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@MattLasky made a point today about insurance premiums and the pain they are about to inflict on many NNN tenants and, with lag, certain Landlords.
Which got me thinking back to my dark days in asset management and the exciting topic of... denominators. 1/n
Which got me thinking back to my dark days in asset management and the exciting topic of... denominators. 1/n
Most are familiar with NNN leases as they apply to retail, industrial, and in most cases office.
Common understanding is that you pay your prorata share, aka your lease state sf divided by the gross leasable area, or GLA. 2/
Common understanding is that you pay your prorata share, aka your lease state sf divided by the gross leasable area, or GLA. 2/
What is less known on the tenant side, and often overlooked is the denominator calculation.
CRE attorneys spend substantial time fighting for, rightly so, what is and is not included in “Operating Expenses” as it relates to CAM. Landlords often try to stuff junk in this. 3/
CRE attorneys spend substantial time fighting for, rightly so, what is and is not included in “Operating Expenses” as it relates to CAM. Landlords often try to stuff junk in this. 3/
Junk includes property management salaries, wastewater, marketing and other charges typically defined as leasing costs, amongst other things... 4/
But occasionally you will see the denominator itself defined outside the bounds of your typical SF/GLA. These include floors (90%, 80%) and, the most egregious to tenants (and LL friendly) the “Then-Leased” denominator. 5/
The Then-Leased denominator is just as it sounds, your square footage divided by what is then leased (typically at the start of a calendar year) determines your prorata factor.
This is multiplied by the OpEx as defined in your lease (the part attorneys actually spend time on) 6/
This is multiplied by the OpEx as defined in your lease (the part attorneys actually spend time on) 6/
As a quick aside, in larger retail and business parks (office) you will see exclusions. Typically these account for REAs and separately assessed parcels where the occupant pays taxes directly, but can also exclude tenants > than certain footprint (commonly 15k+ sf 7/
Anyways, back to TL denominators and why you should care.
TL denoms are tied at the hip, in terms of risk, to cotenancy clauses. Cotenancy clauses essentially allow tenants to terminate their lease if 1) occupancy %, and/or 2) “named” cotenants are no longer at the center. 8/
TL denoms are tied at the hip, in terms of risk, to cotenancy clauses. Cotenancy clauses essentially allow tenants to terminate their lease if 1) occupancy %, and/or 2) “named” cotenants are no longer at the center. 8/
The major risk currently playing out in retail (much less so in office) is commonly referred to as a cotenancy waterfall, where X tenants has 85% occupancy requirements, and Y tenants have 75% requirements, etc.
If 85% is breached you are almost assured of massive fallout. 9/
If 85% is breached you are almost assured of massive fallout. 9/
If you are an unfortunate schmuck (i.e. small biz owner who doesn’t have $30k earnmarked for legal fees in a lease negotiation) who gets stuck with a TL denominator, and you run into a cotenancy waterfall then that NNN charge from prior years 10/
Will increase proportionately to the amount of vacancy at the center. 100% leased center becomes 90%? Ok, that sucks, but 10% increase is bearable.
85% leased, same thing right? Negative. Cotenancy almost guarantees that 2yrs from now it will be 65%. A massive 35% increase! 11/
85% leased, same thing right? Negative. Cotenancy almost guarantees that 2yrs from now it will be 65%. A massive 35% increase! 11/
Combine that with 1) insurance premiums increasing regardless of asset classes, and 2) cash strapped municipalities looking to CRE to bridge the budgets.
And now you have a compounded problem in the middle of an econ crisis. 12/
And now you have a compounded problem in the middle of an econ crisis. 12/
Lesson to be learned?
If you’re a tenant, never agree to a TL denominator.
If you’re a landlord, you need to seriously analyze risk of cotenancy and secure TL denominators whenever possible to mitigate downside risk.
/end
If you’re a tenant, never agree to a TL denominator.
If you’re a landlord, you need to seriously analyze risk of cotenancy and secure TL denominators whenever possible to mitigate downside risk.
/end
