Gross vs. Net Leases. Rent is the dominant continuing connection between a landlord and a tenant. Almost always, all expenses arising out of real estate development are paid by tenants – taxes, insurance, maintenance and other operating costs, environmental costs, and the rest. These costs may already be included in the initial rent. In such a case, unless the lease is for a very short term, the tenant will thereafter separately pay the amounts by which taxes, insurance premium, and maintenance costs increase over the “base year” cost of those items. The base year is almost always the first year of the lease term. So, it doesn’t matter if the initial rent has already taken into account the then current taxes, insurance premiums, and maintenance costs or whether it doesn’t. When they are included, the rent is higher and the tenant only pays subsequent cost increases – that’s called a “gross” rent lease. When the rent doesn’t included these initial “pass-through” expenses, the tenant will pay, as “additional rent,” its entire share of the cost for taxes, insurance, and maintenance over and above the seemingly lower rent. Leases employing this latter approach are frequently referred to as some form of “net” lease – “triple net” (NNN), “absolute net” or “net.” Unfortunately for the inexperienced practitioner, those terms (and similar ones like them) mean little because, from their “nickname” alone, they cannot tell who is responsible for paying the costs to fix the building’s structure or flooring or items of similar character. As a result, it is imperative that anyone preparing a lease find out “who pays for what.” [Read more…]
How Complicated Can We Make It?
Last week, we presented a wonky piece about present value calculations and their use. We won’t repeat that or extend those thoughts this week, but within last week’s quantitative jungle was a qualitative thought. Basically, we showed that stepping through annual rent increases doesn’t really produce a much different “total rent” than “keeping it simple” by using a level, average rent over the term of the normal lease. Today, we will spit out some other places where “going complicated” or trying to “refine” the financial terms in a lease also show little benefit and some offsetting detriment.
Before we do so, here’s a little more about setting rent. Last week, we suggested that instead of doing a five year lease with per square foot rents of $10, $11, $12, $13, and $14 over the five years, using the average rent of $12 per square foot would be almost the same in “present dollars” as using the $1 annual increases. We thought a reader or two would point out that there are non-economic reasons to use a graduated rent table. We would point out, that aside from the gender clause (and the like), all provisions of a lease are economic. No reader pitched in. So, we’ll do so (a little) on our own. [Read more…]
PrintAre You Tired Of Arguing About Percentage Rent For Internet Sales?
We think too much time has been wasted over the issue of “internet sales” in the context of percentage rent. A long time ago, Ruminations shared some thoughts about the principles behind what should and what shouldn’t be treated as part of a tenant’s gross sales for percentage rent purposes. That blog posting can be seen by clicking: HERE. In that posting, we promised that the “whole subject of “internet” and similar sales will be tackled by Ruminations, but not today.” That was then; this is now.
Today, breaking with our tradition (as can be verified by reading our 329 previous blog postings), we’ll be “record” short and still suggest a practical approach to handling this over-argued, over-negotiated issue. It is based on our belief that if the “location” or the “symbiosis” of the landlord’s project (read that: shopping center) added value to a sale, and if the tenant agreed to pay percentage rent in the first place, then orders placed at the store or paid for at the store or fulfilled using the store’s inventory, should be credited as a sale from the store.
Now, if we wanted to write this posting using our usual 1500 to 2500 words, we would offer a definition for “gross sales.” After all, it seems to us that no two lease forms use the same definition. It also seems that most leases use a definition of gross sales drafted by a committee. For those unfamiliar with this disparaging characterization, it is derivative of this figure of speech: “A camel is a horse designed by committee.” [Read more…]
PrintA Management Fee Puzzle For Tenants
It appears to be generally accepted, though we don’t know why, that management fees are validly included within common area costs (a.k.a. “operating expenses”). We take comfort in something that John Stuart Mill wrote in On Liberty: “It is as certain that many opinions, now general, will be rejected by future ages, as it is that many, once general, are rejected by the present.”
To Ruminations, management fees should be treated as a cost of ownership, not an expense for items that benefit a tenant. The property owner can choose to self-manage what it owns or, in the alternative, it can do little or no work and treat its shopping center or other property as if it was a share of stock in General Motors. It is one thing to seek recovery for the administrative overhead cost of managing the common areas, but quite something else to seek recovery for the cost of managing tenants, working on leasing of the property, dealing with financing issues, bookkeeping, preparing tax returns, and for the performance of similar tasks. [Read more…]
PrintWhat’s So Gross About Sales?
If the term “Gross Sales” had an intuitive meaning, we wouldn’t have had grist for today’s mill. And, thousands and thousands of us wouldn’t have the opportunity to write our own definition for that term. What a sad world that would make!
Percentage rent provisions are common and almost always rely on the starting concept of “gross rent.” But, while “gross rent” might have a generally understood meaning outside of the leasing community, that certainly isn’t the case inside the leasing community. If it had a common meaning, it would be an undefined term just as are most of the words and terms found in leases (and other agreements). Just think of this: we don’t define every word in our agreements (such as leases and mortgages); we rely on common understanding. That’s true even where words succumb to a choice of definitions. In those cases, many as they are, we understand those words and phrases in the context where found.
We’re not talking about “gross sales” as the number to which the “percentage” is applied because, at the end of the day, no one applies the “percentage” to “gross sales.” We apply it to an “adjusted” sales figure. Wherever we start as “gross,” you can be sure you’ll find a list of deductions or exclusions. These are two different “don’t count these” concepts, though, at the end of the day, their effect is the same. The “number” against which the “percentage” is applied is reduced by deductions and exclusions. [Read more…]
PrintWhat’s In A Name? Gross? Net? Does It Make A Difference?
Other than giving a general sense of the way the lease deals with variable costs of operating a rental property, the labels, “gross lease” and “net lease” give no usable information. A good rule when it comes to preparing a lease or when reviewing a lease is to look at each obligation and ask two questions: “Who does it? Who pays for it?” In the truest of “net” leases, the tenant does both. You’ll see that most often for a single tenant property where the leased premises include all of the land as well as the building. That can come about in a number of ways, most often when the tenant developed the property and then sold it to an investor (a sale-leaseback). It is also common when a developer does a build-to-suit project for the tenant. Less often, but not rare, is where an existing single-tenant property is leased. In each of those cases, the overwhelming “rule” is that the tenant will do all of the work at its own expense. A very common, though limited exception, is when it comes to the building’s structure and, less often, the building’s roof. A “smart” exception would be that the landlord maintains the property insurance, though the tenant pays that cost. Such a lease is rightly called “triple net,” “net” or, as Ruminations prefers, ‘absolute net.” [Read more…]
If You Are Going To Do Percentage Rent, Do It Right (The Rest Of The Story)
Last week, we wrote about 65% of what we wanted to say about percentage rent. Today, we’ll write the other 65%. Jumping right in:
Let’s say a party goods store expects to, and actually does, have sales of nine million dollars in its first twelve months of business. The tenant knows that because it is moving from the same size space across the street. If sales were spread evenly over the year it would amount to $750,000 a month or $2.25MM a calendar quarter. Now, Halloween is the big, big one for a party goods store. The year-end holidays are pretty big too. In fact, one can expect that instead of the final quarter of the year accounting for 25% of the year’s sales, it will account for 45%. Let’s call that $4,050,000 or $1,350,000 each month. Yes, October will be bigger than either November or December; November will be smaller than December. [Read more…]
PrintWhat’s The Percentage In Paying Percentage Rent?
First, we’ll define “heresy”: dissension, dissent, nonconformity, heterodoxy, unorthodoxy, apostasy, blasphemy, freethinking – opinions profoundly at odds with what is generally accepted. Now, we’re going to write a few things about “percentage rent,” beginning with a heretical view, “Why should a tenant pay percentage rent in the first place?”
Mind you, we’re not talking about a deal where the entire rent is a function of a tenant’s sales; we’re talking about the usual situation where the tenant has to pay rent even if it sells nothing. [We know of a mail order merchant maven who regales everyone with a story about the biggest flop item he ever handled. The story he tells is that he sold three units and got six returns.] Why should a landlord be a partner on the upside, but not on the downside? Ruminations has written about the concept that, in exchange for money paid as rent to a landlord, the tenant gets exclusive possession of the premises until an agreed-upon date. It’s like buying the premises with the obligation to re-convey it on that date. Further, think about a fairly common lease provision: “landlord and tenant are not partners, joint venturers, etc.” [Read more…]
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