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During my (38)-year career, I’ve seen it happen over-and-over again: business owners sign a lease that seems completely acceptable, but their real estate leasing/purchasing broker hasn’t done their due diligence to help the business owner identify risks and liabilities that could occur ahead. Some of these financial pitfalls include pass-throughs of repairs, insurance, property taxes, and other operating expenses. More simply, a building just may not work right, affecting your comfort and safety.
Imagine the surprise when you receive your annual, pass-through bill for a repair that should have been handled as a capital improvement at your landlord’s expense. It’s not uncommon especially if your advisor didn’t do the necessary legwork before the lease was signed.
Consider this:
Types of Leases
There are generally two types of leases, with other available variations: Triple Net (and Full Service).
With a Triple Net lease, tenants are responsible for paying all of the operating expenses for their own space including property taxes and tenant-specific utilities, insurance, repairs and maintenance, etc., as well as a pro-rata share of common area expenses. Usually, the landlord pays for the high-ticket items including roofing, HVAC and asphalt replacements, fire-life safety equipment and electrical upgrades, and more — all amortizable over longer periods.
Sometimes however, there’s a gray area as to what and when a building system needs to be replaced. This distinction dictates the extent of annual pass-throughs. In this instance, the tenant is relying on the honesty, professionalism, and efficiency (economies of scale and experience) of their landlord to make sure the building they’re in is being cared for properly and honestly. Short of that, the tenant is at risk.
Perform a Building Audit
A lease allows for a tenant’s audit of their landlord’s books. Before lease-signing, a request needs to be made for the operating expense and major capital replacement building history so that a thorough understanding can be reached about how much money is being spent and the fairness and rationale for OPEX pass-throughs. If a landlord is cutting corners and not properly maintaining a property, it will be evident (at least to a broker with a trained eye) that the tenant is at risk.
You and your broker should perform a thorough review and ask questions based on those details, ensuring that the lease gets accurately written. Sometimes, there’s a rush by the broker and client alike, to conclude lease negotiations rather than taking those extra few steps to ensure a satisfying (and financially prudent) result.
Investigate Insurance Claims
Your broker should take the time to investigate and understand insurance claims made by the landlord, and if they have been accurately applied. For example, if the property owner owns several properties and has blanket insurance, proper insurance allocations should be reviewed and implemented.
Understand Possible Property Tax Increases
Property tax valuations differ from one property and area to the next. They can increase and decrease over time due to growth, special improvement district formation, government funding needs and comparable sales, amongst a host of other factors. These differences will often (especially during pandemic times) bring big tax-bill changes. An experienced broker will understand these factors, and should be able to readily share the numbers with you as to how they may come about and affect your lease and your business.
Lookout for Construction Costs
Tenant finish projects can be a sore spot, especially if you and/or your broker aren’t well versed in construction. Often, lease rates are somewhat based in the tenant finish buildout costs that apply to the preparation of the space for occupancy.
Areas of concern and attention include: shortages, as a result of kinks in the supply chain; receiving the best value for materials (for example, whether your landlord is securing multiple bids and securing the best value on your behalf); if hidden or duplicated expenses are being layered into the cost of your tenant finish, (including overhead and profit versus supervisory fees); and ensuring if line-item costs are in line with market unit cost standards. A broker with experience and licensing in construction can provide a great deal of added value.
The excitement of signing a lease for your business and moving into your new space shouldn’t cloud your judgement. Working with a broker who’s sharp and experienced may save you from a lot of distress and unnecessary expense, often providing a much more satisfying tenant experience.
Dan Bartell is the President of Bartell and Company Real Estate and Bartell and Company Real Estate Wealth Management, a 38-year-old firm that focuses on thoughtful approaches to creating and maintaining value. He can be reached at 303-753-9100 or [email protected].