December 2009 - Office Tenant Newsletter

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Houston's Office Tenant Representation Newsletter - December 2009

Contains: Information about Lease Audit Provisions
Capping Operating Expenses to the benefit of the tenant, economic charts, and weekly rewind via Robert Lowery's Blog

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December 2009 - Office Tenant Newsletter

  1. 1. Need assistance with a renewal, renegotiation, relocation, or subleasing of your space? We are Tenant Representation Specialists. We represent your interests, not the landlord’s. OFFICE Robert Lowery & Rick Cagnolatti Checklist for Negotiating a – Fair – Lease Audit Provision Landlords and tenants often argue over lease audit rights in leases. Landlords seek to restrict the tenants’ right to audit by imposing restrictions on an otherwise open right. Tenants seek to ensure that they have a practical, workable clause that will enable them to verify their costs. When landlords and tenants eliminate any gamesmanship from the process they do not seek to outsmart each other or to pursue hidden agenda goals, so agreeing upon a fair audit provision should result in the following agreements being incorporated into the audit provision.  A tenant should have a right to audit, review and copy landlord’s books and records  A tenant may not conduct an audit if it’s in default under the lease  A tenant may not conduct an audit if it is withholding base rent or operating expenses until the audit is completed  A tenant may not conduct an audit unless it agrees to a confidentiality restriction  An overcharge of operating expenses by landlord shall not entitle tenant to terminate a lease  Tenant and landlord shall be barred from asserting any right to charge additional operating expenses or to claim a refund for operating expenses if such right is not asserted and an arbitration or litigation commenced within three years from the date that landlord furnished tenant with an operating expenses statement or, when appropriate, a supplemental operating expense statement  The tenant may conduct the audit itself or by utilizing an accounting firm or a firm that simply specializes in auditing operating expenses  In the event that the audit reveals an overcharge, the amount of the overcharge with interest at the Interest Rate shall be refunded by the landlord to the tenant unless the tenant elects to have such amount credited against the rents next due and owing under the lease  Tenants should be allowed to offset against Base Rent a final award or judgment as to the overpayment of Operating Expenses, if not paid within thirty days  If the amount of the error by the landlord exceeds a certain percentage (typically 3-5%), then the landlord shall pay for the cost of the audit  The procedure for determining any dispute pertaining to operating expense should involve an arbitration where the arbitrator is defined as someone who has had 10 or more years of experience as a lawyer handling real estate leasing matters.
  2. 2. Have the Landlord “Gross-Up” Recalculate Proportionate Share Don’t Let a Landlord Profit from Building’s Operating Expenses if Building’s Size Increases Operating Expenses Example: A lease requires you to An obvious and fair thing to do is The owner should not make any profit pay your proportionate share of to put a clause in your lease from operating expenses. Therefore, increases in operating expenses requiring the owner to recalculate have your attorney include a clause over a base year. If the building and reduce your proportionate prohibiting the owner from collecting were fully occupied, the owner’s share when the rentable area of an amount greater than your fair annual tenant-related cleaning the building where your space is share of the operating expenses. expenses would be $100,000. But located increases. The reduction in the building’s occupancy rate in proportionate share could end up Also, limit the collection of operating the base year falls to 50 percent, significantly lowering your expenses to owner’s actual and so the cost of the owner’s cleaning operating expense bills. reasonable operating expenses. services for the base year is only $50,000. The reduction in your proportionate Finally, try to eliminate any catch-all share should take effect when the phrases in the definition of operating The lease requires the owner to owner receives a certificate of expenses that let owners back in gross-up to 95 percent all occupancy for any new rentable additional operating expenses not occupancy-dependent expenses space in the building, or when any specifically set out in the lease. every year after the base year tenant occupies such new space Examples of such phrases include: when the building’s occupancy rate for its business purposes, falls below 95 percent. If the whichever occurs first. If “any other cost or expense of building is 100 percent occupied certificates of occupancy are not operating or maintaining the during the second year of the issued by the municipality or Property,” and “expenses paid or lease term, the owner’s cleaning another appropriate government incurred by owner for the operation of costs will jump to $100,000. You authority in which the space is the Property, including without are stuck paying your share of that located, the trigger should be the limitation. ...” $50,000 ($100,000 -$50,000) document or event that legally increase in cleaning services. allows a person or company to Limit Controllable Expenses occupy the space. However, if the owner were Try to place an annual cap on required to gross-up such If the owner is not required to increases in operating expenses that occupancy-dependent cleaning recalculate your proportionate the owner can control—such as expenses during the base year, share when the rentable area of building personnel salaries, building cleaning services during the base the building increases, you may be service contracts, and management year would have been $95,000, stuck paying operating expenses fees. Otherwise, these expenses instead of $50,000. Thus, using the old proportionate share, could get out of hand and you could you would pay your share of only unless you want to spend the time end up having to pay your share of a the $5,000 ($100,000 - $95,000) and money to litigate the matter in huge bill. increase in cleaning services in court. In most states, commercial the second lease year. leases are nothing more than For instance, you can add or have contracts, and the parties can your attorney add language to your Because in a full-service gross negotiate any terms they want, lease, in which “Controllable lease, operating expenses are part provided those terms don’t violate Expenses” is defined. The next of the total rental rate, this will the law or public policy. section will address this issue. make a significant impact.
  3. 3. An operating expense cap is essential in leases today as landlords are looking for ways to pass-through expenses to the tenant. Below are four caps that are ranked in order of preference. 1=Most Desirable for Tenant 4=Least Desirable for Tenant YEAR-OVER-BASE CUMULATIVE CAP YEAR-OVER-BASE COMPOUNDED CAP Year-over-base cumulative caps limit expense increases to a fixed Unlike caps based on cumulative increases, which are always calculated amount each year, determined as a percentage of the expenses at the as a percentage of the base year, caps based on compounded increases beginning of the lease term. These caps are simple in that they are are calculated as a percentage of the prior year’s cap. This difference constant every year.These caps often read as follows: causes the cap to rise slightly faster (allowing more expenses). The language for a compounded increase would be: “The annual increase in expenses is limited to 5% on a cumulative basis.” “The annual increase in expenses is limited to 5% on a compounded basis.” As an example, if the starting base amount is $100,000 and the cap is 5% per annum, the cap for year 1 is 5% of base year expenses ($105,000) Continuing with the prior example, if the cap is 5%, the first year’s and thereafter rises to 10% of base year expenses to 15%, to 20%, and so maximum is $105,000 (5% over the $100,000). However, because this is on. This results in caps of $105,000, $110,000, $115,000, etc. now compounded, the next year’s cap is 5% over the first 5%, or 5.25% (making the compounded increase from the base 10.25%, or $110,250). This cap is not affected by the actual expenses (unlike year-over-year caps, as will be seen below). For example, if the expenses in year 2 drop Each subsequent year’s cap would be calculated as a percentage of its to $90,000, when the cap is $105,000, year 3’s cap is unaffected and still respective prior year’s cap, making the caps in this example 15.7625%, rises to $110,000. Note that the landlord is not pressured to keep 21.551%, and so on. This would result in slightly higher caps than the expenses down, and has the latitude to raise them by $20,000 without fear cumulative caps, at $110,250 (as opposed to $110,000), $115,763 (as of hitting the cap. opposed to $115,000), $121,551 (as opposed to $120,000), and so on. Year-over-base cumulative caps are negotiated by those parties that want Because a compounded cap rises at a slightly higher rate than a a known maximum expense exposure for each year of the lease term. cumulative or simple cap, more expenses can be passed through to tenants. Of the four caps discussed in this article, compounded year- YEAR-OVER-YEAR CUMULATIVE CAP over-base caps are the least restrictive and most favorable to landlords. Year-over-year caps are very different from year-over-base caps in that As above, the annual maximums are known to the parties. The they are calculated by applying the cap percentage to the prior year’s compounding just allows slightly higher increases to occur. expenses, not to the original starting expenses and not to the prior year’s cap. They are generally very simple in concept. Typical language is as YEAR-OVER-YEAR COMPOUNDED CAP follows: These caps are unusual. They work by allowing the increase to compound “The annual increase in expenses is limited to 5% of the prior year’s each year, but such increase is applied to the prior year’s expenses. expenses.” Language would read as follows: If the expenses do not reach the cap, the next year’s cap is the allowable “The annual increase in expenses is limited to 5% of the prior year’s percentage increase over the actual expenses. If, on the other hand, expenses, calculated on a compounded basis.” expenses exceed the cap and are limited to the capped amount, the subsequent increase is calculated over the lower capped amount. Here, the 5% cap is compounded each year so that the 5% cap itself Returning to our example, if expenses in the base are $100,000, the cap grows with inflation. Thus, the 5% that would apply in the first year grows for year 1 becomes $105,000. If actual expenses for that year are only to 5.25% the second year, 5.512% the third year, 5.788% the fourth, and $102,000, the cap does not apply. Unlike the year-over-base compounded so on. As with cumulative year-over-year caps, if expenses do not reach cap, the next year’s cap becomes 5% over $102,000 ($107,100) as the cap, the next year’s cap is calculated based on the actual expenses. opposed to 5% over $105,000 ($110,250). This repeats each time the However, this percentage is always applied to the lower of the prior year’s actual expenses fall below the cap. Furthermore, the entire trajectory of expenses or the capped amount. the cap is affected for all future periods whenever this happens, because the cap is thereafter calculated based on the prior year’s lower actual If the cap is intended to limit increases to a certain agreed percentage costs. increase, it seems that the percentage itself should remain static. Because they reduce allowable expenses to a lower trajectory for the Year-over-base compounded caps are similarly restrictive to landlords as balance of the lease term whenever actual expenses dip below the cap, year-over-base cumulative caps, but permit slightly larger pass-throughs. year-over-year caps are the most restrictive to landlords and therefore the most favorable to tenants. Contact Bob and Rick today if you would like a thorough review of your lease for potential overages! Bob - 832-275-6514 and Rick - 832-659-5355
  4. 4. You asked for more charts…we’ll give you more charts! Study: Personal Consumption Expenditures Period: 1960-Present Case: Inflation vs. Deflation Will deflation continue? Study: Stock Market Run-Up Period: Aug 2009-Present Case: Support Lines Which way will the market break support? Study: Home Price Index Period: 1988-Present Case: Home Prices Drop Will home prices continue improvement in 2010?
  5. 5. Have a chart for our upcoming 2010 forecast? Send it. Study: Nasdaq Composition as a % of GDP Period: 1924-Present Case: Technology Will Nasdaq and Tech fall in line with GDP? Study: State Coincident Index Period: 1979-Present Case: Recessions and State Activity Will states continue to see improved activity in 2010 or will we see a “W” like the 1980’s? Study: FDIC “Insured” Problem Institutions Period: 1990-September 2009 Case: Banks Will the banks see a steady or severe spike in takeovers by FDIC?
  6. 6. Study: Unemployment Period: 1976-Present Case: Highs and Lows since 1976 (red line is current unemployment) Can Texas remain a stable employment state? Study: Capacity Utilization- Industrial Production Period: 1967-Present Case: Manufacturing Can US demand bounce back? Study: “Cash for Clunkers” Period: 2009 Case: Texas Car Purchases (right of map) Will Texans continue to buy more foreign cars than American made?
  7. 7. Blog : a Web site that contains an online personal journal with reflections, comments, and often hyperlinks provided by the writer OFFICE Robert Lowery & Rick Cagnolatti o Houston gasoline – cheapest in the state. o Could a new kind of stress test be looming for CRE? Don’t have time to keep o Food stamps now feeding 1 in 8 adults and 1 in 4 children. up with local and o Texas adds 41,000 jobs in October. national financial news o With the future for CRE unknown, one expert advises banks to raise equity and headlines? now. o Former high end Zales jewelry shop, Bailey Banks & Biddle moves out of Weekly Rewind is CityCentre. posted on Sunday o Parent declares bankruptcy. evenings. o Regulators are pushing small banks to cut back CRE lending. o US Bancorp to “flip” a Houston bank and 8 others it purchased via FDIC..just one month ago. o Morgan Stanley admitted defeat, handing back Crescent Real Estate Equities to lender Barclay’s. o Weekly jobless claims less than 500,000 for the first time in over a year. o Hong Kong IPO brought in $2.5B for the Sands China…the low end of the range. o Harvey Green says existing debt needs to be paid off for commercial real estate to improve. o Macarthurcook REIT has approved a rescue by AMP. o Transco (Williams) tower now a LEED building. November o Energy saving equivalent to removing over 2,000 cars from the road. o Are investing in REITs a medium risk way to boost yields? 23-27 o Shares of Landry’s surging. o Is TALF assistance unneeded for the upcoming CMBS issues? KBR on Air Force contractor list. o Will the hotel sector see a rebound in 2010? o Is the stimulus creating construction jobs? Texas ranked… o Could the CMBS market be getting a huge assist from the government? o Judge does not block Lions stadium purchase for 583,000. Go to… o The U.S. ranks second in distressed commercial property. o SBA to run out of stimulus funds for 90% loans. Tenantrepresentative. o Back to 75%. Could the market rebound make GGP investors fistfulls of wordpress.com cash? o BASF to sell Clear Lake manufacturing facility and transfer employees. Follow Us… o The Feds want to know when they will be repayed TARP money. o US business economists raise 2010 growth forecast. Twitter.com o Want construction financing? @leasinghouston o Being a good credit medical tenant willing to sign a long lease helps. o US homes sales highest since July 2007. Facebook.com o Animated unemployment rates by county. @Houstonofficeleasing o Moody’s says that CRE property values have fallen to their 2002 levels.
  8. 8. Tenant Representatives… Analyze your space needs. Investigate all properties and determine which are the most appropriate for your needs. Create a bidding war amongst several landlords for your business. Protect you during lease negotiations. Identify lease provisions that may cost or save you money during your lease term. Handle paperwork. Settle disputes that arise even after the lease is signed. Ensure you get the most value from tenant improvement allowances. Win concessions that anticipate your current and future needs. *Obtain payment from the landlord for procuring you, the tenant, for their building. Robert S. “Bob” Lowery & Rick Cagnolatti Tenant Representation Team Coldwell Banker Commercial 2121 Sage Road, Suite 150 Houston TX 77056 832-275-6514 or 832-659-5355 Office: 713-840-5000 http://www.cbcworldwide.com We represent your interests. Landlords pay our fee.

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