Article: Common problems for commercial real estate owners and fiduciaries
1. Leasing practices and deal structures are out of touch with the market.
In the absence of full and accurate information on events and trends in the market, owners can consummate deals that leave money on the table, take too much risk, or give away too many concessions. It's not just about vacancy rates and asking rents. It's about what size spaces are most desirable; whether prospects are more sensitive to rate or concessions; what the lease terms should be, given the owner's objectives and market projections; how the landlord establishes the prospect's ability to pay; how the landlord controls fit-out quality and interface with building systems; how occupancy costs are distributed between landlord and tenant; and how one's property is positioned to compete.
Synthesizing knowledge of the objectives for the property, the building's current competitive position, and the overall state of the market is essential to maximizing the owner's return and maintaining the long-term health of the investment.
2. Lease language does not adequately protect the owner's interests.
When a lease document does not contain the proper language it can expose an owner to controversy with tenants, loss of revenue, and legal liability. Language that is unclear on whether landlord or tenant is responsible for specific duties and costs; measurement language that doesn't capture common areas; language that does not adequately provide for the recovery of operating expenses and utility costs; a lack of limits on the use of the premises, or on signage; all can cause tenant relations issues or loss of revenues. While significant, these pale in comparison to the liability exposure for the landlord that inadequate language can create. Inadequate requirements for insurance coverage by the tenant or for indemnification of the landlord by the tenant; the absence of language covering hazardous materials or security issues can result in judgments that can force the refinancing or sale of the property.
A current lease form, drafted with input from attorneys and risk managers and accurately reflecting circumstances at the property, is an essential tool for protecting the owner’s interests
3. Collections are suffering.
Perhaps the tenant’s finances are no longer sufficient to support their financial commitments. Perhaps tenant relations have been allowed to descend to the unprofessional. Special treatment based on off-line communications, undocumented arrangements that by-pass lease language, or unofficial rent deferrals, can creep into the landlord tenant relationship. Collections suffer and the tenant’s sense of entitlement may grow. The tenant wrongly may attempt to place the responsibility for a failing business on the landlord’s lease terms. Returning the relationship to a business footing may be difficult for the parties involved.
A dispassionate assessment of the long-term viability of a tenant is the basis for sound landlord decision-making. Bringing extraordinary arrangements to an end, devising realistic payment plans where warranted, and occasionally replacing a non-performing tenant will restore the proper performance of an asset.
4. Vacancies are high due to a lack of effective marketing.
A property that does not have an effective marketing plan can lose deals. An unrealistic view of the property’s position in the marketplace, inaccurate information on the property, unrealistic expectations for lease terms, or an unresponsive leasing process, can all contribute. Whether attempting to retain or replace tenants, an unprepared owner may not be able to prevent vacancies. Vacancy loss has a direct effect on cash flow and can affect the ability to pay bills or meet required capital expenses.
Knowledge of one’s own property and its competitive position are key to assessing deals. Frequent communication with existing tenants and knowledge of an existing tenant’s business climate are keys to understanding and responding to a tenant’s intentions. Knowledge of who is the market for the property and how to reach them effectively are keys to acquiring tenants.
5. Critical obligations are missed due to poor lease administration.
The lease as contract binds the landlord and tenant to certain obligations. Often the obligations have time sensitive requirements or other performance consequences. If a landlord fails to timely collect a periodic rent increase, a utility reimbursement, or tax and operating escalation, it can lead to loss of revenue, damaged tenant relations or both. If an insurance policy, a letter of credit, or an option is allowed to lapse, it can have serious financial or liability repercussions for the landlord.
Full knowledge and documentation of the landlord’s obligations and the tenant’s obligations are essential to protecting the landlord. A system that records and gives early warning to administrators of critical lease provisions and dates can materially improve lease administration and landlord protection.
6. Maintenance of life/safety and mechanical systems is inconsistent.
A fundamental right of tenants and landlord’s employees is a safe workplace. Sometimes a landlord is unaware of the deterioration of critical systems. A failed vendor relationship or other circumstance may prevent the systems from getting the proper attention. Changes in codes or in the property may alter the state of the building’s compliance. A system may become obsolete due to age or change. When an emergency arises or a new tenancy triggers tests and inspections, problems come to light. A best-case scenario is that remediation requires expenditure, perhaps at a premium due to the emergency nature of the problem. A worse case is that someone is taken ill or is injured and holds the landlord responsible.
An inspection and maintenance routine of life/safety and other critical systems consistent with the age and condition of the equipment can anticipate problems, avoid failures, and allow the address of any significant problems in an efficient manner. Documentation of the care a landlord has taken to meet fundamental obligations may limit loss in the event of a lawsuit or insurance claim.
7. Cash management fails due to a lack of capital planning.
If routine inspection of the structure, mechanical systems, and finishes of a property is absent, a property may make sudden capital demands that overwhelm an ownership’s cash flow. Sudden capital expenditures, particularly those of an emergency nature, can be more expensive than the same project conducted in a planned manner. In addition to replacement costs and the like, there may be rental loss due to abatements allowed under leases for the failure to meet landlord’s obligations. The need for cash for these expenditures may coincide with cash needs for high utility billings or real estate tax bills. The impact on immediate cash flow may imperil distributions or even result in a cash call.
An on-going inspection and planning process should lead to a capital budget or to a capital reserve based on realistic projections of needs and costs. These projections may assist in prioritizing expenditures so that insurance premiums are contained or leasing projections are met. They may be used in reevaluating an owner’s objectives for the property. #
-Richard Horgan, CPM, CCIM
Click here to inquire about a complimentary analysis.