Long or Short? Think Hard About Lease Term

The lease on your facility is likely the first or second largest expense line item for your business. The lease term – the duration of the contract – is a fundamental as well as very strategic aspect of your lease. After thinking through your business plan and taking into account risks (and how to mitigate them), you will come to a natural conclusion as to what term length is best in your case. This goes both for franchisees assuming the liability by signing the lease as well as franchisors who create the master strategy for their brand.

Let’s look at two key dynamics of the lease term: long vs. short and options to renew.

Long vs. Short

The default lease term for a retail shop space is five years. This is a reasonable amount of time: long enough for a business to establish itself in a given location or, perhaps, demonstrate it doesn’t have the “legs” to keep going. From a landlord’s point of view, it is a “bankable” duration; that is, a sufficient amount of time for lenders to underwrite. Terms can be longer and shorter, of course, and there are pros and cons to both.

A long term lease – five years or longer – is more attractive to the landlord who covets a continuous stream of income without the interruptions of vacancy and leasing expense. In return, landlords will be more flexible with lease rate, lease concessions, and tenant improvement allowance when considering the possibility of a long term lease. There are benefits to the tenant, too. The negotiating leverage suggested above should also translate into lower rents, giving the tenant more control over what can be a very volatile expense item.

The “con” side of a long term is based on the precept of the lease as a liability. If circumstances change – which they most certainly can do – and you need or want to escape the lease because of business failure or the desire to move to a different location, a long residual term is a heavy weight to bear. The alternative is to sublease the space, but that puts you squarely in the real estate business, not doubt not what you envisioned when you installed your sign and opened your store. There is one instance where a longer residual term is a boon to the departing tenant: if the business is for sale, the lease term – assuming the rent is at market rent or lower – is an asset and adds value to the business.

The contingent liability of the lease is eased by a short lease term, but you will encounter more resilience from the landlord when it comes to rents, concessions, and the investment of capital for premises improvements. There is also the amortization of your own capital investments to consider, particularly for businesses such as restaurants, dental offices, or dry cleaners that require expensive electrical and mechanical systems for their operations.

Lease Options

Options to renew the lease are quite common: loved by tenants but not so much so by landlords. All of the benefits accrue to the tenant, since it is their “option” to exercise or decline. However, with the new FASB lease accounting standards coming down the pike, publicly traded companies will need to think twice about the complicated bookkeeping rules associated with rent expense projections before negotiating renewal options into their lease. But by all means, negotiate them and try to get the rent rate for the option period fixed in the lease, or at least adjusted by a defined factor such as the consumer price index.

In summary, let your business be the driver of the ideal lease term.

Stand Tall With Your Landlord

These are challenging economic times. We have seen them before and we will see them again. From our personal perspectives, they seem like they will never end.

Tenants -- large and small -- are under tremendous pressure. You signed a lease when the economy was booming and expectations were high for your new business or new location. You found a facility that fit your needs perfectly and negotiated a lease with a much bigger business enterprise than your own: the landlord. You were proud of yourself for establishing a fair market rent with periodic increases that were about the same as you had heard were typical for the submarket.

Now you are facing stiff headwinds. Your revenue growth did not keep pace with the business plan you shared with the landlord before lease negotiations commenced. In fact, you just lost one of your stable customers to bankruptcy and others are calling you with reduced orders. The rent is weighing you down and you fear the increase coming just two months down the road could sink you.

Does this scenario sound familiar?

Well, it's time to set your fears aside and realize that the landlord is feeling the same pressure to be creative and protect his real estate business interests. A failed tenant or broken lease is a vacancy with no rental income. The landlord wants to avoid this. With a modicum of understanding of the landlord's business, you can quickly convince him you are a tenant worth sticking with.

For the past 27 years I have managed property for landlords of all stripes and been a landlord myself. I will be offering a webinar in the near future providing no-nonsense tips on how to "classify" your landlord and sensible tactics on how to do business with them. If you would like to receive details on this opportunity to gain useful insights and ask those questions that have been nagging you, please add your comment to this blog or contact me directly at aaron.weiner@weinerproperty.com.

More to come!

So what's happening the the world of distressed real estate?

All owners of commercial real estate are curious about the trends in “distressed” real estate, whether they are one of the troubled owners or just wondering how all of this is going to affect the value of their property. The news media is reporting stats like two thirds of all commercial real estate loans coming due in the next year are underwater. This portends high rates of foreclosures and falling prices.

I attended the Distressed Real Estate Summit in Los Angeles on February 3. Panel after panel of phenomenal speakers gave the 500 attendees a good feel for what is happening out there today. Things have changed…dramatically.

The market mood and what is actually happening on the street is schizophrenic. Several speakers related the buoyant mood at the recent lenders conference in Vegas. Institutional debt is off the sidelines and itching to be invested. LTVs have gone from 50% just 90 days ago to 70%. But here is the “Catch 22″: nobody can agree on what “V” is today!

There are hundreds of billions in equity capital — what I like to call “dry powder” — also looking for worthy real estate assets to invest in. All of this debt and equity capital is targeting the few choice real estate assets out there, creating a bidding frenzy. Well located properties on the market are generating 30 to 50 offers. Cap rates are actually compressing as a result! If you are seeking an IRR greater than 12% on prime assets, you are out of the game. Can you believe it? I was stunned.

Lenders continue to “pretend and extend” and aren’t foreclosing as much as the vultures thought they might. This is exacerbated by the FDIC’s directive that lenders work out their loans with the borrowers. And this includes all of the CMBS (Commercial Mortgage Backed Securities) debt that is upside down out there: the special servicers (the administrators of these loans owned by countless institutions that own a sliver of each CMBS loan) are also approachable.

Amidst all of the excitement in the capital markets, the fundamentals remain grim for most commercial real estate; from worst to best, hotels, office, retail, industrial, and multi-family. Fundamentals will remain in the doldrums as long as unemployment remains high and job growth is absent.

What I took away from the day is that the next couple of years will be a roller coaster ride. Many investors, including the very big hitters are having doubts that the tsunami off distressed real estate opportunities will ever materialize. I think it is a windy road we’re on, with unpredictable weather ahead. Stay tuned.

A well written lease: the key to investment performance

Many investors are taking a fresh look at income producing real estate after reading that there may be great deals out there. Other investors are hanging on to their existing income real estate investments wondering if and how they will be affected by the vagaries of this vicious down cycle.

In either event, the focus is on prudent, professional management as it always is when real estate values are sagging. Believe me…I’ve been around this block a few times. At the very heart of good property management is a sound, well written lease, the contract between the landlord and tenant and very crux of the relationship. I could put on a three day workshop on writing a good lease, so I will just address some key principles and concepts on this week’s blog. Look for future blogs to address many of these subjects individually.

The term “good fences make good neighbors” is the rule of thumb here. If the three most important words in real estate are “location, location, location”, the three most important words in leasing would have to be “clarity, clarity, clarity”. Using the bullet points below as a guide will keep you in good stead:

Using an industry standard form produced by an organization such as the American Industrial Real Estate Association (AIR) is a good start. They have versions to fit almost any situation. For more information, visit www.airea.com. Avoid defaulting to your old lease form or the form used by the previous owner. The AIR forms are constantly revised to keep up to date with evolving legal precepts.

State the name of the parties accurately or you may have trouble enforcing the lease later in case of a default.

Don’t forget to enter a date at the top of the lease: this is unrelated to the lease term dates, but will serve as a critical reference in all future official or legal correspondence. You would be amazed how many times as a property manager I received a new, fully executed lease from a national institutional client, authored by their $500/hour attorney without the lease date filled in. Amazing!

Make sure the rent schedule is clearly stated. Favor actual dollars (i.e. $3,250.51 per month) over dollars per square foot ($2.05 per square foot per month), as the latter focuses attention on the size of the premises which is often contested down the road by sophisticated commercial tenants or gadfly consultants.

Accurately and clearly spell out the parties’ mutual repair and maintenance responsibilities. This is a key to avoiding fights later.

Address respective insurance requirements thoroughly. In particular, this is an area that has evolved legally.

Make sure the default provisions are clearly spelled out. These will serve as the rules off engagement in case of a battle down the road.

Your property manager should be fluent in all practical lease matters. If he or she isn’t, keep looking!

Going green when the economy is in the red

Barely two years ago, those of us in commercial real estate were dealing with a tsunami of a different sort from the torrent of financial distress we are bracing for today. The words on everybody’s tongue were “sustainable” and “green”. After experiencing fits and starts over three decades, the concepts of energy and water efficiency really took hold this last time around. Every major corporate boardroom put in place initiatives to make environmental stewardship a part of their “brand” and corporate culture. If you have corporate clients, have you noticed the blurb at the bottom of their emails asking you to lighten your carbon footprint and “think twice before printing this email”?

Green, however has always been a double edged blade: it lightens our impact on the environment and non-renewable resources, but it costs money, also green. When the economy hit the proverbial iceberg, environmental initiatives were one of the first to be thrown overboard. But unlike times past, these ideas have absorbed deeper into the cellular structure of these corporations, and when the market returns, so will their sustainability initiatives.

Now that corporate America — indeed, corporate Earth — is tuned into these concepts, green building features are seen as necessary to meeting a new environmental standard. Here are a few that demonstrate relatively short term ROI (return on investment):

Waterless urinals – Go ahead ladies, hold your noses. These devices go against every notion about cleanliness we have ever been taught. You have to wash urine away! Not so. Just gravity does the job perfectly. There is a device in waterless fixtures that puts a light film of oil over the urine in the trap, in effect putting a lid on the odors. The fixtures themselves are a bit more expensive than a traditional urinal, but the elimination of the plumbing during initial construction and the water savings more than offset that.

Fluorescent lighting – the relative efficiency of the modern iterations of fluorescent tube technology — T-8 and T-5 — are well documented (the lower the number, the more energy efficient). The energy cost savings are significant and, with rebates offered by most electrical utilities today, pay back in about three years. This pay back can be shortened by using motion detectors which let lights turn off in unoccupied areas. For the past seven years, I have worked with a Fortune 100 company who recently changed their warehouse lighting specification throughout the U.S. to T-5 fixtures with motion detectors. If you have been in the property management business for a while (or manage very old industrial properties), you will recall how fluorescent lighting was the standard until high output fixtures like high-pressure sodium and metal halide took over. What was old is new again…

Xeriscaping – I put this one down just because it is such a cool word! But seriously, this is all about being sensible when it comes to landscaping your property. Using materials that are indigenous to your region and eliminating thirsty turf grass will seriously lower irrigation water and monthly maintenance bills (mowing grass is the most labor-intensive task in landscaping). It can also be striking in appearance. Hook up with a local landscape architect who is on board with sustainable landscaping and you might be amazed!

Being able to feature even these few ideas will give your building the status of being “with it” with today’s new sustainability standards and will make it stand out in a competitive leasing market…and has the leasing market ever been more competitive?

Tenant cries for help

If you own commercial real estate today, you are likely to have received a pleading phone call from one or more of your tenants asking for rent relief. Ignoring or denying these pleas might result in your having another vacant space in your building, but you just hate to buckle under to such demands; after all, you don’t have the right to call the tenant in a strong economy and ask them to pay “just a little more rent”.

These strategies are tried and true and might make sense for you:

• Clearly define the term of the rent relief. Try to dole it out in increments of three to six months at a time.
• If the tenant’s rent is already below market, negotiate a rent trade-off: get them to agree to a new rent schedule for the balance of the lease term in exchange for a rent concession now.
• Amend the lease term in a manner favorable to you in exchange for a concession
• If the request comes from a retailer in a shopping center and their lease has a % rent clause, you might consider allowing the tenant to pay just percentage rent for a while, but at a higher rate than what is stipulated in the lease. When the base rent break is over, the percentage should remain at the newly negotiated level, improving your chances of recovering some of the rent concession through percentage rent overages when their sales pick up.
• Ask to see the tenant’s financials. Every tenant is jumping on the bandwagon in this economy and holding their hand out. Save your concessions for the tenants that matter the most and who really need it. A retail property manager friend of mine was just telling me about how Walgreen’s approached him for a rent reduction at one of their really strong locations. I mean, really!
• Always ask the tenant to prepare a business plan for you showing what they are doing to improve their bottom line during the rough economy. Perhaps you can induce the tenant to do some cross merchandising with another tenant or invest in some strategic marketing initiatives. If you are willing to extend a concession, the tenant should be a captive audience for your ideas. If a retail tenant has lost heart and is just dying on the vine, keeping them around could be toxic for your center, so consider cutting bait and letting another successful tenant use the space temporarily or for storefront merchandising.

Any approach that helps the tenant survive and gives you some security in return is worth exploring. and see the silver lining: these challenging times present great opportunities to show some heart and fortify your landlord-tenant relationships.

Is your property open for business?

It’s one thing to own a commercial income property, but another to run it successfully. The former takes capital, the later requires a strategy, planning, a head for contracts and budgets, a team of supportive vendors and contractors, market savvy, a bit of a competitive streak…and, yes, some capital (that will usually be available in the form of spendable rent).

This blog is a place to get insights into what makes commercial property tick and how to “tock” to your tenants. Running a commercial property is about facing daily challenges and capitalizing on opportunities. My posts will range from bite-sized tips to overarching principles that should be a the foundation of any property management business