Creative Leasemaking
“Change is the law of life. And those who look only to the past or present are certain to miss the future.”
The marketplaces industry is in constant flux, which requires deliberate change and educated efforts to evolve along with new stressors. Retail has had its fair share of stressors since its inception, and with every evolution, it has become more resilient and more malleable. No matter the current state of the market economy or other demanding current events, the core function of retail will always attract crowds - creating the “place to be”. However, I would like to share some of the ways in which retailers and real estate owners have implemented creative solutions through lease restructuring and decision making as we all face record high inflation, a post-pandemic recovering economy, supply chain disruptions, etc.
How should landlords account for inflation so that their rental rates reflect market conditions? The fixed 3% annual rental escalation standard is no longer indicative of current inflation. Inflation isn’t the only contributing factor to overall market rent increases. Demand for retail space and limited availability has caused the market rent from Thousand Oaks to Calabasas to soar over $3.00 per square foot with only a 6.5% vacancy rate in the recent months. As such, leases are now being structured to remain concurrent with said increases by relying on a CPI to determine annual rental escalations. As some tenants are uncomfortable with this notion, a floor and ceiling can be implemented to cap the potential increase per annum. Likewise, many property owners are avoiding option terms being a continuation of a fixed annual rental increase, and rather reevaluating at FMV - fair market value - for comparable retail space in the surrounding area. Inflation also has an affect on capital and operating expenses. As per the nature of triple net leases, landlords have the right to pass through all operating expenses (taxes, insurance, maintenance) to the tenants, who are carrying the weight of recent property tax and insurance increases. While a triple net lease lacks the certainty that a full service gross lease provides, tenants can benefit from a lower overall base rent - if managed and structured correctly.
Assignment and subleasing
Another tool for lease structuring is the percentage lease, which is commonly used for restaurant tenants, as they operate on thin margins to begin with. Essentially, this gives the landlord the ability to “invest” in their tenants and the tenants some additional security in uncertain times. If government orders another business shutdown, or some other extraneous circumstance which prevents the business from meeting its desired rent-to-sales ratio, a percentage lease may provide some leniency until sales are back on track.
Commercial leases are complex animals, which require deliberation for a more favorable long-term relationships. I would encourage anybody to contact a real estate attorney if they would like to further explore whether or not their lease is working in their favor.
