CIP Blog

Surely paying rent is easy, right?  All you do is write a check at the first of every month.  Piece of cake.   Yes it is easy. 

Rent:

In most leases, rent is paid to the landlord on the first of every month.  The language is very specific in the lease document as to how it is paid, when it is paid, to whom it is paid and what happens when you don’t pay it.   To make sure you don’t forget to pay your rent many landlords suggest, or require, automatic draft of all payments from your account. 

A couple of things to watch for…

• When you are starting a new lease make sure the rent commencement date is negotiated.  Rent rarely starts the day you sign the lease.  Do your best to make sure that rent does not start until you open for business or until your construction is complete.  Nothing can put a crimp in a business plan like paying for construction and rent at the same time.
• Negotiate free rent periods.  In this economy many landlords are giving incentives. Free rent is one of them.  Two to three months of free rent is not uncommon.
• Pay attention to late fees.  Rent is due the first but most late fees are not charged until the 5th of the month.  This is not a hard and fast rule but something to watch for.  Also, late fees can be as much as $25 per day. Those can add up quickly. 
• Load factor:  You may notice you pay rent based on “Rentable Square Feet”.  This is based on the amount of “Usable Square Feet” you occupy, multiplied by the load factor.  This is the percentage of the building taken up by the common area (restrooms, hallways, lobby etc…).  This varies from 0% to 20% depending on the building.  Learn your buildings load factor before signing the lease to make sure the rent is properly calculated.

 Operating Expenses:

These costs are defined as the amounts paid to maintain property, such as property taxes, utilities, insurance, repairs, maintenance, legal fees etc…These have more than a dozen names.  They can be referred to as CAM (Common Area Maintenance), NNN charges (known as triple net), operating expenses, pass throughs…you get the idea.  They are handled differently depending on the type of lease but to simplify the process we will look at basic retail and office leases.

Admiral Pointe-Common Areas

Office Operating Expenses:  In typical Class-A office leases the tenant pays a full-service rent.  The tenant writes one check each month to cover rent, utilities, CAM, etc…However, in the lease there will be what is called a “Base Year” or “Expenses Stop”.  This defines the amount of annual payments that goes towards operating expenses.  For example, if you pay $20.00 per square foot in rent in a full service lease your “expense stop/base year” may be $6.00psf.  At the end of the fiscal year the landlord will reconcile all the operating expenses.  If the operating expenses exceed $6.00psf the tenant will be required to cover the difference (Example: if it ends up at $6.05psf, the tenant will have to pay $0.05psf to reimburse the landlord).  But it goes both ways, if costs come in under your expense stop/base year the landlord is sometimes forced to writes the tenant a check for the difference.   

There are some leases that do not have operating expense stops; these are typically called Gross Leases.  There is no year end charge to the tenant; however, these leases typically include annual rent increases to cover the increase costs of services.

The Gallery on Kingston Pike

Retail Operating Expenses: In most retail leases these are called NNN pass through or Triple Net Charges.  It is the same scenario as offices lease only the rent and NNN charges are broken down into separate categories.  The tenant usually rights only one check per month for rent/NNN but the NNN charges are more volatile and fluctuate more year to year than an office lease.  Remember the retail leases often don’t include things like janitorial service, HVAC repair or light bulb replacement that you might find in office lease.

Protect yourself:  There are ways both the tenant and landlord can protect themselves from outrageous increases in operating expenses in both office and retail leases.  

• Put a cap on controllable expenses:  Landlords have the ability to bid out many of these services, landscaping, janitorial, insurance etc…this allows them to keep operating expenses lower.  In your lease try to negotiate a cap on year to year increases.  Most landlords can agree to around 7% per year.  Note:  Landlords can not control some expenses like taxes and utilities so these are excluded from this type of cap.
• Carefully read the section of your lease regarding operating expenses (it may be called Additional Rent, Operating Expenses, Rental Adjustments or Excess Operating Costs).  Some landlords reserve the right to charge administrative fees on top of the operating costs.  Try and negotiate these out of the deal if you can (its tough).
• Make sure the landlord provides you with a reconciled record of the operating expenses for each year and review it.  If expenses went up 10% make sure there is a reason for it.  
• Negotiate the ability to audit the landlord’s records, but be reasonable about it.  The tenant is paying the rent and the operating expenses so they deserve the right to review the costs.  This is done at the landlord’s or managing group’s office during normal business hours.  Depending on the way the audit rights are negotiated, if the operating expenses are incorrect the tenant can be reimbursed for the excess cost as well as the cost of the audit.

You might have noticed I used the words “typically” and “usually” often in this blog, this is because every lease is different.  Just about everything in a real estate lease is negotiable, these factors are no different.

Be diligent when reviewing these sections of the lease.  A property negotiated lease can save your business thousands of dollars per year.

As always, if you have questions please feel free to contact me at 865-584-3967 or jcazana@ciprop.com

Justin Cazana, CCIM

First a word of warning…commercial real estate leases can be MASSIVE!  I have negotiated leases that are ten pages and I’ve negotiated leases that are 110 pages.   Don’t let the size of the lease intimidate you.  You should have a commercial brokers and an attorney that will get through the finicky details that you may have never heard of; subordination, estoppel, force majeure and the like. 

Over the next few weeks we will delve into the world of commercial leases, everything from Assignment to Warranties.

First stop:  Term

Definition:  The period of time which something is in effect. Typically a condition specified in an agreement. 

Every real estate lease must have defined beginning and ending date to be legally binding.  It sounds quite simple.  A lease starts January 1, 2010 and ends December 31, 2010. 

The term can last any period of time from one week to 100 years (this is usually reserved for ground leases).  Typically they are for set periods but these times can be flexible depending on a number of factors. 

Some of these factors can be:

• Construction timing
• Governmental approvals
• Tenant delays, etc…

This is where things can get complicated.  Both the tenant and landlord will negotiate the lease with an eye to protecting their interest in the lease.  

Office space leases

For example, if a lease term, and rent, are set to being June 1^st and the landlord is doing construction for an office tenant in preparation for their occupancy, the tenant will often put in language stating that the term (and rent) will not being until construction is complete.  That way the tenant is not stuck paying rent if the landlord has not completed construction. 

In retail leases, where the tenant might be performing their own construction, the term may consist of language stating that the term commences on June 1^st or the first day the tenant opens for business, whichever comes first.  This protects the landlord from the tenant opening early without paying rent or the tenant never completing construction and hence not being forced into ever beginning the lease term.  

A properly determined construction schedule for both the tenant and landlord can alleviate many of these concerns.

Nine times out of ten the term is a simple starting point and ending point but it is important to have a commercial broker and attorney on your side when negotiating these details.  The reason many of these lease points are so hotly contested in because landlords, tenants and attorneys have been burned in the past by unscrupulous parties who prosper by taking advantage of the ignorant or inexperienced.   

As always, if you have any questions feel free to contact me at 865-584-3967 or jcazana@ciprop.com

Justin Cazana, CCIM

Commercial & Investment Properties