit may be short-lived. If the landlord cannot recoup its costs, it will be strongly motivated to cut expenses. Disputes may arise about whether minimum maintenance standards are being met and patronage at the center may decline as the center begins to show its age without necessary or important upkeep. One solution to this problem is to periodically reset the fixed number based on actual costs. However, for tenants, the reset concept is somewhat unappealing because it diminishes the fixed nature of the tenant's costs.
With a fixed CAM, landlords typically demand that tenants forgo the right to audit CAM costs as CAM essentially becomes additional rent that is not based on actual incurred costs. Administration of CAM is also simplified with fixed charges. Also, because fewer CAM details must be negotiated, closing a lease deal can generally be accomplished more quickly under this arrangement.
A difficult issue
CAM continues to be a difficult issue for both landlords and tenants.
While fixed CAM initially appeared to be the answer to so many problems from lease negotiation to lease administration, in all but the largest portfolios, it carries substantial risk for the landlord. Since we do not have a crystal ball and cannot predict exactly what will happen with costs in the future, the landlord assumes a great deal of risk in the fixed CAM situation. Therefore, pro rata CAM continues to be the most common method for payment of these expenses. Landlords and tenants need to adopt the long term view of their relationship to insure that the landlord is fully reimbursed for its costs and the tenant is receiving for its CAM investment what it bargained for - a well maintained and managed shopping center from which it can grow its business."
from Shopping Cemter Business, May 2006 for more information call 713 782-0260 or check our web site: www.houstonrealtyadvisors.net
Friday, February 9, 2007
Tenants have the Power and more with Consent
"In a commercial tenancy, the tenant typically must obtain consent of the landlord to assign or sublet the premises. Unless specifically stated otherwise in the language of the lease, a landlord must not unreasonably withhold consent when a tenant is seeking to alienate its interest.
But what about the reverse, albeit somewhat less common, situation where a landlord must obtain tenant consent in order to further develop the property? Typically, tenant consent obligations arise in shopping centers where major tenants have negotiated the right to approve or reject further construction that affects their business.
The most recent decision addressing the reasonableness of a tenant withholding consent from a landlord is Safeway Inc. v. CESC Plaza Ltd. Partnership, 261 F. Supp. 2d. 439 (E.D. Va. 2003). In Safeway, a supermarket leased space in an Arlington, Va., shopping plaza. The lease contained a clause requiring the landlord, after completion of initial construction of the shopping plaza, to obtain Safeway's consent for any future alterations to the common areas (including parking).
The shopping plaza encompassed about 40 stores, located on the ground floor of the Plaza Block. The Safeway store opened onto the interior of the Plaza Shops mall. Therefore, customers entering from the surface parking lot would have to walk down an interior mall corridor, approximately 100 feet in length, to reach the store entrance. A two-story parking structure ran alongside the plaza between the roadway and the structure containing the stores. The question presented involved whether Safeway acted reasonably in withholding consent to the landlord's $40 million proposed renovation of the Plaza Block and surrounding area, which included the removal of the parking structure used by Safeway customers and the construction of new retail stores.
In determining whether a tenant has unreasonably withheld consent, the Safeway court first adopted the Restatement rule that places on the party seeking consent the burden of demonstrating that the other party acted unreasonably rather than objectively, and not on mere whim or caprice. The court next established what can be seen as a business judgment rule in evaluating the reasonableness of a tenant's reasons for withholding consent. When evaluating whether reasons asserted by a tenant are valid business reasons, the court will defer to the tenant's prior experiences in the industry as a basis for determining how it reasonably believes the landlord's alterations will affect the tenant's business and customers.
When evaluating whether to withhold consent, a tenant need not perform studies or hire experts to determine whether the proposed
alteration(s) by the landlord will indeed result in adverse impact(s) to its business. Instead, the tenant may draw from its prior experiences with issues such as those resulting from the landlord's proposal, e.g., reduction in parking or loss of visibility. Further, the tenant's refusal to grant consent will be examined from the time such refusal is made, not post hoc on the basis of studies conducted and data collected by the parties subsequently for the purposes of litigation, although "[t]hose studies may be relevant with respect to other issues presented.
The deference given to the tenant's concerns presents a difficult burden for the landlord to overcome. This is evidenced by the Safeway court holding, `even if post hoc studies did not support Safeway's concerns or tended to show that those concerns were unfounded or of doubtful validity, it does not necessarily follow that the concerns were therefore an unreasonable basis on which to refuse consent.'
Safeway proffered several arguments, including modification of the parking arrangement and loss of visibility, to buttress its position that withholding of consent was reasonable under the circumstances.
The court's analysis as to these individual reasons for withholding consent are worth exploring because they are probably the most common reasons for withholding consent. In addition, these factors play a key role in negotiating shopping center leases and culminate in bargained-for covenants within a lease whereby a landlord is required to obtain the consent of its tenant prior to altering the premises.
The number and location of parking spaces are very important to a shopping center tenant. In Safeway, the landlord's proposal would alter the parking configuration by eliminating a surface parking lot, leaving Safeway with only underground parking for its customers.
Safeway withheld consent on the ground that this change in parking would deter customers from its store because, in past experiences at other stores, Safeway had determined its customers did not perceive underground parking to be as safe or convenient as surface parking.
Safeway did not, prior to denying consent, conduct any parking studies, hire a traffic engineer or take site-specific customer surveys concerning the landlord's proposal.
Relying on the tenant's business judgment, the court held that `Safeway's reliance on its experience, without undertaking any study, cannot be said to be unreasonable given the Restatement standard. Safeway's concerns in this regard cannot be said to be without significance or based on mere caprice or whim or personal prejudice.' In fact, the court took its analysis one step further by referencing studies performed for trial that concluded that urban grocery store customers were indeed receptive to underground parking. Safeway even conceded that underground parking at a nearby Safeway store functioned effectively and was accepted by its customers. Nevertheless, in the court's view, this did not render unreasonable Safeway's decision to deny consent, and the court found in favor of the tenant on the parking issue.
When evaluating whether visibility was a valid business reason for withholding consent, the court in Safeway relied on K-Mart Corp. v.
Oriental Plaza Inc., 694 F. Supp. 1010 (D.P.R. 1988), aff'd, 875 F.2d
907 (1st Cir. 1989). The K-Mart court applied the same section of the Restatement as did the Safeway court. In K-Mart, the court upheld the tenant's argument that consent was reasonably withheld because the landlord's construction would impair visibility of K-Mart's building and signage.
Examples of valid business reasons recognized in K-mart for withholding consent based on loss of visibility are the inability to identify the store from the local roadways, the reduction that the loss of visibility would have on impulse shopping and the negative impact loss of visibility would have on the established street presence of the store. K-Mart's belief that these factors would reduce sales was more than reasonable in the court's view, noting that `the decision to enter a shopping center is difficult enough without removing the major incentive, the sight of the K-Mart.'
The court further acknowledged K-Mart's desire to maintain its goodwill through uniformity of its stores, which the visual obstruction would essentially tarnish. The court in K-Mart stressed the ability to protect `the kind of surroundings K-Mart bargains for when opening stores' and recognized that `without the high visibility that this K-Mart store once possessed, impulse sales will suffer.'
On the other hand, the facts in Safeway led to the conclusion that Safeway would not suffer a loss of visibility justifying the withholding of consent. This conclusion was primarily due to the fact that Safeway, even before the landlord's proposed construction, had no visibility from the street and therefore lacked the street presence at issue in K-Mart. In addition, the only Safeway sign was located on the interior of the building, and the parking structure that already existed blocked all views from the street of the entrance to the shopping plaza.
Although the court did not accept Safeway's loss-of-visibility argument, it did acknowledge that an obstruction to a storefront's visibility typically would be a reasonable ground for withholding consent. As stated by the court, `placing a building in the parking lot of a store would normally have the effect of blocking the view of the store from the street, thereby reducing, at least to some extent, the general visibility of the store.'
In distinguishing Safeway from K-Mart, the court conceded that the shopping plaza in Safeway was not the normal suburban-type center where a grocery store fronts an open parking lot in view of passing traffic. Therefore, if a tenant has established a street presence within a shopping center, withholding consent will be reasonable if the tenant in its own business judgment believes the proposed alteration by the landlord would have a negative impact on its street presence.
The Safeway and K-Mart cases demonstrate that a tenant possessing a right of consent to the landlord's additional development can have broad latitude to withhold consent based on objective reasons in consideration of the tenant's business judgment. By developing a business judgment rule for determining whether a tenant acted reasonably in withholding consent, the courts have established a trend that favors the ability of tenants to maintain their business at the expense of a landlord's ability to maximize its profits by expanding the premises.
These decisions easily could have resulted in a rule mandating that a tenant come forth with factual proofs demonstrating the adverse impacts resulting from landlord's proposal. Clearly, courts have taken into consideration that businesses engage in substantial due diligence concerning issues such as parking and visibility before choosing a store location. Furthermore, a business's desire to maintain its goodwill by having uniformity among its store locations will be deemed significant.
Finally, these decisions establishing a business judgment rule reflect that a tenant's decision to withhold consent should not be judged in a vacuum. Allowing a tenant to draw from past experiences at different locations indicates a willingness to account for future considerations and events, which are sometimes unknown, to be factored into the equation of determining whether to withhold consent." National Law Journal, March 27, 2006
To answer more of your questions please see: www.houstonrealtyadvisors.net
or call Ed A. Ayres at 713-782-0260
But what about the reverse, albeit somewhat less common, situation where a landlord must obtain tenant consent in order to further develop the property? Typically, tenant consent obligations arise in shopping centers where major tenants have negotiated the right to approve or reject further construction that affects their business.
The most recent decision addressing the reasonableness of a tenant withholding consent from a landlord is Safeway Inc. v. CESC Plaza Ltd. Partnership, 261 F. Supp. 2d. 439 (E.D. Va. 2003). In Safeway, a supermarket leased space in an Arlington, Va., shopping plaza. The lease contained a clause requiring the landlord, after completion of initial construction of the shopping plaza, to obtain Safeway's consent for any future alterations to the common areas (including parking).
The shopping plaza encompassed about 40 stores, located on the ground floor of the Plaza Block. The Safeway store opened onto the interior of the Plaza Shops mall. Therefore, customers entering from the surface parking lot would have to walk down an interior mall corridor, approximately 100 feet in length, to reach the store entrance. A two-story parking structure ran alongside the plaza between the roadway and the structure containing the stores. The question presented involved whether Safeway acted reasonably in withholding consent to the landlord's $40 million proposed renovation of the Plaza Block and surrounding area, which included the removal of the parking structure used by Safeway customers and the construction of new retail stores.
In determining whether a tenant has unreasonably withheld consent, the Safeway court first adopted the Restatement rule that places on the party seeking consent the burden of demonstrating that the other party acted unreasonably rather than objectively, and not on mere whim or caprice. The court next established what can be seen as a business judgment rule in evaluating the reasonableness of a tenant's reasons for withholding consent. When evaluating whether reasons asserted by a tenant are valid business reasons, the court will defer to the tenant's prior experiences in the industry as a basis for determining how it reasonably believes the landlord's alterations will affect the tenant's business and customers.
When evaluating whether to withhold consent, a tenant need not perform studies or hire experts to determine whether the proposed
alteration(s) by the landlord will indeed result in adverse impact(s) to its business. Instead, the tenant may draw from its prior experiences with issues such as those resulting from the landlord's proposal, e.g., reduction in parking or loss of visibility. Further, the tenant's refusal to grant consent will be examined from the time such refusal is made, not post hoc on the basis of studies conducted and data collected by the parties subsequently for the purposes of litigation, although "[t]hose studies may be relevant with respect to other issues presented.
The deference given to the tenant's concerns presents a difficult burden for the landlord to overcome. This is evidenced by the Safeway court holding, `even if post hoc studies did not support Safeway's concerns or tended to show that those concerns were unfounded or of doubtful validity, it does not necessarily follow that the concerns were therefore an unreasonable basis on which to refuse consent.'
Safeway proffered several arguments, including modification of the parking arrangement and loss of visibility, to buttress its position that withholding of consent was reasonable under the circumstances.
The court's analysis as to these individual reasons for withholding consent are worth exploring because they are probably the most common reasons for withholding consent. In addition, these factors play a key role in negotiating shopping center leases and culminate in bargained-for covenants within a lease whereby a landlord is required to obtain the consent of its tenant prior to altering the premises.
The number and location of parking spaces are very important to a shopping center tenant. In Safeway, the landlord's proposal would alter the parking configuration by eliminating a surface parking lot, leaving Safeway with only underground parking for its customers.
Safeway withheld consent on the ground that this change in parking would deter customers from its store because, in past experiences at other stores, Safeway had determined its customers did not perceive underground parking to be as safe or convenient as surface parking.
Safeway did not, prior to denying consent, conduct any parking studies, hire a traffic engineer or take site-specific customer surveys concerning the landlord's proposal.
Relying on the tenant's business judgment, the court held that `Safeway's reliance on its experience, without undertaking any study, cannot be said to be unreasonable given the Restatement standard. Safeway's concerns in this regard cannot be said to be without significance or based on mere caprice or whim or personal prejudice.' In fact, the court took its analysis one step further by referencing studies performed for trial that concluded that urban grocery store customers were indeed receptive to underground parking. Safeway even conceded that underground parking at a nearby Safeway store functioned effectively and was accepted by its customers. Nevertheless, in the court's view, this did not render unreasonable Safeway's decision to deny consent, and the court found in favor of the tenant on the parking issue.
When evaluating whether visibility was a valid business reason for withholding consent, the court in Safeway relied on K-Mart Corp. v.
Oriental Plaza Inc., 694 F. Supp. 1010 (D.P.R. 1988), aff'd, 875 F.2d
907 (1st Cir. 1989). The K-Mart court applied the same section of the Restatement as did the Safeway court. In K-Mart, the court upheld the tenant's argument that consent was reasonably withheld because the landlord's construction would impair visibility of K-Mart's building and signage.
Examples of valid business reasons recognized in K-mart for withholding consent based on loss of visibility are the inability to identify the store from the local roadways, the reduction that the loss of visibility would have on impulse shopping and the negative impact loss of visibility would have on the established street presence of the store. K-Mart's belief that these factors would reduce sales was more than reasonable in the court's view, noting that `the decision to enter a shopping center is difficult enough without removing the major incentive, the sight of the K-Mart.'
The court further acknowledged K-Mart's desire to maintain its goodwill through uniformity of its stores, which the visual obstruction would essentially tarnish. The court in K-Mart stressed the ability to protect `the kind of surroundings K-Mart bargains for when opening stores' and recognized that `without the high visibility that this K-Mart store once possessed, impulse sales will suffer.'
On the other hand, the facts in Safeway led to the conclusion that Safeway would not suffer a loss of visibility justifying the withholding of consent. This conclusion was primarily due to the fact that Safeway, even before the landlord's proposed construction, had no visibility from the street and therefore lacked the street presence at issue in K-Mart. In addition, the only Safeway sign was located on the interior of the building, and the parking structure that already existed blocked all views from the street of the entrance to the shopping plaza.
Although the court did not accept Safeway's loss-of-visibility argument, it did acknowledge that an obstruction to a storefront's visibility typically would be a reasonable ground for withholding consent. As stated by the court, `placing a building in the parking lot of a store would normally have the effect of blocking the view of the store from the street, thereby reducing, at least to some extent, the general visibility of the store.'
In distinguishing Safeway from K-Mart, the court conceded that the shopping plaza in Safeway was not the normal suburban-type center where a grocery store fronts an open parking lot in view of passing traffic. Therefore, if a tenant has established a street presence within a shopping center, withholding consent will be reasonable if the tenant in its own business judgment believes the proposed alteration by the landlord would have a negative impact on its street presence.
The Safeway and K-Mart cases demonstrate that a tenant possessing a right of consent to the landlord's additional development can have broad latitude to withhold consent based on objective reasons in consideration of the tenant's business judgment. By developing a business judgment rule for determining whether a tenant acted reasonably in withholding consent, the courts have established a trend that favors the ability of tenants to maintain their business at the expense of a landlord's ability to maximize its profits by expanding the premises.
These decisions easily could have resulted in a rule mandating that a tenant come forth with factual proofs demonstrating the adverse impacts resulting from landlord's proposal. Clearly, courts have taken into consideration that businesses engage in substantial due diligence concerning issues such as parking and visibility before choosing a store location. Furthermore, a business's desire to maintain its goodwill by having uniformity among its store locations will be deemed significant.
Finally, these decisions establishing a business judgment rule reflect that a tenant's decision to withhold consent should not be judged in a vacuum. Allowing a tenant to draw from past experiences at different locations indicates a willingness to account for future considerations and events, which are sometimes unknown, to be factored into the equation of determining whether to withhold consent." National Law Journal, March 27, 2006
To answer more of your questions please see: www.houstonrealtyadvisors.net
or call Ed A. Ayres at 713-782-0260
Wednesday, February 7, 2007
Landlords are Charging tenants for capital improvements
Some lease charge tenants for all capital costs as an operating expense, presumably on the grounds that if you do not ask, you do not get. If read literally, that would make a tenant who is in the building at the time a roof is replaced liable for its prorate share, in a single year, of the entire cost of the roof, ignoring that the expected life span of the new roof far exceeds the term of the lease.
Capital costs are usually predictable years in advance (and so are already a component of base rent), or are usually covered by insurance if arising from force majeure, etc. The clause (in the BOMA publication) is fair, in that it offers to amortize the cost.
But it still charges the tenant for capital costs and the underlying principle is still at stake.
Another common compromise is to charge the tenant only for capital costs that reduce, or are intended to reduce – what would otherwise be operating expenses – or the rate of increase in operating expenses – so that the landlord at least recovers the cost of expense- saving equipment.
There may still be some further negotiation, such as a tenant request that the amount passed-through to the tenant under such a clause not exceed, in any given operating year, the amount of operating expense savings realized. This sounds fair but is extremely difficult to calculate, particularly given outside variables (such as the weather, the comparative cost per gallon of fuel oil). The advantage of such a clause may be that the tenant has no greater ability to challenge such a determination itself, is unlikely to audit operating expenses anyway, and its outside auditor also probably lacks the expertise to seriously challenge such a determination by the landlord." From : Guide to Writing a Commercial Real Estate Lease, published by Building Owners and Managers Association International (BOMA) For more info: contact www.houstonrealtyadvisors.net ask for Ed A. Ayres ; President
Capital costs are usually predictable years in advance (and so are already a component of base rent), or are usually covered by insurance if arising from force majeure, etc. The clause (in the BOMA publication) is fair, in that it offers to amortize the cost.
But it still charges the tenant for capital costs and the underlying principle is still at stake.
Another common compromise is to charge the tenant only for capital costs that reduce, or are intended to reduce – what would otherwise be operating expenses – or the rate of increase in operating expenses – so that the landlord at least recovers the cost of expense- saving equipment.
There may still be some further negotiation, such as a tenant request that the amount passed-through to the tenant under such a clause not exceed, in any given operating year, the amount of operating expense savings realized. This sounds fair but is extremely difficult to calculate, particularly given outside variables (such as the weather, the comparative cost per gallon of fuel oil). The advantage of such a clause may be that the tenant has no greater ability to challenge such a determination itself, is unlikely to audit operating expenses anyway, and its outside auditor also probably lacks the expertise to seriously challenge such a determination by the landlord." From : Guide to Writing a Commercial Real Estate Lease, published by Building Owners and Managers Association International (BOMA) For more info: contact www.houstonrealtyadvisors.net ask for Ed A. Ayres ; President
Friday, February 2, 2007
Ill-Defined Provisions are Generally Interpreted in the Landlord's Favor.
"Many tenants focus exclusively on things like fixed rent, operating expenses, real estate taxes, insurance, utilities and sundry charges. In many office leases, the landlord is required to provide basic services which are included in the monthly rent or charged extra via the operating expense reimbursement clauses. Services typically include heating and cooling, cleaning and vacuuming, electricity, elevator services, security, water, and parking. The landlord also maintains, repairs, landscapes, cleans and lights the public areas of the building. Extra services for which the landlord typically bills extra may include special security, freight service, overtime heating and cooling, and after-hours special cleaning.
It is best for both parties to anticipate these services and specify the rates and quality of the services as well as the mechanism for requesting them. If pricing or a methodology for costing the services is omitted from the lease, the tenant can be at the mercy of the landlord. Likewise, the landlord should be fairly compensated for running a chiller all weekend during a hot summer.
Some specific examples of services that can be negotiated upfront by both parties:
• Definition of normal building hours and how operations are affected by weekend or holiday.
• Normal hours for heating and cooling.
• Performance levels for HVAC and response time for adverse conditions.
• Electrical power supply capacity.
• Method and pricing of utilities (electric, gas, water, sewer).
• Cleaning specifications and timing.
• Cafeteria, gym, daycare and parking hours.
• Elevator service and hours (passenger & freight).
By discussing, anticipating and negotiating some of these services upfront both parties can set expectations properly for extra services. The tenant will be happy with the level and quality of services and the landlord will benefit from a satisfied tenant that pays the agreed-upon charges promptly." from SS&C, May 12, 2006 For more information contact Ed Ayres at : www.houstonrealtyadvisors.net
or phone 713 782-0260
It is best for both parties to anticipate these services and specify the rates and quality of the services as well as the mechanism for requesting them. If pricing or a methodology for costing the services is omitted from the lease, the tenant can be at the mercy of the landlord. Likewise, the landlord should be fairly compensated for running a chiller all weekend during a hot summer.
Some specific examples of services that can be negotiated upfront by both parties:
• Definition of normal building hours and how operations are affected by weekend or holiday.
• Normal hours for heating and cooling.
• Performance levels for HVAC and response time for adverse conditions.
• Electrical power supply capacity.
• Method and pricing of utilities (electric, gas, water, sewer).
• Cleaning specifications and timing.
• Cafeteria, gym, daycare and parking hours.
• Elevator service and hours (passenger & freight).
By discussing, anticipating and negotiating some of these services upfront both parties can set expectations properly for extra services. The tenant will be happy with the level and quality of services and the landlord will benefit from a satisfied tenant that pays the agreed-upon charges promptly." from SS&C, May 12, 2006 For more information contact Ed Ayres at : www.houstonrealtyadvisors.net
or phone 713 782-0260
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