We’re not sure that last week’s blog posting was a satisfying one for more than a small part of the Ruminations audience. Long-term readers will know that we are not deterred by that. After all, for those that have not yet reviewed our page-end disclaimer, here it is, moved to the top:
Disclaimer: Ruminating and rambling can easily be confused. There are a lot of dictionary meanings for “ruminating.” Our favorite (today) is: “to turn a matter over and over in the mind.” That sounds a lot like “rambling.” For that reason, no one should mistake anything written on this blog as resembling legal advice, even when written by an attorney —not the original blog entries, and not any comments. This blog is intended to be a discussion board for concepts–some flaky, some not–that affect Retail Real Estate Law. Please join that discussion.
We think that understanding underlying principles, such as the issues involved in allocating operating expenses, makes for better deals, better documents, and better agreements. And, to the extent each party has bargaining power, the real driver of an agreement’s business terms, knowledge is power.
The examples we explored last week all highlight the difficulty of being precisely fair when it comes to allocating costs among parties who share, but don’t “consume,” services proportionately. In the multi-tenant retail project context, i.e., when it comes to the burden and risks attendant to common area expenses (including shared utility services where that is the case), landlords are generally indifferent as to the manner by which the “bill” is shared among tenants (so long as the landlord doesn’t come up “short”). That’s not to say that some landlords aren’t perfectly happy to recover more than their actual costs, but it generally doesn’t matter which tenant pays what, so long as the landlord meets its recovery goal. Unless…
That is, unless a tenant with bargaining power creates a “situation.” What kind of “situation”? We’ll answer with an illustration based on a classic approach taken in anchor-based enclosed malls. Years ago, and still today in many projects, anchor stores, generally ones who “own” their own buildings and parking areas, won’t pay any portion of the mall’s maintenance bill. It doesn’t matter that many, probably most (but we don’t know) of their customers access the anchor store though the mall’s internal areas. Yet, by their refusal to cover any portion of the cost to maintain the mall’s interiors, this allocation shifts that entire cost to the smaller, interior tenants. The justification for this is presumably that the smaller tenants benefit from the customers drawn to the project by the anchor stores and thus the “extra” cost is worth paying. Many retailers, themselves “destination” stores, could successfully rebut such an explanation, but life isn’t “fair.” Like it or not, landlord or tenant, a tenant’s proportionate share of the “bill” will not match its actual share of the services covered by that bill.
Let’s look outside of the shared utility conundrum. Ground level retail space commands a higher per square foot rent than does basement or upper floor space. Ad valorem real estate assessments for rental space are based on the market rent for the taxed property. Thus, on a level by level basis, the “assessment” (if it were done on a floor by floor basis) for basement space will be lower than that for ground level space. So, how should a multi-level retail project’s tax bill be hacked-up? Should every square foot of a retail store count the same or should there be a “discount” for space on other than the ground floor level? Certainly, a lot of projects apply a formula adjustment for the lesser value floors, generally (but not universally) counting those floor areas at 50%. That adjustment factor assumes that the fair market rent for basement and upper level space is half of that for prime, ground floor space. Is that true? Is that how the 50% was actually determined or was it just a gut shot at “fairness”? What about projects where no such adjustment is employed? In such a case, how does one respond to a tenant taking a small “lobby” to serve its major space on a lower rent, lower tax value, floor? Giving that tenant a floor value adjustment will result in the landlord coming up short and will give the other tenants a slight discount in their own share of the tax bill.
What about a tenant taking space at the rear of a strip mall, such as a warehouse-style beverage distributor or a health club or a medical facility? These tenants may not use a proportionate share of the project’s common area features. In fact, they don’t really benefit from the synergy that is the core of the shopping center concept. They neither draw from the customers shopping at the center’s other stores, nor do they draw customers to those stores. Basically, they utilize otherwise unusable space. Should they pay a proportionate per square foot share?
Look, as with health care – “it’s complicated,” “more complicated than originally thought.” That’s why, after a great deal of hand wringing, Ruminations has concluded that where costs can’t be directly matched to use, such as with utility metering, and except where some rough approximation can be made, such as allocating tax shares based on rental values, the marketplace will adjust to the inherent unfairness of calculating proportionate shares based on floor area without regard the burden imposed by the particular use of that space.
When a tenant shops for space, the price it looks at is not (or should not be) the rent alone. It is (or should be) the occupancy cost for that space. Forget how the common area costs or taxes are to be calculated and focus on what they will cost. Recognize that it is as likely that a high services/utility consuming neighbor will be at the property as it is that a low one will appear. Protection comes from shifting the risk of unexpected changes to the landlord, the one who is making the decision as to who the next tenant will be. Variable costs (operating expenses, taxes, etc.) will increase year after year. The real question is how to avoid surprises. If taxes shoot up because the property becomes sharply more valuable, there is no reason why the landlord shouldn’t take a fair portion of that risk. After all, the property’s tax assessment corresponds to the higher rents the landlord can collect. Similarly, if the landlord chooses to dramatically boost the number of water-consuming users at its shopping center, that’s because it made good business sense for the landlord to sign those leases. Existing tenants shouldn’t subsidize the cost to change the tenant mix.
Well, now that we’re at the end of today’s rambling (and we’ll readily concede that’s what we’ve done), we feel pretty good. After all, our disclaimer warns readers that this is exactly Ruminations’ objective. But, another objective is to retain our thousands of loyal followers, so we’ll be returning to sharing our more concrete postings next week. Of course, for those whose who are “turning” the thoughts shared this week and last week “over and over in their minds,” that’s called Ruminating. Welcome to our world.
[Apropos of our May 21, 2017 posting: “Save A Tree – No More Paper Copies – No More Ink,” we just learned that on May 10, Fannie Mae, by an amendment to its Servicing Guide, is now accepting electronically recorded mortgages in lieu of original documents with “wet” signatures. This catches Fannie Mae up to Freddie Mac. Last September, Freddie Mac removed its requirement that it receive wet-signed documents when the mortgage has been electronically recorded.]
Hmm, you seem to think that Landlords can change their leases any time they please. Fact is, many leases can’t be changed for decades. The “lift” you presume from higher taxes is questionable – municipalities raise taxes based on their own formulas, that doesn’t necessarily equate to higher rents.
I read ruminations weekly, and value much of what you consider. But you have a reverse view of the commercial retail field. Many large retail tenants have far more bargaining power than most landlords – ever negotiated for a 1,500 sf Starbucks? Or Dollar Tree, Wal-Mart, Tim Hortons (I’m in Canada) – I could go on. I would very much like a level playing field, but major retail tenants do not play fair. And it is unreasonable for the mom and pop stores – or the landlord – to pick up the slack.