Usually, at the end of every year or at the beginning of the new year, landlords send out their “CAM Notices” or “Rent Notices” in which they inform commercial  tenants of their monthly rent for the upcoming year. Depending upon what type of commercial lease a tenant might have, one or more factors  may cause the rent to increase in the new year. Tenants should spend time examining these notices to ensure that the information contained in them is correct and consistent with the lease they entered into and perhaps modified afterward.

Some leases do not directly pass on any of the operating costs of the property. This type of lease is called a “gross lease”.  Notices received under gross leases may only detail an increase in the rent because of a stated increase or fixed percentage increase in the rent provided for in the lease at the outset when it was signed, or alternatively refer to an index, such as the Consumer Price Index as a basis for any rent adjustments in the coming year.

Under a “modified gross lease”, the landlord passes on some but not all of the operating costs of the property to the tenant, such as real estate taxes and insurance. In addition to containing the information noted above, when there is a modified gross lease, the landlord’s notice will probably state the anticipated cost of the passed through expense for  the coming year, and  the tenant’s monthly (i.e., 1/12th)  share of the these passed through expenses based upon the tenant’s pro-rata percentage occupancy of the building.

When all of the operating expenses for the property are passed on to the tenant by the landlord under a lease, the lease is typically referred to as a “net lease” or “triple net” lease. In this instance the rent increase or CAM notice is more elaborate. As before, a portion of the notice details the basis for any increase in the monthly rent due to a  preset rent increase in the lease or an external  formula  for adjusting the rent,  but now the portion of the notice dealing with the operating expenses of the property passed through to the tenant might expectedly contain more information than if the notice related to a modified gross lease.

No matter what the lease type, the tenant should carefully compare the information contained in the landlord’s notice to the lease (e.g., pro-rata percentage of building, basis for base rent increases in the lease independent of any pass through, specifics of the passed through expense, if any). If the rent increase was based upon a CPI increase, the back up for the CPI based increase should be provided.  In the case of both a modified gross lease and a net lease the tenant may want to ask the landlord for copies of the 2017 real estate tax bill and the 2017 insurance premium bill so that the tenant can compare those actual costs to the projected 2018 cost. If the landlord’s notice pertains to a net lease, the tenant may also want to ask for a copy of the property’s operating expense statement for 2017 to compare it to the projected operating expenses for 2018.

This coming year, tenants should also carefully review the monthly sales tax amount that they are being charged. Beginning on January 1, 2018 the state level sales tax will be reduced from 6% to 5.8 % for rental payments attributable to a tenant’s occupancy of a premises during January, 2018 and after.

Certain counties, such as Miami-Dade County, Florida impose a local option surtax on commercial or short term rents. . The recent change in the state level sales tax has no effect on local surtaxes. Thus, in Miami-Dade County, FL. the sales tax rate on monthly commercial rents will be 6.8% instead of the 7% that was previously charged.

The year is young and there is still time to save money by critically reviewing the landlord’s recent rent or CAM notice

A shopping center landlord client has had some difficulties with one of his tenants recently. The tenant, a bagel shop and restaurant, and the largest tenant in the small suburban strip center, is not maintaining the area surrounding the restaurant very well.  The corridor that the tenant utilizes to accept deliveries to the restaurant and to haul trash to the dumpster is stained with cooking oil and grime.  Tenant, though obligated to pressure clean, paint and maintain the area, has failed to do so.

In addition, the tenant has an out door seating area. The shopping center is designated as tobacco free/no-smoking.  This is contained in the lease there are signs posted around the center.  However, tenant permits his employees and customers to smoke and they use shopping center planters as ash trays.  Consequently, the planters are filled with cigarette butts.

There are other issues between the landlord and the tenant, but the most difficult problem is garbage. Tenant has been causing both the waste and recycling dumpsters to overflow.  All the other tenants are small retail or office and generate little trash.  And, from the type of trash in the dumpsters, it is very easy to identify the cause of the over flow.  Therefore, several months prior, tenant requested that landlord 1) upsize the waste dumpster from a 2 yard dumpster to a 4 yard dumpster, 2) increase pickups from weekly to 4 timers per week, and 3) obtain a 2nd 2 yard recycling dumpster.  Landlord made the changes and increase tenant’s CAM charges accordingly which Tenant paid for 2 months.  For whatever reason, Landlord to slide back to the prior CAM amount for the remainder of the year.

In an effort to get the shopping center cleaned up, landlord recently required that tenant fulfill its lease obligations and maintain the premises and surrounding areas and enforce the no-smoking policy. In addition, landlord sent a new CAM statement reinstating the increase in CAM charges.  Several days later, tenant’s attorney responded.  Funny thing is, there was no objection to the requested maintenance.  There was a question about the no-smoking policy which was quickly put to rest.  Tenant and its attorney strongly object to pay any increase in CAM charges for garbage pick up.

I can’t figure out if tenant has selective amnesia regarding the requests for additional services or if tenant believes it does not generate an inordinate amount of garbage as compared to the other tenants in the shopping center. We have provided the attorney with copies of the invoices to show the charge is a straight pass-through without up charge and corresponds with the services that were requested and agreed to.  I have provided the e-mail correspondence between landlord and tenant regarding change of service.  The attorney has acknowledged that the lease is NNN.  The extra service and capacity, even if not specifically requested by tenant is necessary because of tenant’s use.  All of the other tenants are gross leases.  So why do tenant and tenant’s attorney think that they don’t have to pay for their own trash pick up?

My mother and grandmothers always told me to clean up my mess. My father always had me take out the trash as soon as I was old enough.  This is good advice for this tenant.

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        An attorney negotiating for tenants should be diligent in reviewing expense provisions of commercial leases. While most such leases start with the premise that the tenant is 100% responsible for the operating costs of the premises (a triple net, or NNN lease), tenants should look for every opportunity to limit and control these expenses. If not careful, the pass-throughs can become a blank check for landlords.

             There are several provisions in a lease that a tenant can look to in order to control or limit expenses. Some examples:

 

  • Limit the landlord’s ability to increase “controllable expenses” each lease year. Uncontrollable expenses are the big 3: taxes, insurance and utilities. But everything else can, and should be managed and controlled by landlord year to year. Set a cap as to how much the landlord may increase controllable expenses each year. While this might invite the landlord to actually increase the expenses up to the cap, the language should provide that landlord must prove the actual costs (see below).

 

  • Landlord should be required to reconcile operating expenses within 90 days of the end of the calendar year (or lease year, if payments are adjusted at that time) and tenant should have the right to audit. There should be a penalty to landlord, including payment of tenant’s cost to audit, if landlord overcharges tenant by more than a stated percentage.

 

  • Go through the list of CAM Charges/Operating Expenses carefully. If there is not a list, create one. Many items in the list can be eliminated or limited. For example, exclude items relating to landlord’s operation of its business and the property. Limit charges for management of the building, charges for depreciation and marketing. Costs of enforcement of other leases, brokerage commission, tenant improvements and costs of repair of damage caused by casualty should be excluded from operating expenses. These are but a few ways to reduce costs charged to tenants.

 

  • Limit tenant’s responsibility for capital expenditures, particularly in the final months of the lease. And, cap the amount that landlord may charge for reserves for future capital improvements. Limit or eliminate tenant’s responsibility for replacement of HVAC and other electrical, mechanical and plumbing systems if such systems are not new at lease commencement. While tenant may be responsible for ordinary maintenance, landlord should be responsible for replacement of HVAC and systems required due to catastrophic failure (generally covered by insurance) or because the systems are at the end of their useful life (budgeted in reserves).

 

        As you can see, NNN does not have to mean NNN. Costs can be shifted and mitigated. While net leases will never provide absolute predictability of costs for tenants, risk of sudden large increase can be somewhat mitigated through negotiation.

Walgreens has announced that it will close some 200 stores in a cost-cutting effort.  The company hopes to realize $1.5 billion in cost savings by the end of 2017.  Walgreens has not yet announced the locations of the affected stores.

Walgreens are traditionally strong candidates for investors looking for NNN properties.  Before purchasing Walgreens properties, potential buyers need to be certain that the targeted store is not on the close list.  It is possible that Walgreens store sales will be put on hold altogether until Walgreens announces which locations will be closed which in turn could drive the price of other NNN properties higher.

At this point, we don’t know which stores will be affected or how Walgreens will implement its closing strategy.  But it is safe to assume that the company does not have 200 leases that are set to expire in the next 2 years.  Walgreens might simply choose to close its stores and default on its leases and risk its credit rating.  Or Walgreens could seek to negotiate Termination Agreements with its landlords.

Walgreens Landlords had best prepare for all possibilities by becoming familiar with the lease provisions.  Landlords should determine what their damages will be if Walgreens defaults or seeks early termination. Here are just a few of the questions that should be asked when any tenant defaults or asks for an early termination of the lease:

What is the remaining term on the lease?

  • Who was responsible for tenant improvements?
  • What are the default provisions and are there any limitations?
  • Is the tenant responsible for Landlord’s attorneys’ fees?
  • What about the cost to re-let and brokerage fees and brokerage fees previously paid?

Our real estate team represents both landlords and tenants in all aspects of lease negotiations.  Please feel free to contact us.

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