I am a blue belt in JiuJitsu, the powerful Brazilian martial art and combat sport. One of my favorite parts of the JiuJitsu experience is that you line up in rank every day, with the most skilled grappler on one end and the new guy on the other. When it is time to train, everybody pairs up, and the most experienced person pairs with the least experienced person, and so on, all the way down the line. This way, every person has an opportunity to learn, work with peers, and teach. After you train in this manner for an hour, you get a chance to spar with people of all skill levels to test your knowledge and gain insights through practice.
At Gracie Barra, the gym where I have trained for years, I am blessed to train alongside a number of black belts who provide me with ongoing support. They can pinpoint exactly where I am in my journey to black belt within the first few minutes of sparring.
I am pleased to step into the role of experienced mentor whenever I speak with clients. Even if I have not talked to them in years, I can instantly understand where they are in a real estate process and help them right away. Like the JiuJitsu black belts that help me, my real estate practice deliberately focuses on improving each aspect of helping clients, even after the lease contract is signed.
After the excitement of the move is over, I recommend that clients should debrief, abstract the lease, and consider lease administration. As time goes by, it pays to keep in touch with your landlord, integrate your real estate discussions into your quarterly management meetings, and make adjustments to your lease. I also help clients deal with surprises—some of which pop up with enough frequency that I can see them coming before the clients do.
PROJECT DEBRIEF
Your company has acquired its new industrial building, and your project team’s job is complete. Great job, team! While all the details are fresh in your mind, you should memorialize the lessons learned in the process, as a lot can change over the first five to ten years you are in your warehouse.
Have each team member write down what worked, what did not, and what they wished they had known earlier. Then ask your assistant to compile these answers and identify trends in the feedback, key takeaways, and future actions. Transforming experience into learning is the process by which you build institutional capital your team can draw upon and use as raw material for continued growth.
LEASE ABSTRACT
A lease abstract is by far the most overlooked document in the history of commercial real estate. The abstract is a two page brief of the lease document in Excel, with all the critical dates, dollars, rights, and obligations that you can upload into a data base in the cloud. The purpose of a lease abstract is to have a form of the lease that is easy to access and manage, so you do not have to go through a sixty page contract to solve a problem.
You will find your lease abstract helpful when the roof leaks and you are not sure who is responsible or whom to call. The same goes for HVAC, plumbing, lighting, dock equipment, and so on. Another great example is with subleases. When the roof leaks and you have subleased the building, you need to know if you should call your sublessor or the master lessor, now that three parties have some form of responsibility.
The most missed item is the option to extend your lease. As you reach the end of your lease, the landlord may be planning a huge rent increase, looking for a company with better credit who will sign a longer term than you will, or planning to sell the property to a user who will pay a higher price. If you exercise your option to renew and extend your lease, you have the right to be in the property for the foreseeable future and lease term. An option to extend the lease has to be exercised six, nine, or twelve months in advance of the lease expiration.
Executives usually do not have a system to remind them of dates like this, but you should, especially once you have multiple leases. You will want to systemize how you keep track of these dates. Most executives send their lease to their accounting department to pay the rent, and they do not look at it again. The accounting department will not look at it again until a problem arises. Even large and sophisticated companies miss dates due to lack of oversight or just because of the sheer volume of minutiae they have to tend to daily. Managing all these dates can be done simply, at a low cost. The industry term for this management is “lease administration.”
Ask your broker to prepare a lease abstract for your new lease, or hire a third party lease administration company to do it for you. The cost per abstract is nominal.
LEASE ADMINISTRATION
For companies with ten locations or more, lease administration software is the best way to keep track of all dates and dollars, rights and responsibilities, reconciliation, and option dates. Over the last ten years, we have seen the rise of property technology (PropTech) software. This gives us the ability to keep track of clients’ leases within user friendly databases on a per lease basis. The software rates are reasonable, and they come without a lot of the overhead or glut of features. A calendar overlays all real estate–related dates and provides teams with timely emails and alerts in advance of critical inflection points in the lease.
Many executives resist adding yet another type of software to manage, fearing it may not be worth the price and effort of implementation. I get it. If additional software is not for you, you can hire a third party firm that specializes in lease administration. Most do an excellent job at this specialized work. Some brokerage houses have lease administration departments in house as well, which will handle this for a monthly flat fee. Some provide the service free of charge if there are enough lease and sale transactions in your book of business to offset the cost.
BUSINESS PLANNING
If your company is anything like mine, you have quarterly and annual meetings where management tracks performance, reviews forecasts, and discusses high level initiatives. At a minimum, your lease(s) should be addressed during your annual meeting. However, real estate–related matters are usually discussed quarterly and in board meetings, as real estate topics overlap with operations, finance, space use, HR, IT, and so on.
This is so your company’s vision can continue to align with your company’s physical space. You do not want these to get out of alignment for long.
For example, if you are experiencing growth, you might try to increase the density of your office space to fit more employees before deciding to relocate. In the warehouse, the telltale sign is when you find yourself shuffling pallets because you cannot find enough space. Some companies even stack or stage steel shipping containers in the yard as an overflow measure before they decide they need more space.
I frequently see buildings reach their capacity of workers in the warehouse. This is most evident when a shift comes to an end and employees pour out into the parking lot, into the street, down the road, around the corner, and into vacant neighboring parking lots to be picked up by friends or family. Some manufacturing operations eventually find their parking shortage starts to impact their operations. One company I worked with had so many extra tractor trailers during busy seasons, they stored them up and down the street and always received parking tickets and code enforcement notices during the holidays. Signs of overcapacity do not mean it is immediately time to move, but it is a signal you should be actively thinking about and discussing your future space needs.
In advance of annual and quarterly meetings, business leaders ask me to provide them with an analysis of their building in context of current market conditions. I will often offer a handful of different scenarios that provide multiple ways in which a current concern can be alleviated or approached in the future. These scenarios can be helpful for business leaders to provide context to their discussions about outside competitive forces, future legislative changes, and other internal business considerations.
For example, one trucking company I work with in South Florida noticed one of their competitors was going through a difficult point in their operation and was likely to close. This happened to coincide with my client’s growth and our search for a suitable property. Their competitor had built a warehouse specifically with a trucking operation in mind, including unique characteristics that were not readily available in the industrial inventory. Because the client and I were working in lockstep and discussing these trends during our project, we were able to identify the opportunity, formulate a plan, and execute it. The result: we won the right to lease the building before it came to market.
Large tenants of industrial properties run operations that are capital intensive. It takes time to formulate strategies and get executive buy in, funding approval, and resource allocation. The more time you have to recognize trends and identify concerns, the more time you have to take ownership of your future and create opportunities that have a positive impact on your company’s future growth potential.
LANDLORD COMMUNICATION
I have found it helpful to stay in touch with my clients’ landlords each year as we make business adjustments. Industrial landlords commonly own property, buy land, and develop new buildings in multiple size ranges and geographic regions. Talk with your landlord about the other areas where you have business interests, and learn more about the direction of their investments. I have found local and national opportunities for clients that were off market, based purely on exploratory conversations with landlords.
BLEND AND EXTEND
Another ongoing way I support clients is by monitoring their lease rate compared to the market rate. At certain times in the market, we will find it is possible to lower the rent in exchange for an early lease renewal. In the industry, this is called a “blend and extend.” In a descending market, tenants want rent relief because a descending market usually means decreasing revenue and GDP, and the need for lower overhead. On the other hand, landlords want occupancy to preserve cash flow and, in many instances, preserve their lender’s confidence in them to pay back their loan.
Tenants who are in a stable position to remain in the property for years to come can take advantage of this opportunity to negotiate an extension of the lease with a reduced rent that is effective immediately. The key word here is “immediately.” Not at the end of the lease or at the end of the year, but at the first of the next month.
An offshoot of this idea is an early renewal. Along the same lines of “blend and extend,” there may be times when you know you need to remain in the building for longer than the time left on your lease, but your actual lease expiration date is not for two years. You may need to renew it early to secure financing or sell the company, or just to be conservative and lock in the next lease rate before future escalations. In an environment where lease rates are increasing, you may be able to negotiate tomorrow’s price today, in exchange for more terms to your lease.
I was able to do this for a distribution company I work for in Charlotte, North Carolina. In this instance, my client had a different landlord than the one who had initially leased them the warehouse property eight years earlier. This new landlord had a long term plan to hold this building in their portfolio. We had one year left, but had recently needed to rebuild some of our key team members, which caused us to delay our plans for a larger warehouse. We instead negotiated a modest future rent increase in a market that was likely to have twice the future market rent growth. We then were able to get the landlord to replace several interior and exterior doors and upgrade all the warehouse lighting to modern LED motion sensor lights at the time of signing.
CHANGE OF PROPERTY OWNERSHIP
At the most fundamental level, a change of ownership adds another party to the agreement that was not present during the initial negotiations. There are times when nothing changes except for the property manager and life goes on. However, a new landlord is usually a sign of change to come.
When you hear your property is going to be sold, you might want to be on the lookout for the following:
- The new landlord making significant renovations
- A substantial increase in rent
- An increase in property taxes
- New property management
- Different leasing protocols
- Different level of service to the property
The biggest suggestion I can give with a new landlord is to make sure you understand your lease and what you are due. The most common items of an existing lease that are accidentally omitted are outstanding debits and credits on lease anniversary dates, such as security deposit credits and free rent credits.
A change of ownership does not have to be all bad, though. One example is the $16 billion Prologis acquisition of Liberty Property Trust. One of my favorite clients was a tenant of Liberty Property Trust. Instead of having a modest portfolio of potential properties to relocate to for our next lease term, we ended up with ten times the opportunities because Prologis maintains 2.5million square feet in that market. Additionally, Prologis might be disposing of a few assets in this market to balance out their portfolio in the future. This can spell opportunity for my client to buy their facility instead of leasing it.
CAM RECONCILIATION
Executives are often surprised when their landlord sends them a reconciliation statement, then asks for a check to cover last year’s increases in property tax, insurance, and maintenance. We call these CAM (common area maintenance) reconciliations or
“CAM recs.” While they are normal in the commercial real estate world, the size and type of operating expense pass throughs are not always what they seem.
One third party logistics client of mine in Fullerton, California, had a lease that stated the landlord was responsible for landscaping costs. However, the landlord told the tenant they could take care of landscaping if they wanted, and the landlord would remove that expense from their bill. It never happened, though. The landlord had a large portfolio of properties, pooled all of their costs, and was not able to remove this expense from one individual property after all. The client paid a landscaping bill twice each month for years before they even noticed. After they called me for help, we were able to negotiate a lease extension on their 50,000 square foot warehouse that forgave the expense and converted their triple net lease to a gross lease, which is almost unheard of in today’s age of institutional landlords.
Another warehousing client of mine leased a 25,000 square foot industrial building in San Antonio, Texas, within a mixed use business park that included a few R&D buildings with greater than 25 percent office space. In this particular municipality, the county tax assessor used the office space as a reason to classify the entire business park as a research and development park and assessed it at a higher tax rate. It was only through the client’s and my collective review that we were able to figure this out, contrast it with other landlords’ property tax bills, and use it to negotiate a favorable relocation.
A third client in Huntington Beach, California, received a bill from a new landlord that was going through a large renovation of the property. Part of the capital expenses were being inadvertently classified as operating expenses and passed on to the tenants. We were able to parse through each operating expense to identify the double billing and obtained an immediate refund and credit to the following month’s rent.
In all three cases, only a thorough review of the reconciliation bill brought these topics to the foreground.
Most leases allow for some form of a review of the landlord’s books (called “audit rights”), but sometimes limit who can review the books. It can be the tenant, the tenant’s broker, the tenant’s accountant, or a CPA firm specializing in lease audits. If there is no mention of “audit rights” in the lease, then it is up to you to approach the landlord and determine a reasonable solution.
There can be risk in contesting CAM reconciliations, just like there is risk in baseball arbitration in fair market value litigation. In the lease audit process, the outcome may result in the landlord owing you for accidental or malevolent overcharges. But it can also result in an under accounting and an additional bill to your company. Think through whether it is worth your time and effort to fight potential discrepancies before you take action.
In the industrial real estate realm, the room for aggressive management of expenses and human error is less pervasive than in the office leasing world, but still possible. If you play the game long enough, you will come across discrepancies. Here is how you should look at these reconciliations:
- Review your prior CAM reconciliation bills and chart them in a spreadsheet to look for trends and discrepancies in each expense category. Look for scale of magnitude inconsistencies, then annual increase discrepancies.
- Ask your broker for industry standards for operating expenses. With my experience, I can provide ballpark costs for property management, HVAC, paint, carpet, insurance, office buildout, and sprinkler retrofits off the top of my head.
- Ask your broker to procure a copy of the BOMA’s annual operating expense benchmark report. This report is aggregated by all property managers across the country in office, industrial, and retail real estate. This report is a great way to validate your concern and justification to audit.
Being aware of these discrepancies will give you the proper lens to evaluate each bill and determine whether or not challenging the reconciliation is a worthy endeavor.
KEY TAKEAWAYS
Real estate is a lifelong learning opportunity for executives, and there are always ways to improve. Knowing how to handle moving into a new building, making adjustments, and dealing with common issues is empowering. Knowing your rights and reviewing them annually will help you scrutinize bills you receive from your landlord, and you can utilize your broker to locate the necessary resources to reconcile them. All of this keeps you in the driver’s seat, actively managing your real estate, rather than reacting.
We will now shift our focus to how companies of scale operate their real estate. The goal is to provide a benchmark standard so you can create the right environment for continued growth.