Lease Terms Versus Operation
Beyond Appraisal and Into Consulting
There is a unique Chicago property where a high percentage of its tenants consist of professional service providers. All space users pay the same $/sq ft rent and management makes it known that tenants must either accept management’s lease terms or find alternative office space. No lease negotiations: tenants either “lease it or leave it” (that sounds like a great HGTV show title!) when it comes to lease provisions. There’s wisdom in standardized lease provisions with limited deviation from preprinted terms; consistency among leases results in simplified rent rolls and operating statements.
We have seen this story many times in our 30+ years of operation. However, despite so-called standardized lease provisions, problems surface when properties are not managed subject to strict interpretation of lease terms.
the problem & calculated approach
The Argianas team was recently asked to review information in a similar scenario. The property owner – a passive investor – adopted a “standardized lease” policy however, many tenants were not strictly held to their lease provisions. The Argianas team sees this frequently, resulting in sit-down sessions with property owners to explain the difference between rent vs. effective rent. Effective rent represents how a property is operated regardless of what the lease says.
In a recent engagement, the Argianas team reviewed all leases at a subject property and reported on income and expenses for the last three years as a foundation for the preparation of pro-forma financials. This is a typical Argianas task. Our team is particularly skilled at reading and interpreting leases before we project a property’s net operating income. In all cases the Argianas Team delivers, but one must always read the lease!
NNN & Gross
Leases are at their most fundamental, contracts. As you most likely know, contracts can, at times, be complicated. While there are several conditions when reviewing a lease, most in the real estate space refer to three basic lease concepts: Net, Gross, or Modified Gross.
- Net Lease: In its simplest sense, a ‘Net’ lease means tenants pay their rent plus their defined proportionate share of expenses. From the perspective of the property owner, these are reimbursements for the space user’s proportionate share of common area maintenance (CAM), property taxes, and building insurance.
- Gross Lease: The tenant pays a set dollar amount and the owner is responsible for all expenses. If properly drafted and assuming market equilibrium, a grossed-up rent should yield a consistent $/sq ft. rent on a net to lessor basis.
- Modified Gross: Landlord and tenant agree on lease particulars. Modified gross has different meanings in different scenarios.
While there is no ‘one size fits all’ for property owners, it’s important that landlords and tenants understand effective lease agreements. Leases should be carefully reviewed, and terms and conditions should be defined.
leases | what is said vs. what is operated
Lease terms should be understood by both lessor and lessee. When a disconnect arises, it’s time for a reset.
In a recent Argianas engagement, the subject property’s leases included language suggesting the leases were net, with tenants responsible for expense reimbursements. However, the property was not operated as such despite the owner’s insistence otherwise (because the leases said so). Obviously, this presented a problem.
How ownership manages a property is not an appraisal related issue; however, a ‘reset’ is sometimes suggested when we render real estate consulting and valuation services. A good solution sometimes involves landlord-tenant execution of estoppel certificates, which are signed certifications by lessor and lessee that differentiate lease provisions from the way a property operates. Our lease-by-lease analysis with financial operating statement review services make the estoppel result in meaningful analyses.
Are you experiencing a disconnect with your property? The Team at Argianas is up for the challenge and welcomes the chance to assist. You can contact us at 630.390.0113 or by completing this form.