Gerald Tostowaryk

Commercial and Residential Real Estate

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So last week we discussed in some detail lease negotiations; this week I was going to address Lease Costs and Lease Documents but Lease Costs turned out to be a more complex topic than I had estimated so let's talk about lease costs you are likely to encounter in a lease negotiation so that you can more confidently negotiate your lease and next week we will discuss;

Small Leases: Part IV - Lease Documents

Lease Costs

This is actually a relatively simple topic but in practice it becomes complicated mainly due to improper usage of some of the terminology used in leases. Let’s discuss those terms, what their textbook meanings are, and how they are used in practice.

Textbook Definitions

Rent

The textbook definition of rent is the amount you pay to occupy the space. All other costs are above this amount so utilities, taxes, maintenance, insurance and any other cost is in addition to rent.  This is more appropriately called Net Rent. If all the taxes, insurance and maintenance were included in your rent that would be called Gross Rent.

Additional Rent/Operating Costs/Common Area Maintenance (CAM)

Depending on the scenario, according to textbook, the property taxes, property insurance, and property maintenance are either called Additional Rent (usually retail setting), Operating Costs (industrial) or CAM charges (office).

Utilities

This generally refers to utilities specific to your occupied space. Utilities for the common areas of the building are usually covered in Additional Rent. Depending upon whether or not the building has separate meters for each space your utilities will either be your own responsibility (separately metered) or included somehow in Additional Rent. If they are included in Additional Rent, have your accountant or lawyer check the formula.

 

Common Usage

In common usage these terms get intermingled quite a bit. Net Rent is usually used correctly but sometimes Net Rent may include some of the Additional Rent or even some of the utilities. Gross Rent is most often misused and often only includes some of the items of Additional Rent as well as some or even all of the utilities. The key takeaway is to make sure what is or is not included in “Rent” is clearly specified.

If Rent is being misused you can be sure that the term Additional Rent (Operating Costs, CAM costs) is also being misused. The bottom line is the same in any scenario; forget what terminology is being used and just ensure the lease spells out what items are or are not included in “Rent” or “Additional Rent”. Generally the larger the landlord, the more likely the terms are being correctly used, but this is not written in stone.

Additional Rent

In retail, and especially in shopping centre settings, Additional Rent can mean a few things. In major shopping centres, landlords will often charge a Percentage Rent. This is basically a charge based on a percentage of your sales, so the more you sell the more rent you pay. At first this seems unfair (and sometimes is for small tenants in large malls) it is an incentive for the landlord to make their shopping centre more attractive to shoppers. The more attractive their centre is, the more money you make. I guess it’s a win-win…of course the landlord probably wins a bit more than you do.

In any setting (industrial/office/retail) with multiple tenants in one building or complex there can often be Gross Up charges. How this usually appears is if you are renting a space of, say, 2400 sf, you pay rent on 2425 or something like that. Why? What this is, is a way of making sure each tenant pays for their share of the common spaces of the building like a foyer, hallways, washrooms, elevators, etc., etc. This is common and if done properly is perfectly legitimate.

 

Okay, with those two comments out of the way, additional rent is, as mentioned before, the Property Taxes, Property Insurance and Property Maintenance. Some first time tenants wonder why they have to pay these costs if they don't own the building. The short answer is one way or another tenants pay for everything. Is this unfair? No. Investors (landlords) invewst their money to make a return. If they don't make a certain return, they don't invest.

 

If you are in a multi-tenant building, additinal rent must somehow be apportioned properly between tenants. This is normally done on a square foot basis. In otherwords if your space is 12% of the entire leasable space you pay 12% of the total additional rent. In larger shopping centres with "anchor" tenants (large well-known retail firms that attract a lot of shoppers) will sometimes pay less than their share or none at all, and you can guess who picks up the slack. While this may not be fair, there are only two things we can really say about that. First, nobody ever said it would be fair and secondly, the argument made is that the anchor brings in all these people that end up buying some of your products. The bottom line is that this is normal in retail shopping centre leases.

Many multi-family properties do not have separate meters for utilities and in these cases, utilities are often included in additional rent. In these cases, you want to pay particular attention to how those utilities are calculated. What if your neighbor is a type of business that uses a lot of water? How is water apportioned?

 

Utilities

 

This is a fairly simple topic. In common practice, utilities are pretty much the same as textbook. The tenant pays all their own utilities and their neighbor pays for all hers or his. This does get a bit tricky in situations as mentioned above where there is no separate metering of utilities. If there is separate metering you can easily determine your utility usage. If there isn't, the lease will specify how utilities are to be apportioned.

 

A Final Note on Lease Costs

 

If there is one precept to burn into your memory for lease negotiations, remember that there is very little legislation governing commercial leases. In otherwords, whatever that lease says, goes! Whatever you agree to will likely be upheld in court. Residential leases have The Residential Tenancies Act (Alberta - similar ones in other

provinces) but there is nothing for commercial leases.

If you are a landlord, definitely visit your lawyer and get a "Standard Lease". Read it through carefully and be sure you understand each clause because some of them are rather complicated and written in legalese. You can be sure sophisticated tenants will want to negotiate some of the clauses and you need to be sure you understand what you are negotiating away.

If you are a tentant, don't be intimidated by a landlord's "Standard Lease". Every lease is negotiable (although check my last post in this series for just how much some leases are or are not negotiable). So beware.

Most landlords are very fair people but you can be sure the leases will be written in the landlords favour, wouldn't you? Read them and have your lawyer read them first.

 

See you next week for...

 

Small Leases: Part IV - Lease Documents

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Well last week we covered some of the basics of small commercial leases; this week we delve into negotiating the lease. Negotiating is without a doubt the key link in the leasing chain. The consequences of the negotiations are critical. Poor negotiating can lead to no agreement (lose-lose scenario), or one party having undue benefits and power over the other party (win-lose), or a great five year relationship for both parties (you got it, win-win).

 

 Win-Win vs Win-Lose

 

I can't emphasize enough how many folks are still stuck in old, ineffective win-lose negotiating. So many go into negotiations to get the "best" deal they can for themselves at the expense of the other party, not understanding that especially in a lease scenario, this is the worst thing to do. Stop and think for a moment. You are negotiating a relationship with someone that is going to last at least five years and, with renewals, as long as twenty. How do you want that relationship to begin? How do you want it to develop? How you act now will set the stage for the next five years; trying to take advantage of someone doesn't go far in building trust.

 

Trying to get as much for yourself as you can with traditional win-lose negotiating may seem like the best thing to do, but usually isn't. The other side may not appreciate your negotiating and may spend the next five years returning the favour whenever the opportunity arises. With win-win negotiating, you still look out for your own interests, but look for opportunities to concede something to the other side if it helps you win something you need in return.

 

As an example, if you are the tenant and the landlord absolutely won't give you any free rent up front, maybe negotiate a larger tenant improvement allowance to help defray initial costs.

 

Know The Other Side

 

Have you ever watched the show Mantracker where an experienced tracker tries to find a couple of "prey" who are trying to get to an objective point miles away without being found? What does he say at the beginning of every show? "Know your land, know your prey".

 

The same applies in any negotiation process. Find out whatever you can about the other side. Search engines like Google are an amazing resource these days for researching people or companies.

 

Am I dealing with a large firm or a small "mom and pop"? Do they have more properties? If the other side is the landlord, maybe talk to a couple of their existing tenants, and view how they manage their buildings. If the other side is a tenant in other locations, go visit their sites and see how they maintain their lease space, maybe contact their landlords. Don't ever listen to anything someone said who knows somebody who rents from someone. That is not research; that is gossip.

 

If the other side is a large public company, your public library is likely to have loads of information on them including annual financial statements. If you have a stockbroker or online trading account, you can review more financial information about public companies.

 

The Players

 

To negotiate a good lease, you will need varying degrees of assistance from a few professionals. Depending upon the size of the lease in question, you should have on hand a good agent, attorney, accountant, design and construction people, and your lender. Good leasing agents and lawyers will do their best to keep it professional and negotiate in a win-win manner. A good agent will be able to do what is called "Net Present Value" calculations to help you compare several different lease scenarios to determine which will cost you the least or make you the most. If your agent can't, your accountant should be able to. Design and construction people can give you an idea of whether or not your idea is do-able and how much it will cost. Of course, keeping your lender informed goes without saying.

 

Preparing to Negotiate

 

The two most important things to keep first and foremost in any negotiations are your goals/objectives and the other side's. Clearly knowing your objectives will help keep you on track when the negotiations start to take unexpected twists and turns. Knowing (or estimating) the other side's objectives help you to give meaningful concessions to help get more of what you want or need. There is no use in conceding something to the other side that doesn't help them achieve their goals, but conceding something that helps them meet their needs in return for something you need is the hallmark of good negotiating.

 

The next thing you need to determine is your walk-away point. You need to know in stone above or below which point you will not go. There is nothing more powerful when negotiations stall than an ultimatum that is not a bluff. Remember, ultimatums are not good negotiating, in fact they are usually more destructive than constructive, but when you are at your limit, a real ultimatum as opposed to a bluff send a clear message you will go no further.

 

Offering a bluff ultimatum is very risky; it may get you what you want but if they call your bluff you have just lost a lot of negotiating power.

 

Once you know the other side, goals and objectives and your walk-away point, you are ready to negotiate. Just negotiate in good faith, using the professionals mentioned above to assist you, remember win-win and you can’t go wrong. Well okay, it’s a bit more complicated than that. In our next installment next week we will discuss two important topics in more detail, lease costs and lease documents, so stay tuned for

 

                              Small Leases: Part 3 – Lease Costs and Lease Documents


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Introduction


As a commercial real estate agent in a mainly residential office, I often deal with smaller tenants. Most smaller tenants ("mom and pops" as the slang goes) are much less sophisticated than large national and international organizations with substantail commercial leasing experience, and can only draw upon the experience they have...residential real estate. And therein lies the problem. In residential real estate clients often fall in love with and buy something totally different than they set out to buy. In commercial real estate leasing, that doesn't happen; you must lease a property that fits your needs which is why that commercial agent asked you so many questions before showing you the property you called on, and in the end wouldn't even show you the one you called on. What's up with that? Well, let's find out as we examine How To Search For Commercial Lease Space. Please note that these comments are intended for the Edmonton commercial real estate market and surrounding areas.


Preparation


The first thing you absolutely need to do is put your needs down in writing, and be specific. Even if you fall in love with a space, if it doesn't meet all your needs it won't be long before you wish you never signed that lease.
Some of the obvious things to consider are;

 

Size of Space: Forget how much it costs, just ask yourself in a perfect world how much space is not too big or not too small.

 

Cost: At this point, don't get into analyzing different spaces, just ask yourself realistically how much you can afford. Remember leases have three components: Lease Rate, Operating Costs, and Utilities. We will discuss this point in more detail later as it is a major issue in small leases, but for now determine your budget for all three combined.

 

Location: Where would your customers expect you to be? What works best for you? Remember where you live and where your customers are.

 

And the less obvious things to consider are;

 

How Pretty Are You? Financially speaking of course. Just because you want a space, the landlord is not going to escort you in on the red carpet. At the end of the day/lease, you leave and the landlord still owns the property. Most landlords will want to know intimate financial details about you and your company. Do you have a business plan? How many years have you been operating? Show me your last 3 years of financial statements. The larger the landlord the more demanding they will be. Their cash flow and the value of their properties depends upon the quality of the tenants. Get your financial information ready.

 

Employees  When choosing a location, if you have any employees will the want to drive to that location? Be sure to consider where they live also.

 

Ceiling Height  This is most commonly important in industrial situations but is often important in retail also.

Parking  Is there enough parking for your employees and clients? How many stalls (if any) are assigned to you? Is parking on a scramble basis? Is there on-street parking

 

Accessibility: What sort of accessibility do you need? Left turns onto or off of a busy street will chase customers away. Gas stations locate so that people can turn right into and out of their stations on their way homes after work. Drive through coffee shops locate for right turns on the clients' way to work in the morning (gotta have that morning coffee).

 

Visibility:  Is your business a destination business where people come to you specifically for your service or the products you carry, or is your business dependent upon walk-in or drive-by traffic? Remember high visibility locations cost more.

 

Utilities: Do you have any specific utility needs?

Layout:  What would be your perfect layout? You will likely never find it, but having a draft design of the perfect layout will help you choose your space better.

 

Tenant Improvements:  Since you won't find the perfect layout, you had better budget a realistic amount for tenant improvements.

 

 I could go on endlessly, but there is a good list to get you started. This covers the main points to consider when preparing to lease space.

 

The Search

 

When To Start Searching

 

I am often surprised by the number of folks who call on lease space and I find they need something within a month or two. Not going to happen, at least not in the foreseeable future in the Edmonton commercial real estate market. Even in a balanced market, you need to commence your actual search at least six months as a minimum before you need to locate. The search will take at least a couple months (possibly more), the negotiations will likely be about a month, and you will need at least a month, more likely two, to complete your tenant improvements and move in.

 

Commercial Real Estate Agents

 

So many small tenants do their own searching, calling the listing agent on each property they find. Let me put this gently...don't do that. Check with any regulatory body in the real estate industry and they will tell you it is in your best interests to have your own agent working for you. When we list a property for sale we are legally bound to get the most money and best terms and conditions for our clients...at your expense. So if landlords have their own agent getting them more, why not have your own helping you pay less?

Do your research before you begin your property search. Interview several agents and find ones that are prepared to work with you. Check what their experience is, the services they provide, how they get paid and what their expectations are from you. Don't be surprised if you are asked to sign what is called "Buyer's Agency". Real estate agents don't get paid a penny until you actually lease space through them and subsequently take possession. Adding to that, the agent's fee on a small lease is not very large and many agents, especially the better (and busier) ones, will not be likely to take you on as a client without a reasonable assurance of a payday at the end of the day.

 

The Actual Search

 

Don't be surprised if you find numerous properties your agent didn't find (or didn't tell you about). Commercial real estate is much different than residential. Most properties for lease never make in onto a listing service like the MLS. Because of this, searching for commercial properties is much more difficult and time comsuming than searching for residential properties. You will be in this together with your agent. The real benefits of your real estate agent show up in the lease negotiation process...and that is our next topic in this series next Friday...

 

Small Leases: Part 2 - Negotiating The Lease

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