Sometimes, when you think you’ve won, you’ve really lost. In my most recent case, I was very successful in working out a bad lease for a client.  Prior to coming to me, the client had been through several rent deferments.  The deferments had come due and the landlord was unwilling to give any further accommodations.  After months of negotiation, the tenant thought she had the parameters of a lease extension.  But, there were numerous open issues and financial terms to address.

After discussing the client’s financial position, I was able to negotiate a write-off of the deferred rent, over $300,000, and a tenant improvement allowance to modernize the space in exchange for only a 3 year extension of the lease and a slower increase in the rent. Only the TI would be guaranteed.  These negotiations took over 2 months.  We determined that the tenant did have an A/R balance of under $20,000 which would have to be paid as a condition of the new lease.  The client assured that the could make this payment and could fund any tenant improvements in excess of the TI allowance.  The tenant signed the new lease in early September.  We all felt like this was a win – the landlord, tenant and I.

After Hurricane Irma, I called to check on the client to make sure everything was ok as I had not received the fully executed lease back from the landlord. She complained that the landlord was stalling on signing the lease and therefore, she couldn’t start the TI.  Before I volunteered to check on this, I probed.  She complained that business loss was significant due to the hurricane and its aftermath and she was not able to make the promised payment and that landlord was being unreasonable, refusing to work with her.  Alarms started going off all around me.  This money should have been available before the hurricane at the time the lease was signed.  She started pointing fingers at everyone again – the landlord, the property manager, her partner, FPL, me.  Clearly, the issue was, is and always has been the tenant’s inability to pay the rent and other obligations prior to and since the execution of the modification.

What appeared to be a big, hard fought win looks to be turning into a loss. Could this have been avoided?  I don’t think so because the tenant, the client, has not been honest.  Mostly, she has not been honest with herself about what she could and could not afford.  But she also wasn’t honest with me and therefore, I could not properly advise her or handle the negotiations.  Expectations were set based on false premises and when we thought we had a win, we really lost.  Any bargaining position we might have had was lost as soon as she signed the lease.  If the tenant did not have the financial wherewithal to meet its obligations, either under the prior lease terms or under the renegotiated lease terms, she should have never signed the new lease.  As a result, we have lost the thrill of victory and now feel the agony of defeat.

Tenants shopping for new space should understand how the cost of Landlord funded Tenant Improvement affects rent. When negotiating for space, one of the first questions a Tenant should ask is whether the advertised rent includes any TI allowance because after negotiating a comfortable rent, Tenants who then turn attempts to negotiate a TI allowance as an incentive to lease will find that rent will increase as TI dollars increase.  However, Tenants should be careful to assure that the increase in rent is limited to the actual cost of the TI allowance and that the Landlord is not adding a profit, unless the profit was specifically negotiated.

 

The formula for adding Landlord funded TI to rent is simple:

TI =     {(X/Initial Lease Term in Years)}

________________________                      add result to per square foot Rent

{Premises Square Feet    }

 

For example, if the Landlord has agreed to a $180,000 TI Allowance and the initial lease term is 5-years on a 4,000 square foot lease, $9.00 per square foot would be added to the quoted rent [(180,000/5)/4000].  If rent was originally quoted at $18 per square foot, with the TI added, rent would now be $27 per square foot.  Of course CAM would be a separate issue.  If the Landlord quotes rent higher than $27, Tenant should be aware that landlord is charging overhead or is not providing all of the improvements for which Tenant is being charged.  Additional negotiations might be necessary.

Another point Tenant should consider is rent increases following the initial term.  While annual increases during the initial term are, and should be adjusted, on the gross amount (including the adjustment for TI), following the initial term, rent at the commencement of the first renewal term should be adjusted back to the base rent without the amortization for TI.  Most Landlords and Tenants over look this in negotiations and negotiations begin with the same percentage increase on the rent from the end of the initial lease term.  Other times, Landlords attempt to re-set rent based on “market rent” then existing, but with a floor, limiting the ability to lower rent below the rent of the prior year or even adding a percentage above the prior lease year.  Tenants who have paid the fully amortized cost of TI should insist that, at the beginning of the first renewal term, that rent be adjusted to deduct the cost of the TI.  Increases going forward would then be based on the adjusted amount.

If Tenants are aware of how TI allowance affects rent, there should be cost savings down the road.  Be savvy!

 

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