Subordination and Distressed Assets

In a real estate market where failing loans are more common than in years past, tenants should be aware of the concept of subordination. Any lease entered into subsequent to a loan being placed on a particular property will be subordinate to that loan. In the event that a lender takes ownership of a property through foreclosure, or other such means, it is under no obligation to honor a lease that commenced subsequent to the loan that was placed on the property. Clearly, the potential impact this could have on a tenant is devastating. Tenants considering entering into a long term lease and/or spending a great deal of money on improvements to a leased property should seriously consider investigating the solvency of the landlord and status of the loan to which their lease will be subordinate. In addition, tenants may want to consider making the receipt of a non disturbance agreement from the lender a condition for entering into a lease.

Video: AIR- Single Tenant Net versus Gross Lease

Negotiating with the GSA-Consultants

The ITC office building in Guam, (www.itcguam.net), has gotten a great deal of attention from the U.S. Government lately. As you may have seen in my profile, I'm the president of Fujita Property Guam, the company that owns and manages this 210,000 square foot office building. We are currently in various stages of negotiations with several U.S. Government tenants. As you may know, the job of negotiating leases on behalf of the Government belongs to the General Services Administration, (GSA).

Candidly I was shocked when I received the GSA's version of a request for proposal/solicitation. The document was over 100 pages. It was overwhelming to say the least. In addition to the volume of the solicitation, it required a great deal of attention to detail. Landlords are required to respond to a number of requests, surveys and questions. A potential property can be disqualified if just one error is made in response to the GSA’s solicitation. This is just the start of the process of leasing space to the Federal Government. If our building is selected, we will begin the process of negotiating the lease document and constructing the tenant improvements. I have been told that neither is easy because of the difficult requirements set forth by the GSA.  

Because of the importance of these transactions, I sought out a consultant that could provide guidance from start to finish. As it turns out, two former GSA employees have started a company that provides such consultation. It is called Unified Interest (www.unifiedinterest.com). They offer a comprehensive set of consulting services for dealing with the GSA.

Considering that the U.S. Government is expanding quite rapidly, the likelihood of leasing space to them is greater now than ever. Landlords, and brokers for that matter, should seriously consider utilizing the services of expert consultants to help them through the rigorous process of completing a lease transaction with the U.S. Government. Here's a link to an interesting article relating to GSA leasing. www.ccim.com/cire-magazine/articles/gsa-way

The Square Footage Debate

I worked on a large office lease transaction and part of the deal involved determining the exact square footage of the floor that the tenant would be occupying. We, the landlord, hired an architect to measure the space as did the tenant. Both architects were instructed to use the BOMA standard as their basis for measuring the space. As it turns out, the architects both came up with different results. As a resolution, we agreed to hire a third architect to measure the space. That architect, too, came up with a different number. Three professionals using an exact standard of measurement could not agree upon the square footage of a single space. This may sound odd, but it is not unusual. In fact, it is not uncommon for the actual square footage of a building to be different than what is shown on the original building plans. Obtaining an accurate measurement of any space or building can be tricky at best.

With that in mind, all leases have a section where the premises are described. Many people feel compelled to include the square footage as a part of that description when preparing the lease. I urge against that. It opens the door for disputes during the term, such as tenants wanting to renegotiate their rent based upon a discrepancy in the square footage of the space. In other words, in the lease the landlord states that the square footage is 1,000 square feet, but two years into the term the tenant decides to measure the space and comes up with 975 square feet. In addition, the California Court of Appeal has weighed in on this matter in the matter of McClain v. Octagon Plaza. For further information visit http://www.gordonrees.com/publications/viewPublication.cfm?contentID=576 

If it is necessary to provide the square footage in the lease, have an attorney draft language that specifies how the space was measured and by whom, and that the Lessor and Lessee agree upon same.

Getting an Estoppel Signed

Buyers in a transaction involving the purchase of a leased property will usually require the tenant to complete an estoppel certificate. By completing this form, the tenant has an opportunity to confirm the terms of the lease, verify that the landlord is in compliance with those terms and/or provide any other information relating to their relationship with the landlord. It is important for a buyer to have a solid understanding of the tenant's perspective of their relationship with the landlord; after all it is a relationship that the buyer will inherit. Because of its importance, the estoppel certificate is usually a condition of closing a sale transaction. Most leases have language that requires tenants to complete and execute an estoppel certificate within a certain time period, say 10 days. 

Despite its importance and the requirements of the lease, it is not uncommon for tenants to make completing the estoppel a low priority. This can lead to a delay in closing the sale transaction. Depending on the language of the lease, the landlord has a few remedies against the tenant. First, he can pursue a breach action against the tenant. This option is probably not practical considering the time required and the fact that most buyers do not want to inherit a lease that is in breach. Secondly, many leases have language which allows landlords to provide an estoppel on behalf of the tenant if the tenant refuses to provide it. That being said, most buyers prefer to have an estoppel provided by the tenant themselves. Perhaps the most effective option is a monetary penalty. Try adding language to your leases that allows for charging an amount equal to one month’s rent. This could be the most effective way to motivate a tenant to complete an estoppel certificate.

One last word on estoppels. It's not unsual for a buyer or lender to add language to an estoppel that essentially amends/modifies the lease rather than just confirm its terms. Tenants are under no obliation to execute such an estoppel.

Video: Defined Terms

Tips for Using CPI Rent Adjustments

Rental adjustment provisions are a common component of most leases. Often such adjustments are linked to the rise and fall of the Consumer Price Index (CPI). Sometimes referred to as a cost of living adjustment (COLA), these adjustments typically occur annually on the anniversary of the start date of the lease.  The adjustments parallel the increase, or decrease, in the CPI over that same period. For example if the CPI increases 3% then the rent will increase 3% as well.

One inherent problem with using the CPI as an index for adjusting rent is that landlords are forced to wait a few months before billing tenants for the newly adjusted rent.  This problem is a result of the fact that there is a delay in the publication of the CPI. In other words, the CPI for January may not be published until March because the Government must gather and analyze data prior to releasing the index to the public. This forces landlords to bill tenants retroactively for the adjustment in rent each year. If January is used as the month that the rent adjusts each year, then landlords must wait until the CPI for January is published at some later date in order to know exactly how much to increase, or decrease, the rent. Besides being inconvenient, retroactively billing a tenant causes budgeting problems and accounts payable issues for tenants not to mention cash flow planning problems for landlords.  

One solution is to set the CPI index date as a date prior to the rental adjustment date. In other words, separate the two dates. If a lease begins in January and the landlord would like to bill and collect the adjusted rent annually in January, he should set the CPI index date as the month of November (i.e. two months prior). In doing so, the landlord can be assured of having the published CPI index by the time he is ready to bill the rent for January. The difference between the November CPI and January CPI will be almost certainly be negligible, so there is little downside for either the tenant or landlord.

Conceptually, and in an abbreviated form, the lease language might read: "The monthly rent shall be adjusted annually in the month of January. The adjustment will be based upon the difference in the CPI between the months of November 2011 and November 2012…"

For more information about the Consumer Price Index you can visit:

http://www.bls.gov/cpi/home.htm