It’s The Occupancy Cost, Not Just The Rent, Stupid

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 Sitting, as we are, in the northeast, with what seems to be a steady barrage of snow and ice storms, our thoughts naturally turn to “occupancy costs.” Before readers call for the white coated bearers of big nets to take us in, let us explain. But, first we’re going to Ruminate a little more.

At one time, the prices quoted by hotels and airlines could be held next to one another to find a good deal. No longer. Now, even they have “unbundled.” That would be fine if it were easy to “build and then price” your own travel package. But, it isn’t. [Want a pillow, a movie, and a hummus platter?]

Shop for a rental car today. Look at the web price and then get to the counter: “return the tank full; pay $9.00 a gallon; buy a tank from us at $3.35 a gallon; add a driver; return an hour late; and, it goes on an on.” When you go to ebay.com to buy something, be sure to sort by “price plus shipping.”

Now to leased space. The pricing system appears to be the same model as that adopted by airlines. The stated rent is similar to a published airfare in that both are only a starting point.  With air travel, you then add-in the baggage fee, your snacks, and perhaps a seat that you can almost fit into. At least one airline has proffered a restroom charge. Want a pillow, there’s a price.

The comparison between the cost to rent a space and to travel on an airplane is far from perfect, primarily because when you fly, you can avoid some of the charges by not taking baggage or bringing your own food or pillow. When space is rented, you are faced with charges, above and beyond the quoted rent, for taxes, operating expenses, insurance, advertising, merchants’ associations, marked-up energy charges, rent tax, and more.

You can’t compare prices location to location by looking at the rents alone. It’s not just a difference between “net” leases and “gross” leases, whatever those terms might mean to you (because, they’ll mean something different to the person at the desk across the aisle). You need to look at what is called “Occupancy Cost.” Yet, all too often, we receive a negotiated Term Sheet listing the base rent and nothing more in the way of those “other costs.” Well, that’s not strictly true; our national and regional tenant clients often get estimates of those “extra” costs printed right on the Term Sheet. Some get operating expense histories.

But, woefully, the most vulnerable – small space, small budget – tenants rarely get that information and rarely ask for it. That is, they rarely ask for it before they get their first billing for “additional rent. Afterwards, it’s a different (sad) story. Why is that?

Ruminations thinks tenants and the brokers they work with should get this information right up front – at the time alternate rental spaces are being evaluated, i.e., when the Term Sheet is prepared. We also think that those who negotiate leases on behalf of tenants should insist on receiving a forward budget and historical cost information, and then pass that along to the prospective tenant. There isn’t any need to give advice beyond telling the recipient how to read the information.

Why does this thought come to us at this particular time? Well, there are three reasons, only one of which will tie in to our introductory remarks. First, this posting is timed to precede a national holiday, Presidents Day, and that’s a slow week for readers and their responses. A segment of our readership gets jammed up on the day after a holiday and set that week’s blog aside with the delusion that it will be read “later.” So, we’ve made it uncharacteristically short and less than ordinarily dense.

Second, we get a small, but steady stream of calls from tenants we never represented, coming to us on their own or sent to us by their attorney or accountant, asking us to figure out if their landlord is charging them for a proper item (and if the calculation was proper). In a large majority of cases, the billings are valid under the lease. Some involve what the tenant comes to view as a “trap,” but those were almost always anticipatable when the lease was negotiated.

Lastly, and here is the tie in, we and those around us are just plain tired of all the snow and ice we’ve experienced this year (thus far). Right now, it is the inconvenience and disruption. Later, however, it will be the snow and ice removal billings. We’ve never seen a cap placed on those costs and don’t expect to ever see one. Perhaps, an insurance-type product will become available and it will, for a constant multi-year premium, cover the cost of snow and ice removal. But, for now, tenants and landlords in the northeast, in the mid-west, and (to the consternation of some of them), in the southeast, expect a shock at reconciliation time. It occurred to us that we don’t know how to figure these extraordinary, though hardly unanticipatable, expenses into an estimate of operating costs.

What’s the take-away? If you are a tenant or represent a tenant, get those figures before the lease is signed.

As to more “substance” (in line with what Ruminations readers have come to expect), there is always next week (when we think we’ll be Ruminating about negotiating mortgage term sheets), and there are these blog postings from the past describing some unexpected issues found in “additional rent” items. To see them (possibly, again), click: HERE, HERE, HERE, and HERE.

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Comments

  1. Great article. The problem is that most Landlords won’t provide their operating costs (“opening part of the kimono”) to a broker representing a tenant, until a ” real offer response” is made to the Landlord’s very “cursory” response to the tenant rep’s RFP.

    Variable cost swings must be realized as “the cost of doing business” at a particular
    location and should not impact negotiations in the rent and terms of the deal.

    Howard Applebaum, Corporate America Realty & Advisors

  2. Ira, it’s not only important to get costs up front, even if estimates, but to get a fair idea of what constitutes “CAM” and “taxes”. When the leases arrive, many are shocked by what is included in these costs. When the deal penciled out during the negotiations, that may no longer be be true later on. also, even where costs and increases are fixed, many retailers are misled into what drove those numbers. By then the Landlord says: “Well, you approved the economics of the deal at those fixed numbers so what’s your problem?” Well, the tenant didn’t realize that 25% of the CAM estimate paid for the renovations and expansion of the mall. Or that the tax figure included the landlord’s income taxes. Since most landlord leasing agents don’t carry the lease definitions around with them at the LOI stage (and they might not even know what they say), it’s difficult for a retailer to protect himself unless he reads the lease first and by then, one might as well skip the LOI process (which we know is impractical) Thus, it’s left to the attorneys to try to reverse the bleeding – an unenviable position.

  3. Taking the time to thoroughly review the Lease document and having a capable attorney review/revise any onerous language is worth the time and effort. Realistically, Landlord’s leases are slanted to the advantage of the Landlord and the Tenant must be diligent in understanding the commitment that they are making. It is a reasonable expectation that the Landlord have adequate funds to be able to maintain a property in a safe, effective, clean environment and have these cost covered. NNN expenses are typically identified and quantitative and the Landlord will not pass through expenses which are not permitted. As a commercial Realtor with over twenty years experience in negotiating Leases I’d rather see the Tenant with a NNN lease which defines the Landlord’s responsibilities of care to be provided; rather than a Gross lease wherein the Landlord refuses to maintain the property because they don’t have adequate margin to provide keeping the property in good order.

    • Deb:

      You said “I’d rather see the Tenant with a NNN lease which defines the Landlord’s responsibilities of care to be provided; rather than a Gross lease wherein the Landlord refuses to maintain the property because they don’t have adequate margin to provide keeping the property in good order.” I concur wholeheartedly. If they insist that I pay extra in the rent to maintain their property then I expect them to maintain the property.

      Further, I would much rather see a NNN lease in order that I am able to negotiate (i) what constitutes common area; (ii) what charges are legitimately passed on to me; (iii) what charges may NOT be passed on to me; (iv) what charges the administrative fee will apply to; (v) what my audit rights are; and, (vi) what minimum standard of care must be applied by the landlord in maintaining the property with my money.

      In a gross lease, it is very difficult to get a landlord to identify the expenditures he/she is including in the rent, nonetheless negotiate what may or may not be passed on to the tenant or establish an audit right to make sure that the tenant isn’t being over/wrongly charged. Also, in a gross lease with pass through increases, the landlord gets the benefit of both the pass through increases and a base rent increase that is compounded on top of a gross rent number that includes the NNN base charges. So they get a double dip. And many times, the landlord who writes the gross lease also has language that says “Landlord shall maintain the property in a manner determined by Landlord in its sole discretion.

      Many small tenants say “I don’t want one of those NNN leases where I have to pay those extra charges.” Clearly, they don’t understand that they’ll pay those charges one way or another – whether its a gross lease or a net lease. And with a gross lease they have far less control of their own destiny.

  4. George Vaill says:

    Howard:

    You said “The problem is that most Landlords won’t provide their operating costs (“opening part of the kimono”) to a broker representing a tenant, until a ” real offer response” is made to the Landlord’s very “cursory” response to the tenant rep’s RFP.”

    My experience is substantially different. I’ve been negotiating leases for 39 years. In the last 22 of those years I have specialized in representing dentists and veterinarians who pay me to negotiate the LOI. And in that process I have used my customized RFP form to gather information WAY above and beyond what most people seek at the RFP stage. It is a check-the-block, fill-in-the-blank form which is designed to ferret out as much detail about the property opportunity as possible BEFORE an offer is made. If there are going to be potholes in the road, I’d rather discover them BEFORE I drive into them.

    Is the form exhaustive? No. Is it NEARLY so? Yes. Does it delve into a specific definition of what net charges may be legitimately passed on to the tenant? No. But a subsequent request for operating expense histories DOES go a long way toward better understanding how “adventuresome” a landlord might be when it comes to levying those charges down the road.

    Having used this form more than 3,000 times in the last 22 years, I have encountered VERY LITTLE resistance from listing brokers or landlords. I tell them that I need authoritative answers as we will be relying upon this information in order to properly understand the value of their property opportunity. Sometimes the form is returned without all of the requested info. In that instance, I push back and reinforce that we cannot proceed unless and until we have ALL of the info requested. Invariably, I end up with the info I need in order to properly guide my clients.

    I tried to “snip” a picture of my form and paste it below but it would not paste here in a way that is easy to read. So the spacing is way off in what I have pasted below. But if you read through it, you’ll see that this is about securing DETAILS – in which the devil resides.

    Here is a pasted version of the form. ————————

    Name___________________________________ ___ Prop Owner ___ Owner’s Employee ___Broker ___ Prop Management Rep
    Company__________________________________Phone____________________ Email ______________________Date____________
    Property Name/Address______________________________________________________________________Space/Suite #__________
    Total BUILDING Size _______________SF ___ Office Bldg ___Strip Mall ___Medical Building ___Mixed use ___ Free Standing
    Building is ___ Years old or ___Under construction or Construction will start _______ and expected finish date is____________
    There are #____Bldgs in complex ___Space is a condo There are #____condos in the complex Landlord owns #____ of the condos
    Building has _____ Floors There is ___Interior Common Area ___Elevator ___Atrium Lobby ___Covered parking ___Basement
    Anchor Tenants are ______________________, _______________________, Approximately ____% of the property is currently vacant
    Space is ___ already subdivided ___must be subdivided out of a larger unit that is _________SF
    Space is ___In line ___End cap ___In Basement ___Ground floor ___Upper floor Entrance is ___From interior lobby ___From outside
    Space USABLE area is _____________SF Common area loss/core factor is ______% Space RENTABLE area is ____________ SF
    There are #______Parking spaces on site ___Paid parking #______ Parking spaces are currently dedicated for exclusive use by others
    Tenant may have typical retail store type lighted signage on building ___ Front ___Side ___ Both ___On Monument/Pylon
    Tenant may run pipes, wires, etc. above the ceiling in the space below the floor of the Premises ___Yes ___No In the slab ___Yes ___No
    Tenant may use the basement for storage and for installation of dental compressor, vacuum unit and other equipment ___Yes ___No
    ___ The Property IS zoned for dental ___ Is NOT zoned for dental ___Needs a Special Permit ___Needs a Change of Use Permit
    Other Dental use or zoning restrictions/requirements_____________________________________________________________________
    Property is served by ___ Public sewer system ___ Public water supply ___ Private septic system ___ Private water supply
    There may be an issue with how much wastewater a dental tenant may put into the sewer/septic system in this property ___Yes ___No

    – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – TERM, RENT & EXPENSES – – – – – – – – – – – – – – – – – – – – – – – – – –

    Landlord wants an Initial Term of ____Years and offers ____Renewal Options of ____Years each Base Rent starts at $_______________
    During the Initial Term the rent will increase____________________ During the 1st Option the rent will increase ___________________
    During the 2nd Option the rent will increase ____________________ During the 3rd Option the rent will increase ___________________
    Landlord offers _____ Months of Free Rent during build out and a Tenant Improvement Allowance of $______/RSF or $______ /USF
    This is a ___NET Lease ___GROSS Lease ___ MODIFIED GROSS Lease ___FULL SERVICE Lease
    CAM ___Tenant pays PR share ___Included in Gross Rent ___Tenant pays share of increase over Base year______ or $______Stop
    INSUR ___Tenant pays PR share ___Included in Gross Rent ___Tenant pays share of increase over Base year______ or $______Stop
    TAXES ___Tenant pays PR share ___Included in Gross Rent ___Tenant pays share of increase over Base year______ or $______Stop
    Estimated Charges for CAM $_____/sf RE Taxes $_____/sf Fire/Casualty Insurance $_____/sf Condo Fee $______/mo
    Above charges based on ___Previous History ___1st Year Estimate RE Taxes based upon a ___ Partial Assessment ___ Full Assessment
    HEAT/AC ___Separately Metered to Tenant ___ Included in Gross Rent ___ Included in CAM ___ Billed separately by Landlord
    WATER/SEWER ___Separately Metered to Tenant ___ Included in Gross Rent ___ Included in CAM ___ Billed separately by Landlord ELECTRICITY ___Separately Metered to Tenant ___ Included in Gross Rent ___ Included in CAM ___ Billed separately by Landlord
    SPACE JANITORIAL ___Tenant’s responsibility ___ Included in Gross Rent ___ Included in CAM ___ Billed separately by Landlord
    DUMPSTER ___Tenant’s responsibility ___ Included in Gross Rent ___ Included in CAM ___ Billed separately by Landlord

    In addition to the above charges, Tenant must pay the one-time and/or recurring fees below. (Please provide details in the blank provided.)
    ___Parking Fee, ___Marketing Fund ___Construction Back Charge ___ Construction Mgmt Fee, ___Pylon Sign Fee, ___Condo Fee ___Sewer Hookup/Impact Fees ___Special Assessments ___ Municipal Tax ___County Tax ___Sales Tax ___Transaction Tax ___None

    Details and $ Amounts:_____________________________________________________________________________________________

    – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – CONDITION OF SPACE – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
    ___ Not built ___ Built but never occupied ___ Was occupied but now vacant for ____ months Now occupied but will be available_______
    Now built out as: ___ Dental office ___ Other office (non-dental) ___ Retail ___ Wide open bay Previous use was _________________

    Space will be delivered with the following improvements either ___ as they now exist or ___ as they will be completed by Landlord prior
    to delivery – at no cost to Tenant or deduction from the Improvement Allowance.

    ___ 4 Demising walls ___Studs only or ___Ready for paint ___Insulated to the roof deck ___ Doors (front & rear) ___Windows
    ___ Dirt floor ___ Gravel floor ___ Concrete slab ___Wooden sub-floor ___ Carpet/Tile ___ Ceiling ___ Lights (#____) ___ Sprinkler
    ___ Toilets in space (# HC____) (# Non HC____) ___ Exhaust vent installed Meters in space ___ Electric ___ Water ___Gas
    Size of water line now stubbed in space ____” or ___None. Must be pulled approximately ______ feet to the space
    Size of waste line now stubbed in space ____” or ___None. Must be pulled approximately ______ feet to the space
    Size of gas line now stubbed in space ____” or ___None. Must be pulled approximately ______ feet to the space
    Size of electric service now wired to a disconnect in the space: _____ amp ___ phase service ___ No electric service wired to the space
    Electric service must be pulled approximately _______ feet to space ___ Electric conduit provided to space from power source
    HVAC is ___ Space dedicated or ___ Central Plant or ___Shared with #___Other tenants or ___No HVAC system in space
    HVAC is ___ Operational ___ Distributed or ___ Central Trunk only or ___ No Trunk or ___ VAV Boxes (#___)
    HVAC is ___ Years old Sized at _________ Tons capacity Has (#____) Zones After hours HVAC charge ___(Y or N) $____/hr

    RAW space will have ___dirt floor ___ 4 walls not closed in ___ doors and windows ___ sprinkler main in T-grid with turned up heads
    Other RAW space improvements:____________________________________________________________________________________

    Comments:______________________________________________________________________________________________________

    GEORGE VAILL DENTAL OFFICE LEASE NEGOTIATIONS
    http://WWW. GEORGEVAILL.COM

  5. While we deal with real estate law in Florida, this blog, along with the comments are very insightful. I agree about knowing about costs BEFORE a tenant signs a lease. Great analogy to what airlines do!

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