What is the optimum term for a commercial lease from the tenant’s point of view?

A good question, but there is no “one-size fits all” answer on this one.  The tenant’s objectives play heavily into a decision on lease term.  Let’s talk about some of the trade-offs involved in the decision.

The advantage of a longer term lease (seven years or more) is that they are very desirable from the landlord’s point of view.  Thus, significant concessions can often be negotiated in exchange for a long-term lease.  These can include items such as an expensive workletter or free rent.  The disadvantage of a long-term lease is that you have mitigated one of the major advantages of leasing, and that is flexibility and an easy exit strategy.

The ideal solution for a tenant usually lies between the two extremes in a compromise of advantages.  The average lease term today for industrial and office real estate is five years.  As a tenant, give yourself some flexibility with options.  We recently negotiated a five-year lease transaction for a tenant that included a five-year option to renew, and an option to cancel the lease on six-months notice.  Now that is flexibility!  Options are a one-way street in the tenant’s favor.  Negotiate as best as you can, but ultimately accept any option that you can get!  Down the road, if conditions are favorable, you will exercise your option.  If not, you will be sitting down with the landlord to negotiate.  You have control over the option, not the landlord.

What are the differences between a net lease, a gross lease, and a full-service lease?

These are all terms that are used to describe the manner in which services and expenses are paid in a landlord-tenant relationship.  While the terms are used freely in commercial real estate transactions, there are actually no agreed-upon exact definitions of each.  You should be concerned with the total cost of occupancy, so it is crucial to sort out what services are included in the rent, and incorporating the cost of those that are not.  The following are the generally accepted definitions of these terms:

A net lease refers to a base rent that is being paid solely for the real estate, and does not include payments for real estate taxes, utilities, insurance, and any other operating expenses.  A good way to remember the basis of a net lease is to equate it with the mortgage payment of an owned property.  If you own a property, your mortgage payment is generally due once a month, just a like net rent, but you are also responsible for tax payments, insurance, all operating costs and even the landscaping!  A net lease is similar.  The rent paid to the landlord is simply compensation for his investment and risk in the real estate, and no more.  The so-called triple net lease (usually encountered with single-occupant buildings) puts the entire burden of these expenses upon the tenant, in addition to the net rent that is paid.

A gross lease, on the other hand, usually incorporates some of the operating expenses (almost always real estate taxes) in the rent that is paid to the landlord.  The gross lease may or may not include building insurance or common area maintenance (CAM).  The tenant must take it upon himself to inquire as to exactly what is included in the gross rent that is being quoted.  On Long Island, for example,CAM and building insurance can easily add an additional $0.60 a square foot to the quoted price if they are not included in the gross rent.

Full service leases are almost exclusively encountered in office buildings.  They have, as the name implies, a rent that supposedly incorporates all of the tenant’s cost of occupancy.  A typical full service rent will include the base rent, real estate taxes, insurance,CAM, heating, air-conditioning, cleaning, and rubbish removal.  A “full service plus electric” adds an additional charge to the tenant rent for tenant electric use (lights and outlets).

The definitions for these terms are hazy, and by no means universal.  It is therefore incumbent for you to compare alternative properties and their prices with a full understanding of the total cost of occupancy.  It is important that you ask the necessary questions and dig as deep as necessary to fully itemize the expenses. This is the only way a true economic understanding of the real estate alternatives or pricing can be made.

David G. Hunt

The "Before"

I am always amazed at the number of landlords or sellers who market their property while it remains in an either unappealing or deplorable condition.  Yes, there are some buyers and tenants who have the vision to see past the poor physical condition of property, but the vast majority cannot.

There are probably two reasons for landlord and seller apathy:  They don’t want to spend the money, and they also are not aware of the impact on their prospect.  Many property owners have seen the “before and after” so many times they can literally walk through the property and envision it in pristine condition.  “I’ll do the repairs when I have the tenant” is the logic.  What they don’t realize is that when a tenant walks through property and sees stained ceiling tiles, he thinks the roof needs to be replaced.  An overgrown landscaping bed always means that a landlord does not take care of his property.

The "After"

“Getting-ready-for-market” work is often a lot more economical than you may suspect, and will usually bring back multiples of the cost in an increased rental or sale price. And here is a convincing argument: before a tenant takes occupancy the landlord or seller will probably have to do this work anyway!  Much better to do it beforehand and reap the marketing benefits!

These two photos illustrate a building clean-up by Hunt Construction Services last year.  Which one would you rather lease?

For the techniques of making property sparkle on a budget, click on my article on the subject:

Property Sparkle on a Budget

By investing the time and money to create a positive impression in the eyes of your prospect, you will help ensure that your property is leased or sold quickly.

David G. Hunt

If you are planning commercial construction or renovation of some kind, there are two types of construction estimates.  You need to be aware of the advantages and disadvantages of both.  A “budget quotation” is a rough estimate of the costs of construction which is prepared without a lot of detailed information on the quality or type of materials.  A “contract bid” is a price for which the contractor is prepared to build, and is usually based on a complete set of drawings and/or outline specifications.

Why would anyone want a budget quotation?  Hunt Construction recently provided a budget quotation to a Huntington businessman who was interested in expanding his building.  An architect had prepared a single page plot plan showing an outline of the proposed addition on the site.  That’s all there was.  But enough for a budget quotation.  In this case, a budget quotation helps our client make a GO/NO-GO decision.  Will he be able to finance the addition?  Will the additional carrying costs and taxes be more than offset by the additional business that can be booked?  Our client did not want to bear the cost of a full set of architectural drawings before having an understanding of the scope of the project.

    A contract bid, on the other hand, should be based upon very tight specifications (down to the last doorknob) and a complete set of plans.  If this is not done, the result will be construction bids that vary widely based upon what each contractor believes you want.  So a complete set of plans is the last place where you want to skimp!

David G. Hunt

I have always taken “leading economic indicators” with a grain of salt.  But there are signs out there that the logjam is finally breaking up.  A barometer that I have used for years is, “How often are our properties being shown by the entire brokerage community?”  Showings are at a three-year high at the moment.

We recently met a manufacturer and distributor of B2B shipping products.  His type of product is used by nearly every manufacturing and warehousing company in the country.  He needs more space, reports that his product is flying off the shelf and is struggling to keep up with the demand.  Hmmm…

Yes, there is something going on out there.  Other news:   “CoStar’s monthly National Composite Index of commercial real estate real estate prices increased 2.2% in October from the same period a year ago, the first year-over-year improvement since the economy too a sharp downward turn in 2008.”  Also, “Existing home sales continue to climb in November according to the National Association of Realtors.”

There are enough of these signs that I am finally believing that this is not a short-term aberration.

David G. Hunt

Winter is knocking at our door!.  Are you wondering what you can do to help keep those heating cost down?  Here are some suggestions:

Make sure your windows and doors are properly sealed.  They may need re-caulking.   They may even need to be replaced.  Check to see if the rubber slides at the bottom of the doors are working properly and are in good shape.  Don’t forget about the garage doors.  Make sure they are sealed properly also.

What about the exterior wall penetrations such as water pipes, waste pipes, oil feeds and gas feeds.  Are these penetrations sealed so water doesn’t get by?  You may need to add expanding foam or seal openings with concrete.

Check to see if your thermostats are properly set so you’re not heating an empty building.

The sale-leaseback mechanism has been around for many years, and has been employed by many Fortune 500 companies to divest themselves of corporate real estate and improve their balance sheets. Todayʼs fast chang­ing business climate makes it dif­ficult for companies to forecast their long term need for space. That is one reason that the trend today, for both large and small companies, is to lease real estate. The sale-leaseback is a popular alternative to achieve that goal and generate cash at the same time.

Another advantage to a sale-lease­back is the positive effect it usually has on the companyʼs balance sheet. Typically, your building has been depreciated on the books, but the market value has appreciated. As an example, if you purchased the building for $1,000,000, the depreciated asset value on the books may be $600,000 while the market value of the property may be $2,000,000. By entering into a long term operating lease, the cash and asset side of your firmʼs balance sheet are often vastly improved, which in turn improves the most commonly used financial ratios, notably current ratio and debt-to-equity ratio. And if your building is presently mortgaged, a sale-leaseback will also remove the mortgage debt from the balance sheet.

In addition, for tax purposes, a sale-leaseback allows full deduction of rent paid under an operating lease. If you refinance the property, only the interest portion of the mortgage payment can be deducted, not the prin­cipal payment.

David G. Hunt

There are several advantages to selling your property to a third party and simultaneously executing a long term net lease to occupy the building. As you are probably aware, a sale-leaseback is a mechanism that allows you to access the equity that has been locked into your bricks and mortar. Each situation needs to be evaluated on its own merits, but for many com­panies that presently own their real estate the sale-leaseback is an attrac­tive alternative for several reasons.

Unlike refinancing where some part of the value of the prop­erty must be retained as equity, a sale-leaseback allows the seller to extract 100% of the property’s worth. This can be a substantial figure, since most lenders will not exceed loans of more than 75% of the property value. For example, if the fair market value of your plant is worth $2,000,000, a sale-leaseback will allow you to extract the full amount, less fees. Traditional financing would only allow 75% or less of this amount.

David G. Hunt

The third-quarter CoStar report shows an overall vacancy rate of 5.9% in the Nassau-Suffolk marketplace.  This compares very favorably with an average national rate of approximately 10%.   Not surprisingly, with its huge pool of industrial buildings, the swings on Long Island are moderated as well.   What’s not articulated in the report is the difference between Nassau and Suffolk County.  The Nassau market is tight in many size ranges, whereas bargains abound in the Suffolk market.   Note to those looking for industrial space:  You can achieve at least $2.00 a square foot in real estate tax savings by merely crossing the county line in Suffolk.  For a 20,000 square foot user, that is a $40,000 a year savings!

David G. Hunt