Random Commercial Real Estate Thoughts

Currently, my inbox is cluttered. Seeking catharsis - this column will cause a clearing - which creates calm. Only one week left in the third quarter of 2022. 2023 is an Auld Lang Syne away. Blink and it’ll be here. 

Harvested from two calls today, here are a couple of situations that caused angst. 

What is a gross-up provision and why should you care? For context, this came up today in a marathon round with counsel, landlord and tenant. We are negotiating a lease with a public ally traded company and a local owner. These conversations are steeped in minutia but typically educational. According to Donald R. Oder, an attorney in San Diego, “Depending on the type of lease, the tenant may bear all or only a portion of the landlord’s expenses.  In a “triple net lease,” all of the landlord’s operating expenses are passed on to the tenant.  A lease may, however, contain an “expense stop” which establishes a point at which expenses begin to be passed on to the tenant.  In this type of lease, expenses for a “base year” are determined – the expense stop.  Thereafter, the landlord pays expenses equal to the base year and the tenant pays its pro rata share of the rest.  For example, if a lease contained an expense stop at $10,000 (“base year” expenses), and the landlord’s operating expenses were actually $11,000, the tenant would pay the $1,000 over the expense stop. It has become more common in recent years for office leases to contain what’s referred to as a “gross up” provision. Gross up provisions permit landlords to “gross-up”, or overstate, operating expenses to simulate the building being at full capacity.
 
Here’s how a gross up provision would work in the real world:

Assume the gross up provision states that common area maintenance expenses will be calculated for each tenant as if the building was fully occupied, or at 100% capacity.  Further assume the building is currently only at 50% occupancy.

Under this set of facts, a $1,000 expense to the landlord would be multiplied by a gross up factor of 2 (100% (the markup rate) / 50% (the level of occupancy)).  $1,000 x 2 = $2,000 (the grossed up operating expense).  The tenant is required to pay a pro rata share based on the percentage of space it occupies – let’s assume 20%.  In this scenario, the tenant’s total grossed up obligation would be $400.” 

Vacancy in office buildings has crept up in the past two years. In a healthy environment, the amount of dark space in a building would be a thing. But now it is. So, pay careful attention when leasing office space.

 Contingency periods. By definition, a contingency or due diligence period allows a buyer to study a purchase - upon their terms - with no obligation to complete the sale if something untoward is discovered and not remedied. Sometimes a seller passes along a vault of information which makes review and approval a snap. Other times, this becomes the buyer’s responsibility - third party reports such as environmental, building inspection, seismic, ALTA survey, zoning report, etc. must be ordered, completed, reviewed and approved. Presumably, enough time is built into the purchase agreement allowing the buyer to either approve existing reports or procure and approve. But what happens if the seller is tardy in delivering the reports to the buyer. Does the approval period automatically extend? This devil in the details caused havoc recently in a deal. We found common ground by saying the contingency period is the later of thirty days from opening of escrow or ten days from receipt of the reports. Bingo. 

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com