Gotcha Remedies

Last week we used a football theme to outline several “gotcha clauses” that appear in leases. Akin to a quarterback sneak, these are there but get you when just you’re expecting a long pass. I’ll give the football metaphors a rest until August - I swear. But today, and as promised last week, I’ll give you some strategies to offset these gotchas. To review, discussed were pass-through provisions, relocation, rent escalations, automatic renewals, and uses.
 
Pass-Through Provisions. Pass-through provisions can impact your bottom line, transferring unforeseen costs from the landlord to your business. Generally, during the term of a lease, increases over certain base year expenses are born by the tenant. Such expenses as insurance, property taxes and the cost to mow the lawn are examples. Consider capping specific expenses or requesting transparency through detailed documentation. Explore options such as a fixed monthly fee or excluding certain costs.
 
Relocation Strategies. Relocation clauses can disrupt your business operations and create uncertainty. If you’re an industrial tenant in a freestanding structure - your exposure is minimal as I’ve not seen relocation clauses in single tenant leases. However, beware if you’re signing a multi-tenant lease of an office retail, or industrial variety. Here, spaces are more consistently amenitized and sized - leading to an owner’s ability to move you. To avoid potential relocations, seek limitations on when and how the landlord can invoke this clause. Consider including provisions that require the landlord to cover relocation expenses or provide suitable alternative spaces.
 
Rent Escalation Mitigation. The value of a space that you occupy increases as the rent you pay to the owner increases. Therefore, most savvy landlords will want some bumps in rent throughout the term. The most onerous of these would be an open ended consumer price index increase on an annual basis. The opposite would be a flat rate - no increases - throughout the term. We’ve witnessed many cases of single tenant retail leases that carry no increases in rent throughout a five or ten year term. These flat leases are rare in industrial and office leases. A hedge against annual increases would be to negotiate an increase midway through the term or alternatively agree to a full consumer price index increase at the beginning of any option periods. In today’s robust environment, however, you’d be better served asking for a limit to the annual ups - a 3% vs 4% escalation
 
Automatic Renewal Management. Generally, you should be aware of automatic renewals any multi tenant industrial, retail, or office lease. The typical single tenant industrial, retail, or office lease normally will not carry this type of provision. In my view this is a term that should be stricken as a business point or with a counter position that the lease becomes a month-to-month lease at the termination. Automatic renewals can catch you off guard, potentially locking you into a long-term commitment without your consent. Additionally, seek provisions that allow for termination or renegotiation with sufficient notice before the renewal date.
 
Permitted Uses. Language in most leases reads - “upon your signature, you have reviewed the governing agency’s use provisions and have approved them.” Many tenants sign leases without visiting the city in which the property is located to check on zoning, variances, conditional use permits, and allowable uses within the zone. Consequently, they move in without a complete understanding of potential zoning limitations. If a planned use is not allowable within the zone, I generally recommend hiring a consultant to deal with nuances of governmental zoning. I’ve experienced too many situations - sans the consultant - where an unforeseen requirement arises which results in an unexpected expense.
 
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.
 
 
 

The Blindside

Last week we discussed the narrowest of circumstances. Akin to having fifty yard line seats to the Super Bowl - only of few of you have experienced selling your company and crafting a lease with the purchaser on a building you own. As you’ll recall we delved into clauses and terms you - as the owner of the real estate - should consider. 
 
Today’s subject is a bit broader. Many of you have leased commercial real estate or know someone who has. Certain paragraphs in commercial leases are non-starters and should be carefully avoided - or at a minimum - carry a complete understanding of the impact. I’ve called these “gotcha” because they can be like a blitzing linebacker who strikes from the blind side. You don’t see them coming until it’s to late to avoid the carnage. 
 
So, we're going to continue dissecting those common "gotchas" that are often hiding in the fine print of your commercial lease agreement. And continuing our football theme, let's dive right back in, shall we?
 
First, there's the infamous "Pass-Through" provision. This is like a surprise onside kick - it's completely legal, but it's a play you aren’t anticipating until you're handed an invoice for a share of the property tax increase, a costly building repair, or other operating expenses that the landlord has conveniently decided to pass on to you. Always have your special teams ready for this one.
 
Second, we've got the deceptive "Relocation" clause. You're enjoying a solid drive down the field, your business is building momentum, and out of nowhere, you're forced to laterally move to a different suite in the building. This allows the landlord to relocate you at their whim, leaving you to handle the ensuing confusion, relocation expenses, and the challenge of keeping your business in play.
 
Third, there's the sneaky "Escalation" clause. You think you've locked down your budget with a steady rent, but then you find your rent increasing faster than a wide receiver on a deep route. The clause allows for yearly rent increases, leaving you scrambling to adjust your financial playbook.
 
Now, let me introduce two more linebackers you need to watch out for.
 
The "Automatic Renewal" is one such contender. This, often hidden deep in the lease, will automatically renew your lease for a predefined period unless you give notice within a specific timeframe. Missing the notification window can be just like a missed field goal at the final whistle – a minor oversight, but with major consequences.
 
Finally, beware of the "Use" clause. This clause restricts how you can use the leased property, and any violations could lead to penalties or even eviction. It's like stepping out of bounds when you're sprinting towards the end zone – an action that may seem harmless but can abruptly stop your progress and cost you the game.
 
These "gotchas" might sound intimidating, but fear not. Like any savvy coach, you can prepare your strategy. Read and understand each clause in your lease. Engage a skilled real estate attorney or an experienced commercial real estate broker to help you outsmart these challenges. Spot these blitzing linebackers before they sack you.
 
Next week, I’ll share some offensive plays to help you mitigate the “gotcha” impact. After all, the best defense is a good offense. Stick with me, and I’ll ensure you're not only playing the game but also taking home the victory. Stay tuned!
 
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.
 
 
 

Essentials For Leases

The pace of mergers and acquisitions in Southern California has been frantic for the past five years. With interest rates on the rise, this rabid appetite for businesses has cooled somewhat but is still well ahead of historical numbers. If you doubt for a moment what I say, think about the company from whom you draw a paycheck. Have they recently recently been sold? If you own your own business - I’m sure your inbox has been flooded with private equity groups looking to sign a confidentiality agreement to take a peek at your books and records.
 
Whenever a merger or acquisition occurs, commercial real estate bobs in its wake. Recently, I had the experience of reviewing a lease that was structured upon the sale of an operating company. Candidly, there were some elements included in the lease which make a sale of the building highly unlikely in case the family decides to go that direction.
 
Today’s column addresses some important considerations in a lease that is structured with a purchaser of your company. In this narrowest of circumstances, I am assuming the entity that purchases your operation remains in residence in a building that you own.
 
Assignment and Subletting Clause: If the purchasing entity decides they want to move locations or shut down the operation, they might want to sublet or assign the lease to another party. A lease should include the terms under which this is permissible. As a landlord, you generally cannot refuse a sublease arbitrarily. Your approval must be reasonable and should be based on some objective considerations such as a net worth of the new entity not less than the previous.
 
Lease Term and Extensions: The term of the lease is also a crucial factor, typically aligning with the strategic plan of the group that buys your firm. Option periods - if structured properly - allowing the tenant to extend the lease term can be a beneficial aspect. I would suggest tying options to renew to the than prevailing market conditions as opposed to some fixed amount. Remember, options are to the benefit of the occupant and not you as the owner. Therefore, tying extensions to prevailing market conditions protects you.
 
Rent Amount and Escalations: The lease should detail the initial rent and any escalations over time. Annual increases in rent are a must. Generally, these days we see annual rent increases in the 4 to 4 1/2% range. Yearly bumps are loosely tied to inflation. I would not recommend, however, aligning rent increases with changes that occur in the consumer price index as the calculation becomes challenging.
 
Tenant Improvements and Maintenance: The lease should clarify who is responsible for maintaining the property, including any necessary repairs or improvements. As an owner of the building, you would ideally have the occupant be responsible for maintaining your building. At the start, you may need to warrant the condition of certain systems such as the roof and the heating ventilating and air conditioning. I’ve seen certain circumstances where the occupant requires the owner to address all of these at the beginning of a lease term.
 
Right of First Refusal or Option to Purchase: A right of first refusal can give the tenant an opportunity to purchase the property if the you decide to sell. Similarly, an option to purchase provides the tenant with the opportunity to buy the property at a predetermined price. I would suggest granting neither of these, as once again, your flexibility as the owner of the property is diminished. As an alternative you could consider a right of first offer which gives your occupants first crack at purchasing the building if you decide to sell it.
 
Business Continuity Provisions: In case of a disaster (fire, flood, etc.), a good lease should define how quickly repairs will be made and who is responsible for them, whether rent abatement will occur, and how long the lease will be extended to make up for the downtime.
 
Termination Clause: This outlines the conditions under which either party can terminate the lease, as well as any penalties for early termination. Depending upon the size of the company that requires your enterprise, you may need to deal with a termination clause. I generally advise against termination clauses as you must take a look at the worst case scenario that your occupant will terminate at its first opportunity. Termination clause limits the lease term that you sign with the occupant and reduces your cash flow and potential ability to finance the building.
 
Insurance and Liability: Clearly define who carries the insurance on the building and who is responsible for liability issues that may arise.
 
Environmental Considerations: If the operation of the business involves the use of substances that could potentially cause environmental damage, the lease should clarify who is responsible for remediation.
 
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.
 
 

What Can The NBA Finals Teach Us About Commercial Real Estate

The NBA finals start in a couple of days. I generally lose interest when the Lakers are no longer in it - which means I’ve not cared for a week or so. Plus, there are so many other things to focus on this time of year - the start of summer, Dad’s day, graduation, another school year completed, upcoming vacation, three day summer weekends, and lots of gray days. Yeah. It’s hard to complain about SoCal weather but cmon. A day of sun would be nice. My thoughts returned to the NBA as the stage is now set. Miami v Denver. A television network nightmare. I’m guessing the suits would’ve preferred LA v the Celtics with their rich history of playoff battles. You know Magic and Bird were pining and hoping for a rematch. But here we are.
 
You may be wondering what any of this has to do with commercial real estate. Indulge me while I draw some comparisons.
 
It's a LONG season: Just like the NBA season, commercial real estate deals often require a significant amount of time to unfold. From identifying opportunities, conducting due diligence, negotiating terms, and finalizing transactions, the process can be lengthy and complex.
 
No lead is safe: In the NBA, teams can quickly turn the tide of a game and overcome large point differentials. Deals can have unexpected twists and turns. Motivations change, unforeseen challenges arise, and market conditions ebb.
 
Home court matters: In basketball, playing on your home court can provide a distinct advantage due to familiarity with the environment and the support of the home crowd. In commercial real estate - location plays a crucial role. The right address can significantly impact the success of a business.
 
Teamwork and Collaboration: Just as NBA teams require teamwork and collaboration to succeed on the court, commercial real estate deals often involve multiple parties working together. Transactions typically involve buyers, sellers, brokers, lenders, attorneys, and other professionals who must work together to reach the closing table. Effective communication, cooperation, and coordination are essential for successful outcomes.
 
Strategy and Game Plan: NBA teams develop game plans and strategies to maximize their chances of winning. Investors and developers formulate approaches to identify and capitalize on market opportunities. They assess trends, analyze financial data and evaluate risks.
 
Adaptability and Flexibility: In the NBA, teams must adapt to various situations, including different opponents, match-ups, playing styles, and game situations. Required are the same in the commercial real estate industry. Market conditions, regulations, and economic factors can change, and successful professionals in the field need to be responsive and adjust their strategies accordingly. Adapting to shifting trends and finding creative solutions are crucial for sustained success.

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.

Rep agreements

As commercial real estate agents, our assignments are memorialized through agreements - either agency or representation. In the former, an owner engages us to procure a buyer or tenant for her vacant building or sell an occupied one - referred to as a leased investment sale. The latter tasks us with finding a location for an occupant to rent or purchase. 
 
Owner representations are also known as a listings. This contract underlies virtually all of the signs you see advertising a property and certainly any in the commercial multiple listing services such as AIR or CoStar. If a broker is involved - it’s imperative that such an understanding exists and outline the duties and responsibilities of each party - broker and owner. In real estate transactions, a listing agreement is a contract between a real estate broker and a property owner. This agreement gives the broker the authority to act as the owner's agent in the sale or lease of the property. The term "exclusive" means that the owner agrees to work solely with the broker for a specified period of time to try and sell or lease the property.

There are typically three types of exclusive agreements: exclusive right to sell or lease, exclusive agency, and open listing - by the way all referred to an agencies. 
 
Exclusive Right to Sell or Lease: In this agreement, the listing broker is given the exclusive right to earn a commission by representing the owners and bringing a buyer or tenant, either through another brokerage or directly. The property owner pays both the listing and selling broker's fees.

Exclusive Agency: In an exclusive agency agreement, the listing broker has the exclusive right to represent the property owner. However, the owner retains the right to sell or lease the property themselves without obligation to pay a commission, unless the broker brings a buyer or tenant. 

Open Listing: Though not exclusive, an open listing agreement is a non-exclusive contract, meaning the owner can hire as many brokers as they like. The commission is earned only by the broker who brings a buyer or tenant. 
 
An agreement called a tenant or buyer representation authorizes the broker to represent the tenant or buyer in their search for a new space, negotiate lease or purchase terms on their behalf, and often also may include handling other aspects of the transition such as planning and managing the move.
Much like listing agreements, tenant or buyer representation agreements typically specify the broker's responsibilities, the duration of the agreement, the geographic area covered by the agreement, the compensation that the broker will receive, and other terms and conditions of the relationship. In these types of arrangements, it's especially important for the broker to fully understand the needs of the client. For instance, a manufacturing firm may have very specific power requirements, zoning regulations, and more.
 
Preceding a Tenant or buyer representations could be anything from a company growing and needing larger facilities, to a business downsizing or restructuring its operations, to an operation relocating to a different area. These transitions can often require expert help to manage, particularly when it comes to finding suitable new locations, negotiating leases or sales, and managing the move itself.
 
Among the two understandings  - an agency obligates the owner to pay a fee if certain conditions are met - price, time frame, terms, etc. - whereas the rep agreement asks the agent to seek compensation from the owner as well - in some instances by cooperating through an agency. Yes. That’s correct. By engaging a practitioner to source an address, no resulting fee is promised. In effect, the occupant gets professional representation for no charge to the occupant. What if an owner refuses to pay an occupant’s rep, you may be wondering? The short answer is he’s out, scout. 
 
You may be curious why all occupants wouldn’t proceed in this manner? After all, they get the expertise of a commercial real estate professional for free. I’d offer these reasons as possibilities:
 
Control: Some businesses may prefer to handle the process internally to maintain control over every aspect of their move.

Costs: Even though the broker's fee is usually paid by the owner or landlord, the cost may still be reflected indirectly in the lease or purchase price.

Confidentiality: Some companies might prefer to keep their property searches and moves confidential until they are final, which can be easier to manage without involving external parties.

Complexity: Some businesses may have very specific or complex needs that they believe they can manage better internally.

Past Experiences: A company may have had a negative past experience with a broker and may choose to handle the process internally as a result.
 
In conclusion, while there are many benefits to using a commercial real estate broker, the decision ultimately depends on the specific needs, preferences, and experiences of the individual owner or occupant.
 
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.