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MESSAGE FROM BROKER/TOC
A. MEASURING AND COMPARING
INVESTMENTS
B. REAL ESTATE FINANCE
C. PURCHASE AND SALE ISSUES
D. LEASE LINGO AND LEASE NEGOTIATION
ISSUES
E. TAX ISSUES
D. LEASE LINGO AND LEASE NEGOTIATION ISSUES
1.
What Are “Triple Net” Leases and Why Are They Popular
With Investors?
The “triple” in “triple net”
refers to the manner in which three principal cost items are allocated
between a landlord and a tenant: (1) property taxes; (2) insurance;
and (3) maintenance. A “triple net” lease (sometimes
also referred to as a “net lease”) is a lease where
the tenant is responsible for paying the cost of all three of these
items. This type of lease is popular with investors because the
rent collected by the landlord is free and clear of any obligation
to pay for these three major cost items.
- Application to Single-Tenant Buildings.
The easiest context for use of a “triple net
lease” is a single tenant building such as an industrial
property or a retail drug store. Even in the single tenant context,
building maintenance is not always a clear issue. Typically, the
landlord will accept responsibility for making “structural”
repairs. However, the responsibility for repairing and maintaining
HVAC, plumbing, electrical, and other building systems is often
the subject to intense negotiation, even where the parties have
agreed in principal upon a “triple net” concept.
- Application to Multi-Tenant Buildings.
The most confusion arises over the “triple net” concept
in lease negotiations for shopping centers (and other multi-tenant
properties). Sometimes, a letter of intent will specify that the
lease is to be a “triple net lease” but the parties
don’t actually intend for the tenant to pay for its share
of property taxes and utilities. Instead, they intend for the
tenant to only be responsible for its pro-rata share of increases
in such costs over the “base year”, typically the
first lease year. Property maintenance can also be a confusing
issue with multi-tenant properties. In a shopping center lease,
it is common for a landlord to be responsible for much more than
just the maintenance of the building structure.
2.
What Is a “Full Service Lease"?
A full service lease (sometimes referred to as a “gross
lease”) is the opposite of a triple net lease. With a full
service lease, the tenant pays a rent premium so as not to have
to hassle with taxes, insurance or maintenance. In analyzing an
investment that involves full service leases, the buyer must deduct
these expenses from the gross lease income in order to calculate
the actual net operating income. A full service lease is most commonly
associated with multi-tenant office buildings.
3. Are
There Any Situations Where the Lease Is a Hybrid Between a Triple
Net Lease and a Full Service Lease?
Yes! In fact, it is actually very rare that a lease is
a pure triple net lease or a pure full service lease. Thus, it is
critical to read the lease in order to determine the actual net
operating income that a property will generate.
4.
If a Purchase Price or a Lease Rate Is Measured “Per Square
Foot”, Is There Universal Agreement as to the Standard for
Measuring Square Feet?
The short answer is NO. Many professional real estate organizations
(such as BOMA) have attempted to standardize the measure of square
feet. Unfortunately, in practice, these standardized measures are
not followed on a consistent basis. Thus, it is important to clarify
and investigate the manner in which the square footage of a structure
is being measured.
5.
What Is the Difference Between “Usable Square Feet”
and “Rentable Square Feet”?
It is useful to have at least a basic understanding of
these commonly used terms, keeping in mind, however, that in practice
they are not universally understood to always mean the same thing.
- Usable Square Feet. This
measure typically refers to the actual measured space that a tenant
exclusively uses or controls. Unless the building is a single-tenant
building, it would not include common areas of a building such
as the lobby. The concept of “usable” square feet
is most commonly used for measuring retail space.
- Rentable Square Feet. This
measure is typically calculated by taking usable square feet and
adding on the user’s pro-rata share of common area (such
as a building’s lobby). A multi-user building with a very
large lobby is sometimes said to be “inefficient”
and have a large “core factor” or “add-on factor”,
the cost of which must be shared among the building’s users.
The concept of “rentable” square feet is most commonly
applied to multi-user office buildings and other situations in
which a large amount of common, interior space is being used by
multiple users.
6. What
Are the Most Commonly Negotiated Issues in a Commercial Lease?
Below is a summary of key lease issues that often are the
subject of negotiation by the parties and their respective attorneys:
- Base Rent and Additional Rent.
A good lease form will carefully distinguish between “Base
Rent” (or similar defined term such as “Minimum Rent”)
and “Additional Rent”. The “Base Rent”
typically represents the essential economic bargain between the
landlord and tenant. “Additional Rent” is typically
a defined term used to outline the additional payments that the
tenant will be making to the landlord above and beyond “Base
Rent” for items such as insurance and tax reimbursements.
- Percentage Rent. In
retail shopping center leases, it is common for the economic bargain
to include the concept of “Percentage Rent”. Percentage
Rent gives the landlord an incentive to promote the shopping center
and to enter into leases with other desirable tenants so as to
create a beneficial tenant mix that is attractive to consumers.
Pursuant to a percentage rent clause, the landlord gets a “kicker”
if the tenant’s sales exceed a certain threshold (typically
called the “breakpoint”) defined in the lease. It
is not uncommon for significant negotiations to occur over the
appropriate way to measure sales and the right of the landlord
to undertake an audit of the tenant’s accounting records.
- Security. The most
common form of security required by a commercial landlord is a
security deposit. However, for large dollar transactions, it is
often more practical for a tenant to post a letter of credit.
A sophisticated tenant can sometimes negotiate for its security
deposit to be released after a certain period of time or to be
waived altogether.
-
Options to Renew. A
sophisticated tenant will often negotiate for renewal options.
The lease should set forth the time window during which the
renewal option may be exercised. Landlords typically want as
much advance notice as they can negotiate. There are numerous
methods for calculating renewal term rent, including: (a) a
fixed percentage increase over the rent effective during the
previous term; (b) renewal rent based upon movements in the
consumer price index; or (c) renewal rent at fair market value.
- Use Restrictions. It
is always in the tenant’s interest for the use clause to
be broad and permit the use of the premises “for any lawful
purpose.” This is especially important for tenants that
enter into long-term leases where there is a greater likelihood
of a future assignment of the lease to a successor tenant. The
successor tenant may need the space for a completely different
purpose than the original tenant. Landlords will be most concerned
about restricting uses where either: (i) the Landlord owns, or
has in interest in protecting the desirability of, neighboring
property; or (ii) the Landlord owns a shopping center where potential
future tenants will be requesting exclusive use clauses.
- Assignment and Subletting.
The ideal landlord lease includes an absolute prohibition on lease
assignment without the landlord’s consent, which may be
withheld in the landlord’s sole discretion. In contrast,
the ideal tenant lease provides that the tenant’s interest
can be freely assigned. The classic compromise looks something
like this: “Tenant shall not assign or sublet this Lease
without the Landlord’s prior written consent, such consent
not to be unreasonably withheld, conditioned or delayed.”
- Mortgage Subordination Issues.
A landlord may sometimes be required by its lender to use a lease
form that subordinates the tenant’s rights to the rights
of the landlord’s mortgage lender. In the event of a foreclosure,
this type of subordination language may give the lender the right
to “wipe out” the lease and have the tenant evicted.
A sophisticated Tenant will reject such blanket subordination
and will instead condition any subordination of its lease upon
the delivery of a Subordination, Non-Disturbance, and Attornment
Agreement (“SNDA”). An SNDA is a formal agreement
between the lender and the tenant that sets forth their respective
rights and obligations in the event that the lender becomes the
new landlord under the lease.
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