Articles Posted in Commercial Leasing

Common Area Expenses (or CAM expenses) are nothing new in the commercial leasing business. However, new business owners are often caught off guard by the thought of the additional expense that sometimes is as high as the base rent itself, especially where there is so little control over how the expenses are managed. Leases that require tenants to pay common area expenses (including property taxes and insurance) are called triple net leases. It is common these days for landlords to pass on every imaginable expense to its tenants. So long as the landlord is passing on legitimate expenses that are necessary for the operation and maintenance of the common areas, there is nothing inherently wrong with the practice. However, prospective tenants should work closely with their attorney to carefully review the proposed lease terms to ensure they have a complete picture of the potential liability and that the landlord isn’t using the CAM charges as an additional source of revenue. Ideally, tenants will negotiate for a gross lease that is inclusive of all landlord expenses. However, in most cases negotiating for a gross lease is difficult (if not impossible). Where a net lease is your only option, the following is a list of important considerations:

Pro Rata Share: A tenant’s pro rata share of common area expenses should be determined based on the tenant’s leased square footage compared to the commercial property’s gross leasable space, not “leased” space. In other words, the pro rata share is determined based on 100% occupancy. Landlords often seek to defer costs associated with empty space and will try and include lease language that calls for CAM charges to be calculated based on the square footage of “leased” space rather than “leasable” space. Tenants should seek to amend such language so that the landlord absorbs the expenses associated with empty space.

Audit Rights: Tenants should try and negotiate for the right, upon reasonable notice, to audit the landlord’s accounting records. Such clauses are common in commercial leases and allow tenants to ensure that the common area expenses are calculated correctly. Look closely at the lease language as these clauses typically set forth specific procedures for examination of records and for resolution of disputes. Sometimes leases limit the frequency of tenant audits. The more often you are allowed to audit, the better. At the very least, tenants should have the right to audit accounting records once a year within six months of reconciliation (the time landlords reconcile actual expenses with estimated expenses).

Management Fees: Management fees are common, especially in the retail setting. The practice is prevalent and prospective tenants should ensure that the lease clearly defines what the management fees are and how they will be calculated. Management fees should not exceed three percent of the property’s gross receipts, and shouldn’t include expenses for off-site personnel and overhead. In some cases, landlords seek both administrative and management fees. While this may be appropriate in some circumstances (i.e. landlord hires a separate management company to manage the property), it’s important to clearly understand exactly how these fees are delineated and to make sure that the landlord isn’t double dipping. Try and negotiate for limits on management fees. 

Clearly Defined Expenses: Ensure that the common area expenses are clearly defined in the lease. Vague and ambiguous language that doesn’t spell out precisely what expenses will be included in CAMs leave tenants open to excess costs.

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Commercial leases often appear daunting, especially to new and growing San Diego businesses. After negotiating the rent, business owners often feel they have little choice but to accept the remaining terms if they want to move forward. It is always advisable to consult with a commercial lease lawyer, but the thought of additional costs turn many away from this option. “Understanding Your Lease” is a series of articles designed to highlight important commercial leasing issues. The articles are intended to arm business owners with the ABCs of “commercial leasing”, and are not intended as a substitute for professional negotiation. Most commercial leases are triple net leases. Along with the base rent, tenants are required to pay a pro rata share of the common area maintenance expenses (CAM expenses). The scope of these expenses varies from lease to lease, but is most often inclusive of every imaginable cost. See Understanding Your Lease – Common Area Expenses. In this article we briefly summarize the type of expenses included. It’s important to review your lease and make sure you know what the CAM expenses are.

Common area expenses typically include: repair and maintenance of the property’s common areas; landscaping; exterior painting; parking lot paving, resurfacing, painting and lighting; roofing; repair and maintenance of central plumbing, electrical, sewage and HVAC systems; other repair and maintenance expenses relating to the property’s common areas including renovation and redesign expenses; utility expenses related to the common areas; advertising and promotional expenses incurred by landlords; security systems and on-site personnel; permits, taxes, insurance and legal costs; and management and administrative expenses including the salaries of management personnel. On top of these expenses, tenants are required to pay all expenses directly related to the leased space including utilities, repair and maintenance of electrical, plumbing and HVAC systems, compliance with government regulation such as the American with Disabilities Act and are required to maintain a minimum level of general liability insurance.

Common areas typically include parking lots, landscaping, hallways, elevators and stairwells, lobbies, public restrooms, on-site management offices and other public areas. Ask to see CAM histories to help you get a better picture of what your future expenses will look like, and ask about anticipated renovations. These costs can be significant and you’ll want to know what’s on the horizon. Finally, management and administrative costs can be profit centers for landlords, particularly where both management and administrative costs are sought. Be careful that your landlord isn’t double dipping. Work closely with your attorney to reduce uncertainty.

Common CAM expense exclusions include:

• Initial cost of the land or the construction of the original buildings, parking and other improvements;
• Mortgage principal, interest and related expenses; 
• Refinancing costs;
• Ground rent and related costs;
• Depreciation and amortization of property and equipment;
• Cost of complying with government regulations including compliance with environmental laws; 
• Costs, fines or penalties incurred by landlord for violation of government regulations and costs for correcting code violations or defects; 
• Interest or penalties from landlord’s late payments;
• Advertising, renovation, improvements and other costs associated with seeking and obtaining new tenants and retaining existing tenants;
• Brokerage commissions;
• Tenant alterations and alterations made to leasable space;
• Capital expenditures; 
• Costs reimbursed by other tenants;
• Costs reimbursed by insurance and/or warranties;
• Costs reimbursed by government agencies; 
• Special services for specific tenants;
• Legal services relating to leases with other tenants or with the transfer, sale or disposition of land or buildings located on the property;
• Off site management personnel and overhead;
• Operation of services or amenities for which landlord charges a fee to third parties;
• Costs associated with remedying construction defects;
• Utility costs directly payable by tenants or other occupants;
• Salaries and benefits of landlord’s executive officers;
• Excessive costs for sculpture, paintings and other fine art;

This is not an exhaustive list of exclusions. See Understanding Your Lease – Common Area Expenses for a summary of important common area expense considerations.

It’s now estimated that the San Diego commercial lease market will hit bottom in 2010. Whatever the future has in store for commercial real estate, the present news is not good for commercial property owners. Office vacancies in San Diego are at almost 20% and retail vacancies, while not as high, are still significant at around 8%. It’s likely that most commercial property owners in San Diego cannot remember the market every being this bad. With vacancies so high, commercial landlords are forced to negotiate better lease terms in order to retain existing tenants and to attract new ones. In this highly competitive market, it’s the smaller commercial property owners that are being hit the hardest.

The competition for new tenants is tough. Larger companies can afford to offer cash incentives for improvements, free rent for six months and significant first year discounts to lure the most attractive tenants, leaving smaller properties desperate to fill their empty space. For many smaller property owners, the only way to compete with these incentives is rent reduction. It’s an economic reality that commercial property owners of all sizes cannot get around – continued downward pressure on rent coming from all sides.

Offering incentives to prospective tenants is a good business decision for those that can afford it. For those that cannot, holding on to existing tenants is of paramount importance at least for the foreseeable future. As the market continues to tighten, landlords are beginning to recognize that existing tenants are their most valuable asset. There is little to be gained by eviction of a tenant who can pay partial rent if it proves difficult if not impossible to fill the space once the eviction process is complete. Moreover, existing tenants are known quantities. A tenant with a history of timely payment and who is not constantly at odds with the landlord is a good tenant. This is also the type of tenant that will remember a landlord’s goodwill during tough times. While it may be impossible for smaller commercial property owners to offer cash incentives to prospective tenants, they may be able to afford accepting lower rents for a fixed period of time to keep existing tenants. This also provides the landlord with some control over the term of any renegotiation.

Property owners in San Diego know that their commercial leases are valuable assets. In the face of a struggling market and conflicting input from accountants and lawyers, they recognize the benefits that a long term existing tenant offers. They are inundated with bad news from the media. The San Diego Union-Tribune tells them that the commercial real estate market will not begin recovering until late 2011 or early 2012. They are reminded daily of the recession and its particular affect on the San Diego leasing market because of the abundance of “For Lease” signs around town. While well capitalized REITs (Real Estate Investment Trusts), pension funds, insurance companies and other large commercial property owners should weather the storm, mid-level and smaller companies face difficult times, especially those that purchased at the peak of the market.

Many would rather accept a short or long term rent reduction than face the prospect of losing their tenants to failed businesses. The solution is particularly attractive to smaller-scale landlords facing vacancies rates approaching 25%. By offering rent reductions to help potentially failing businesses survive the recession the property owner not only keeps the particular space filled, she strengthens the business relationship with the tenant and creates a goodwill that cannot be valued highly enough. In addition, the business owner is less tempted to take advantage of the lease opportunities offered elsewhere around the San Diego County.

Under the right circumstances, rent reductions offer a viable business solution to a tough economic dilemma. This is a forward looking approach that leads to long term prolific relationships. When the time comes for current tenants’ businesses to expand, they will look to the property owner that took care of them during hard times first. Rent reductions present a short term practical solution for the commercial property owner while simultaneously creating invaluable goodwill.  Consider contacting a San Diego business lawyer to evaluate your lease. 

As the San Diego commercial leasing market continues to struggle, opportunities abound for young and growing businesses to obtain favorable leasing terms. With the abundance of “For Lease” signs reminding folks of the current recession, commercial property owners are anxious to fill space and are willing to negotiate to do so. 

Businesses and commercial property owners alike would do well to look ahead, and consult with their business attorney regarding their options.  Whether the economy has bottomed out is a question that will remain unanswered for some time.  However, it appears that the economy is in that soft zone somewhere in the bottom of the trough and there isn’t much room left to bottom out on. Fear of a depression with bread lines extending around the corners of major metropolises stifles productivity and investment. Such fear is almost certainly unwarranted. These are the moments that entrepreneurs seize! They don’t seek to weather the worst case scenario. They see opportunities and commercial property owners benefit from their aggressiveness. So does the economy.
 
A strong relationship between the commercial property owner and tenant is itself a valuable asset. The property owner benefits from successful business tenants. They are long term reliable tenants that pay their rent on time and, depending on the lease, pay additional monies based on profits or sales. The business benefits immeasurably from positioning itself in the right location in the right community with a structure that has the right physical properties, and from favorable lease terms. Working closely with their attorneys to draft mutually beneficial lease terms provides much needed security to both the landlord and tenant. Each side should take a hard look at their short and long term business goals, their immediate needs, and the unique fit between them. Most importantly, they shouldn’t be afraid to step out of the box and look to creative lease terms that benefit both sides. Property owners are presently more willing to entertain new and innovative proposals even with existing tenants.

Finding that “it” location for a new or growing business is priceless. Filling space for the commercial property owner is just as important. Whether you are a new or existing business or the owner of commercial property, an aggressive approach to finding the right match will help you over this economic hump and might just be the start of a thriving or rejuvenated business.

It is a great time for small businesses in San Diego to lease commercial space. The recent economic downturn has resulted in an increase in the supply of commercial space putting downward pressure on rents. More importantly, small businesses now have the ability to negotiate better lease terms as commercial property owners scramble to fill empty space.

Over the last 10 years, small businesses have had little bargaining power when it comes to negotiating lease terms. Faced with a highly competitive market, commercial property space was available at a premium. Eager to scoop up a nice location, small businesses were ready to agree to whatever lease terms were proposed or risk losing the space to the next highest bidder. While a good attorney could negotiate some favorable terms, prospective tenants remained largely at the mercy of a very competitive market.

The terms of a commercial property lease have value in and of themselves, and negotiating a lease that best suits your needs can have a profound impact on the future of your business.  Today, small businesses concerned with expansion may be able to negotiate shorter leases.  Some businesses may wish to negotiate the ability to make alterations to a space.  Others might be concerned with the ability to sub-lease.  Retail businesses may expect to rely on the traffic brought into an area by an anchor store and seek to negotiate a bailout clause which would terminate the lease if the anchor store went out of business or moved.  Whatever the terms, commercial property owners are more likely to consider the tenants proposals.