7 Things you should know if you own retail properties – What’s in Store with Karly and Chris
Guest: Karly Iacono
Topics: Lease Provisions, CAM caps, Tenant Entities, Lease Assignments, Termination Rights,
Chris and Karly breakdown seven types of lease provisions, and their thoughts about how to negotiate each one.
What You’ll Learn
- Are reimbursement caps for tenants becoming more common?
- How to analyze the tenant entity on a lease
- Navigating termination rights in leases
- What cases should you allow a right to go dark provision?
- When do you place restrictions on lease assignments?
- How strong should environmental indemnification language be?
- What place does a right of first refusal have in a lease?
About Retail Retold
The Retail Retold Podcast highlights community retailer stories from across the country and gives a behind-the-scenes perspective from business leaders in both retail and real estate industries. The show’s episodes contain valuable insights that help solve the needs of entrepreneurs and real estate pros. Join host Chris Ressa and new guests weekly for amazing insights and thought-provoking stories.
Transcript:
Karly Iacono 00:06
Welcome, everybody to what’s in store the show where we cover hot topics at the cross section of retail and real estate. I’m Carly Iacono. And I’m joined by my co host, Chris Ressa. Chris, great to see you. How have you been?
Chris Ressa 00:19
I’ve been great you
Karly Iacono 00:20
Loving life. Doing well. No complaints.
Chris Ressa 00:22
You’ve been skiing a lot.
Karly Iacono 00:23
I have been skiing almost every weekend in Vermont. It’s been an adventure this year. Not a lot of snow.
Chris Ressa 00:30
Where are you going skiing?
Karly Iacono 00:31
Last weekend was Okemo and it was negative one with 25 mile an hour winds and just a sheet of ice. I literally felt like I was in an Arctic survival show. And as I’m going down the mountain and this gale force winds I’m like, Why do I do this? What I am nuts. So I’m excited to be heading out west in a few weeks, should be a lot better.
Chris Ressa 00:50
So was that fun? Like when you’re on a sheet of ice with gale force winds?
Karly Iacono 00:54
Define fun, It’s adrenaline inducing and adventurous. Fun. Maybe not so much last weekend. Yeah.
Chris Ressa 01:02
Since I grew up wrestling in the winters, I never had time to go skiing. So I skied until I was about seven. And then I don’t think I’ve been on a mountain since I was seven years old.
Karly Iacono 01:13
Wow. And I’m not really selling it today.
Chris Ressa 01:14
You’re not selling it.
Karly Iacono 01:16
I need to tell you all the good points and get you back out there.
Chris Ressa 01:18
I’m going the other direction. In a couple weeks we’re going on vacation to St. Thomas.
Karly Iacono 01:23
Ugh, sounds amazing right now, I wish I could swap out with you for a warm weekend.
Chris Ressa 01:28
I’ll go out on a limb. There’s not too many things that I’m really scared of. But one of the things I’m not great with is heights.
Karly Iacono 01:36
Okay.
Chris Ressa 01:37
Literally, when we went on vacation, my wife and I, we went on a babymoon a few years ago to Palm Springs. They have this monorail up the top of the mountain. And it’s like a car that’s on a cable and it goes from the bottom to the top of the mountain. So we went on it looks fine. But it moves, right, sways, and I didn’t do great with that. I literally fell to my knees and was holding on. My wife’s like Chris, get up
Karly Iacono 02:06
Does she make fun of you or was she supportive?
Chris Ressa 02:08
Right now, get up you look ridiculous. Get up.
Karly Iacono 02:11
Does she make fun of you?
Chris Ressa 02:11
Yes. We got to the top of the mountain and I was like, I’m walking down. And the waiter was like, it’s gonna take an entire day for you to get down, it took you 30 minutes on a monorail to get up, it’s gonna take a day to get down. So, I say that because we’re going to St. Thomas. And the house we rented is at the top of this mountain, the roads are pretty narrow, and they’re like, sometimes the Jeep can get up it, sometimes it can’t. And so, I’m slightly concerned. Once I get there I’m not leaving I don’t think because going up and down. So we’ll see how that goes.
Chris Ressa 02:12
So no ziplining for your family then.
Chris Ressa 02:17
So ziplining I’m okay with. Because typically, there’s water underneath or something that you fall in.
Karly Iacono 03:02
Are you sure that’s not better if you’re 400 feet up? But okay.
Chris Ressa 03:05
Yeah, that’s high, 400 feet’s high. I haven’t been ziplining 400 feet.
Karly Iacono 03:12
Good luck.
Chris Ressa 03:13
Thank you
Karly Iacono 03:13
Hope you make it both there and back on your adventure.
Chris Ressa 03:17
When I see where it is, I might be like, I’m sleeping at the airport, get me in the morning when we go to the beach.
Karly Iacono 03:22
I don’t think your wife’s gonna go for that, so, good luck with all that. Well, we have a really interesting episode today. I think it’s one that’s going to be extremely relevant for all of our investor and landlord clients. And that is lease provisions that impact the value of your retail properties. Really tangible, meaty episode. And I’m excited.
Chris Ressa 03:44
Me too.
Karly Iacono 03:45
I think we should get going and jump in.
Karly Iacono 03:47
So we have seven different things we’re going to cover today in no particular order. It’s not like our you know, best to worst, here are just seven things that you should consider if you own retail properties. So the first one and this is becoming more and more important, as inflation continues to pick up. And that is caps on reimbursements from your tenants.
Now think of these like your nets, your taxes, your maintenance, your insurance. And really, I think the easiest one to talk about is cam caps, caps on any of your common area maintenance. I’m seeing this and I’m really interested to see how you’re dealing with this with your tenants Chris. I’m seeing this with new deals that are being inked where the tenants in single tenant are pushing back saying we don’t want unlimited responsibility. We’ll pay for common area maintenance up to X amount or X percentage over the base year on taxes, right? The tenants are trying to put some limits in these leases, which obviously is a concern from an investor standpoint. So what are you seeing in terms of caps on reimbursements and how are you dealing with it when your portfolio?
Chris Ressa 03:47
Let’s go.
Chris Ressa 04:56
I would actually say I’m seeing this go the other direction a bit, because I think in the shopping center space, caps on cam specifically, have been pretty prevalent for a long time. It’s not a new thing that’s grown. I would tell you I think landlords are starting to push back on what those caps be. A standard provision you would see in a shopping center at least is, you know, common area maintenance is estimated to be $2.50. And the controllable cam won’t go up by more than 5% a year. So, what’s controllable and what’s not, that’s there’s no defined terms, what defines those terms is what’s in the lease, usually uncontrollable will be something like snowplowing.
Karly Iacono 05:40
Right.
Chris Ressa 05:41
And that’ll be pulled out in there’s no cap on that. What I’m seeing is those caps are increasing seven to ten percent, where they used to be standard five, because landlords have the leverage to do that. I haven’t seen them go away totally. But I’ve seen them expand. I think the one thing a lot of shopping center owners, let me take that back, not a lot, some shopping center owners are doing is going to fixed cam. We haven’t done that. I think it’s really interesting. We’ve done it on a couple of deals, and we’re testing it. I think, if you do it right, you can win on fixed cam. Obviously, you’re betting against inflation and fixed cam is when you’re not actually reconciling the actuals.
It’s just here’s what the cam is and there’s a fixed increase per year, whether it happens or not, I would say there’s some landlords who are really going toward that. And there’s if you have scale, there’s some benefits, right. There’s less accounting work to do, there’s less labor and actually managing it. So there’s some benefits in that side of it. In some respects, I think there’s opportunities to win on that. Because typically, what’ll happen is, whatever the year one cam is, it’s typically a number that is not the exact cam, because you’re in the middle of the year, we don’t, that lease won’t be signed till next year. So you’re making an estimate on what that cam will be to start the period. Well, that estimate has the opportunity to be higher than the actual and if the increases are based off that you could potentially beat inflation on fixed cam, you could also lose, I’ve seen the cases where people lose. So that’s happening. But as it relates back to just the basics
Karly Iacono 07:31
Hold on I have a question on that I gotta jump in here. With the fixed increases annually, what percentages are you getting the tenant to agree to?
Chris Ressa 07:39
Five. So what I would say is, we’re not really focused on fixed cam as an organization. We’ve only done it in a few instances.
Karly Iacono 07:48
That’s the line, right? If you think inflation is going to be more than 5%, you’re not gonna do that. If you think it might be less, it’s almost like the line in betting, right?
Chris Ressa 07:55
That’s the argument. I would argue that I think the line is less critical than the starting cam price. That’s the most important piece, which is what is the starting price?
Karly Iacono 08:06
start ahead.
Chris Ressa 08:07
Yeah, then then then you can then eventually, maybe in 40 years, the line catches up to you, but usually not in 10. So it depends on where you start. Like if if you if the estimate of cam is like $250, and you and the tenant agree, okay. The stores not gonna open till next year, we’ll call cam $3. And then we’ll base 5% increases off that, right? You could win, or at least not lose, you might not win, because inflation is high, landscape costs are going up, other costs are going up, but you might not lose. And then I would say specifically, I’m not seeing any caps on taxes or insurance. That’s not happening. Those are deal killers.
Karly Iacono 08:44
So that’s an unknown though, let’s go back to the cam for just a second, you’re saying you would take the potential upside, maybe, right of doing the fixed cam if you start out ahead and have set increases instead of just doing a reconciliation, where you know that your expenses are going to be covered. So you’re almost you’re taking something that is a known. If you have all triple net leases, your cam is gonna be covered on a pro rata share, and you’re making it an unknown, are you gonna be above or are you gonna be below just for the chance of an upside.
Chris Ressa 09:12
Potentially. Yes.
Karly Iacono 09:13
Interesting. Okay.
Chris Ressa 09:14
Like I said, we’re not really doing it. But I’m very we have a lot of discussions internally. Clearly I’ve lost on it. But I’m very open to the concept because I think you could end up winning.
Karly Iacono 09:27
Right, So there’s that chance. So you’re gambling man. Got it. Okay. With thoughtful, you know, analysis behind it. We’re not going crazy here. Okay, got it. Very interesting. So in the net lease space, it’s a little bit different, right? Because these assets are designed to be passive with the tenant covering everything taxes, maintenance, and insurance, usually in their entirety. So if we have a cap, it just changes the structure of the asset class and the developers who have come to me and said, Do you think this is a problem?
This is what the tenant wants. My answer is always yes. Yes this is a problem. We do no caps we want it fully reimbursed by the tenant. And we’ve got to get around this issue. But it’s come up more in the last six months than I’ve ever seen in the past and I think that’s because all of these expenses are rising so fast and the tenants are starting to push back and say, actually, we don’t want that uncertainty of what these nets are going to look like in five years. So, it’s going to be a push and pull, I think, for the net lease space in this part of the market cycle.
Chris Ressa 10:23
Yeah, I haven’t seen at least on our freestanding deals that are structured like ground leases, or like net leases. I haven’t seen caps on cam be an issue yet, but we’ll see.
Karly Iacono 10:34
It’s new. Yeah, the ones in place they’re. They’re not like that, so, anyway, interesting. Interesting topic for sure. Let’s move on to the second one. The second provision that affects the value of your property and your leases is your guarantor and your tenant entity. So we, and on the net lease side we deal with this all the time, right? Just because you have a Wendy’s does not mean it’s a Wendy’s corporate. So,,who is your franchisee? If it’s a franchise deal, and then what entity are they signing the lease in?
Just because you have 100 unit franchisee does not mean the entity on the lease has all 100 units backing that location. So really diving into what the entity is, what real estate they hold, and what that guarantor means is crucial. And I think a lot of the newer investors miss that nuance, right, who’s actually your entity on the lease? So I’m sure that you’re going for the biggest guarantee that you know, the biggest entity that you can with your tenants, because that would be the most security, but how does that conversation look in the shopping center space for you?
Chris Ressa 11:37
It’s one, um, you could ask the leasing team I’m pretty passionate about I have, you know, we make sure we have an appropriate entity on the lease often. And I think it could easily be overlooked, because entities are like something LLC, and you might miss a letter, and it’s the difference. So I think the big thing to understand, I think, I think actually the franchisees are interesting. I think, the and that’s easily understood, because it’s a franchisee it’s not the corporate entity, I think it’s when you’re signing the corporate entity. But are you really signing the corporate entity or sub-entity? Right? So I think that’s really the issue.
Like, they’re like, Oh, this is the entity that holds our leases and then you’re like, Okay, well send me the financials. We don’t run a separate financials for this, because it’s a subsidiary, and we’re not required to do that. We’re not required to do that. Okay, well, then how do I know that all the leases are in there, what might happen is we might get like a, we might have like, in that scenario, you might have like a letter from the CFO that actually says like, Okay, this is the net worth of this entity. This is how many stores are in it. That’s certified by the CFO of that company. But I’m already off on a tangent.
Karly Iacono 12:52
Good luck getting that though. I don’t know
Chris Ressa 12:53
That happens.
Karly Iacono 12:54
Really?
Chris Ressa 12:55
Yeah. Because at the,
Karly Iacono 12:57
Or you’re not making the deal I guess if you’re not getting clarity on the terms.
Chris Ressa 13:01
Right, because you don’t know who’s signing the lease. So now, a lot of times, right, if you went a lot of people, what they’ll do is they’ll look at, like, they’ll Google the stock of the company, and they’ll see what like the stocks, you know, the stock is in that corporate entity, it’s rarely who’s signing the lease. So every once in a while, they might guarantee the lease, but rare, it’s usually some entity underneath it. And so, I think, really understanding like, are who you’re getting right?
Who you’re doing a deal with it, the DBA is one thing, but are you getting the entity that really has this credit worthiness that you think it has, is really critical. And sometimes you have to really unpack to try to find what that is, you know, the easiest way is, do we have financials for that entity? And, you know, sometimes, I would say, I would say most times you can get the financials for that entity. Sometimes in scenarios where there’s like, there might not actually be financials for that entity like audited separate financials, then it’s a little tricky. But yeah, we’re very focused on it, because the entire creditworthiness is behind what signature is on that lease.
Karly Iacono 14:16
And I think it’s even more difficult if you’re not the one initiating this deal. Let’s say you’re buying a shopping center, and it’s an existing lease, this isn’t a new tenant, and they don’t have financials and it’s not required under your lease. Now, you’re kind of asking a favor, and what’s their motivation for giving them to you if it hasn’t been provided previously. So sure, that’s a big challenge I was actually just reviewing a portfolio of deals for a private REIT that I represent. And they have I won’t say which tenant but they have a handful of deals from the same medical tenant. And when we looked at the signatories on the lease, every single one was different. It’s a corporate entity, corporate guarantee, and every lease signator was different on their different locations. And we just just had this conversation. Well, one’s LLC, this one’s Inc. One has a state name and the LLC. And we’re like, what? What is this?
Chris Ressa 15:07
But they were all but so those are all different tenants. But there was the same guarantee?
Karly Iacono 15:12
Same operator, it’s the same corporate guarantee, but the lease is signed differently in each case. And we don’t have financials for the sub entity. So we’re trying to figure out, is there a difference?
Chris Ressa 15:23
But do you have a corporate guarantee?
Karly Iacono 15:25
There’s not a separate guarantee document, but it’s written this is with the parent company signed by the sub entity. So it’s very unclear. And I think that makes a great point. But these are not new deals.
Chris Ressa 15:36
We’ll have that, and a lot of national retailers will do that, which is they’ll have some sub-entity that might be like, store a LLC in New York, is the tenant. But they will guarantee the lease. Right? The corporate entity will guarantee the lease. And what that’s essentially doing is that tenant that store a LLC, that tenant is responsible for the entirety of the lease, the guarantee is just the financial part of the lease. Right. But the obligations of the 50-page lease for the tenant, that’s not what they’re guaranteeing they’re guaranteeing the financial consideration in that lease.
Karly Iacono 16:18
Important distinction, actually. Alright, so know your lease, know your entities and know what you really have, which is sometimes much harder than you realize, right? Dig into that deeper. Alright, our next consideration that affects the value of your property in terms of lease sections is termination rights. Now, this is a pretty varied topic, right? We can go through landlord termination, tenant termination rights, just basic term like a Starbucks where they have an early termination after certain amount of time, or is it sales related, right, sales, benchmarks and terminations, co-terminancy? There’s so many different ways this can show up. What are your biggest concerns with termination rights? And what do you think is unclear or something that you just would not put up with an a lease?
Chris Ressa 17:07
So I think the first thing is to say, All right, so every provision doesn’t have a distinct remedy. And when someone violates, and what the remedy is, you rely on the default provision, either the tenant default, or the landlord default, usually both have termination rights after a period of time in every type of lease because those are controllable events by both parties. What has happened is, and typically in that default provision, what that really means is you’re relying on that you’re going to court to sue the other party. And so to stop those more common issues what happened over time, is certain provisions got remedies. And one of those remedies for certain provisions might be a termination. So that’s why you might be able to terminate if there’s a sales kick, but not for other reasons.
The other reasons are you rely on the default provision. And then if you can’t resolve it, through that, then you go to court. And to stop going to court over what both parties felt were more common issues, they ended up coming to remedy. So the first distinction is what provisions deserve a remedy and what should rely on the default provision. And, I think landlords in general would try to rely on the default provision more and have less, provisions with remedies. But many leases now have remedies in leases. What happens if the tenancy of a property falls below a certain threshold of Co-tenancy? What happens if sales are below a certain threshold? A sales termination or kickout? So the determination of what provisions have remedies is really the foundation of this in my opinion, and what will you rely on the default provision for? And that’s a decision either that you’re going to make and or you’re going to be positioned into by the other party. So that’s the first thing I think.
Karly Iacono 19:15
How careful are you with those thresholds? Like if it’s a sales kick out? Are you really analyzing it and saying, Okay, we believe that this is too low or too high? Are you pushing back on these different thresholds? Are you just saying this should not be a remedy at all?
Chris Ressa 19:29
We’re negotiating those thresholds, really hard, I would tell you, if you want to understand the average store sales, what is their store sales in that market? What are they projecting in that location? When is the measurement period is a big piece. Let’s say the threshold was a million dollars in sales, and they have the right to determine if their sales aren’t a million dollars after your five. Well, what if years one two three and four sales were $1.2 million and in year five they were nine-hundred. What’s the measurement? This is very negotiated right by parties. That one provision.
Karly Iacono 20:10
Interesting. Okay, so this is another thing that we need to look closely at are all of these different termination rights. Any other ones you want to touch on touch determinants? I think
Chris Ressa 20:21
co tenancy and sales are big ones on the co-tenancy piece. You know that typically after a co tenancy violation, there’s usually a cure period, right? Sales termination, they either hit the sales or they didn’t, but those are the two big ones, I think, what if there’s an exclusive violation, that’s the other one. So if a tenant has a an exclusive, this is one like should it be in the default provision or should there be a remedy? You know, a remedy might be okay. We have a coffee shop, I’m not allowed to put in another coffee shop on the property.
If I do, then the existing coffee shops rent goes to half for 12 months, after 12 months, they can either it’s what they call sunsets, they can either go back to full rent or terminate the lease. The coffee shop probably doesn’t love that provision. And they would probably say, well now you can just make a business decision to violate my exclusive and it’s not really an exclusive. Some call that actually call that a restrictive covenant, not an exclusive. And so do we just rely on the default provision? If you do this, I can terminate or we’re going to court, what should we do? And so that’s the other one is exclusive sales kicks, co tenancy, those are big ones.
Chris Ressa 20:27
Really really complex, and just kind of shows how important these leases are, and each section matters. It’s not just the basic business terms.There’s so much more to it.
Chris Ressa 21:57
So that’s another point, are these legal terms or business terms? We talk about this all the time. Every company is different. I think so far, the ones we’ve talked about, we would argue these are more business terms than legal.
Karly Iacono 22:10
Okay. Interesting. They’re not being put forth on your initial tenant loi, I’m sure. But, they’re quickly in that first draft. You’re putting them in the LOI’s?
Chris Ressa 22:20
The retailers are putting them in the LOI. So far, what I’ve talked to, I would tell you for the top 100 public national retailers this is in their LOI’s.
Karly Iacono 22:30
Because it’s their boilerplate language, and they already know where they’re gonna get to. So why not just put it out there in the LOI? And then you’re pushing back on this? In the negotiations? Fun. Love it. Okay. Let’s move on to the next provision, which is the right to go dark. This is an interesting one, because it obviously affects your entire shopping center, if you have a tenant go dark before the end of their lease, even if they continue paying their rent. So in what cases do you want to allow this? And which are you not allowing a right to go dark provision? When is it in your favor to allow them to go dark, let’s say? Or is it ever one
Chris Ressa 23:06
One of the people in our C suite, Basil Donnelly, he would tell you, Chris, the most important provision in the lease is that the tenant pays rent. And the second most important provision is they open and operate. So I don’t know that you ever want them to go dark. For some major national companies that have big balance sheets, it’s really tough to not allow them to go dark if they have an unprofitable business, and they’re losing money, but they’re going to stay and still pay you rent. It’s hard to not acquiesce on that provision.
And now, I would tell you there are nuances to that, I would tell you, you have to open, right, which gets pushed back a lot at times because what if something changes over the year that they don’t want to even though they might pay you rent? But we would push back and say you have to open especially if I have to deliver. If I have to deliver then you have to open. You can’t have the right to not open but I have to deliver by a certain date. But going dark isa really hard challenge you can put timelines around it, you can’t go like you can’t go dark for the first five years. Things like that. But I think you’d be hard pressed for some, if you took the top five largest publicly traded retailers to not find the majority of their leases have go dark provisions.
Karly Iacono 24:46
And are they agreeing to five years where that’s excluded, or is it they want flexibility all the time and that’s your middle ground. Five years.
Chris Ressa 24:57
I’m not I would say most of their leases, I don’t know their private documents, most of them would say, they can go dark, unrestricted, Now there might be a penalty if they go dark. And the landlord might have a remedy. The landlord, if they go dark, might have the right to recapture the space.
Karly Iacono 25:14
Okay, that would make sense.
Chris Ressa 25:17
That might be an option. You say that makes sense. Sometimes they don’t have the right to recapture the space.
Karly Iacono 25:20
It makes sense from a landlord perspective to want that. Because you want a vibrant, viable center. You don’t want a dark space, even if you’re getting the rent hurts. Overall, we looked at a Walgreens a handful of years ago in Staten Island, really high rent store, build to suit, beautiful, they never opened. And the seller came to me and he said, Yeah, they’re paying rent, we have 18 years left. They’ve never opened, they’re just gonna stay, what can we sell this for? I mean, crazy rent per year, too. And they just, never opened and never moved in. And we’re honoring their lease obligations.
Chris Ressa 25:55
Now how did you sell it?
Karly Iacono 25:58
We never took it to market actually. Nope. He decided to hold it because he didn’t like the pricing.
Chris Ressa 26:01
What do you think the delta and cap rates is on that?
Karly Iacono 26:04
Oh, absolutely, tremendous. 300 basis points.
Chris Ressa 26:08
Really?
Karly Iacono 26:09
I think it’s significant. I think it’s significant. You think less?
Chris Ressa 26:15
I don’t know. I’m thinking maybe you and I should buy it if they’re gonna pay rent. I’m just kidding.
Karly Iacono 26:23
What’s in store. First deal.
Chris Ressa 26:25
But 300 basis points?
Karly Iacono 26:27
It’s significant. Yeah. I think it’s significant. Well when does Walgreens push back on that? Right now they’re paying all their rents and their nets and everything. I mean they have a guarantee, but at what point
Chris Ressa 26:42
I understand it from a landlord of multi-tenant shopping centers. But if you’re passive income, you’re, you’re some doctor in Minnesota, your passive income, you’re buying, for lack of better word, you’re buying an income stream, backed by some sort of credit instrument.
Karly Iacono 27:02
But you know, they’re not going to exercise their options, because they’re already not open. Right?
Chris Ressa 27:07
How long of a lease was it?
Karly Iacono 27:08
I think it was 18 years when I looked at it’s probably 15 years now.
Chris Ressa 27:11
I mean, are they not?
Karly Iacono 27:12
And then how do you replace that rent? The rent was absurd. So you know that you have a finite investment period, and a rent that is significantly above market, so what do you do with that space in 15 years? You need to plan for the next step because you already know they’re not going to stay.
Chris Ressa 27:30
So I have two points to that. One is at the end of 18 years, I would hope that your investment or returns, you have made them in 18 years.
Karly Iacono 27:45
Right. So you’ve recaptured principle.
Chris Ressa 27:47
Yeah, it depends on what your metrics are. Right. But that’s the first piece, if you’re buying something where in 18 years, you’re not winning? That’s a tough investment. I don’t know much money out there that’s chasing things that aren’t returning capital in 18 years. Number two. I’d argue that you don’t know if they’re exercising an option in 18 years whether they’re open or not. Options are just that. Options. They are 100% tenant favored, they do nothing for a landlord. And, because they have an option, to me, that doesn’t mean they’re staying open. Because if you’re saying it’s such high rent, if they were staying there, why would they pop it? Why would they pop that option if it’s such high rent?
Karly Iacono 28:42
Well that’s what I’m saying. I don’t think they’re going to.
Chris Ressa 28:43
Well, they’re not going to because they’re closed, they’re dark, right? But even if they were open, someone would buy that for 300 basis points less on a hope and a prayer that they’re going to pop that option.
Karly Iacono 28:54
Well, the thought that they’re performing well, they wanted to be there. They’ve got a Bible store. Today, I will send it to you this afternoon. We will have a deal made by 5pm.
Chris Ressa 29:03
But you see my point? You see my point like in 18 years? We could all pretend, but who knows what’s gonna happen? Exactly. Who knows what’s gonna happen in 18 years?
Karly Iacono 29:16
Okay. I like it, so maybe go dark has some other hidden beneifts here.
Chris Ressa 29:20
But to your point. If it’s 300 basis points. That’s wild. That’s a big difference.
Karly Iacono 29:29
It’s a big difference. Yeah. I really think it’s a big difference. It’s a huge difference in sentiment and the long term viability of the site. I think it’s tremendous difference. Let’s move on.
Chris Ressa 29:39
I think it matters to the real estate don’t get me wrong, but I don’t know that it’s I didn’t know there was three hundred basis points. I just didn’t know
Karly Iacono 29:46
you could buy it for a less spread. You could, there will be that chance. Let’s move on to assignment and subletting language, two more terms that really can change the whole characteristic of your investment if you’re not careful with these provisions, so when we’re looking at single tenant, it’s very clear that you want some sort of limitation on who, let’s say it’s a franchise fast food deal, you really want some limitation on who that can be assigned to. So you preserve the security behind your guarantee.
You don’t want to go from 150 unit operator down to a one unit operator with a personal guarantee. That would be a degradation in the quality of your guarantee. So you want to make sure that in the assignment provisions, there’s some benchmark, right. Subletting, similar, very different, right, you may still preserve the guarantee, but you don’t want it to be a completely different use of something that you didn’t want to own in the first place. So we try to look for leases that have pretty strict landlord favorable language. But on the tenant side, of course they need the flexibility, they want the flexibility, they have to be able to sell their business at times and make business decisions, sell groups of locations. Also, there has to be assignment language specifically. And then if they don’t need all the square footage, they need the subletting language, especially as store sizes grow and shrink and change. They want that flexibility. So how are you coming to a middle ground with tenants on these two provisions? What’s working for you?
Chris Ressa 31:18
I think sublease is a lot more prevalent in the office space world, especially right now. There’s a lot of people trying to sublease. There’s obviously subleasing in retail, I would say it’s not as much as assignments. So I think the general position of landlords in retail is you can sublease, but this is about retailing and we don’t want you to profit off our real estate. I think that’s the general consensus. The real estate profit should be ours. You make the retailing profit.
Karly Iacono 31:52
So hold on, on that point, then would you look to share the delta in the rent? What if they surely suffer more? And you’re gonna get a part of that?
Chris Ressa 32:00
Yeah 100%, the amount of subleases versus the amount of tenants in our portfolio? It has to be less than half a percent. There’s not a lot of subleasing going on. But assignments are very prevalent, like that’s weekly. And they’re more prevalent on the local tenant side.Someone opens up a pizza shop, and they do great, and they want to retire, and they get to sell their business. Right.
Karly Iacono 32:31
I’d be less concerned about that than going from a large, almost corporate entity to a small entity. I think that changes your deal, but a local operator to a different local operator, maybe you look for some sort of financial metrics or net worth of the operator, maybe not, I don’t know.
Chris Ressa 32:44
Yeah, we do feel that there’s parameters, there’s usually two things, Permitted transfers, and those are the transfers, that a tenant can assign the lease without landlord’s consent. And then there’s transfers that they have to consent. Typically, a permitted transfer would be like, if someone went and bought all the stock of Starbucks, right? No one landlord can stop that entire transaction, right? So that’s a permitted transfer. But if they want to just assign their lease, you have a parent as a guarantor, and this retail company has like five different chains, and they decide to sell one of those chains. Well, typically, what would happen, I think the first thing is most of our leases would say, you can do that, but you’re still staying on as the guarantor. So we have a few spaces where, if you saw the DBA, you would think that was the tenant, but the lease was assigned to them. And the guarantor is the previous tenant.
Chris Ressa 34:05
Gon it. Is there a burnoff of that?
Chris Ressa 34:09
When the lease expires.
Karly Iacono 34:10
Ok not before.
Chris Ressa 34:12
Typically, it’s when the lease expires.
Karly Iacono 34:13
Do they go through the options too?
Chris Ressa 34:18
I would say, yes, but then that would mean that tenant wouldn’t exercise their option. So they would say I’m not exercising, work a direct deal.
Karly Iacono 34:30
We want a new lease with it, right?
Chris Ressa 34:32
Well, no, we want you to work a new lease with this tenant. I think my biggest concern of that is like all the spin offs for the major companies, right, like we were seeing in the COVID time. There was a lot of retail brands separating out their e-commerce into two separate businesses and trying to create separate entities and siphon them off and not being cohesive. This goes back to your tenant and guarantor to me, the assignment provision, because if some big brand sells all their stores of one of their retail chains. Well, do you still have the big brand on the lease or not? This was a big thing when in the Acena dress barn. So dress barn went to dress barn like announced before Vegas ICSC a few years ago that they were filing bankruptcy. But dress barn was a sub brand was it was a brand owned by Acena, right, who owned Anne Taylor at the time Lane Bryant, Fashion Book at the time. And, we did some homework and rarely did a parent put a sub in retail into bankruptcy. So they went to Vegas, and they said they were filing bankruptcy.
And then, we made all these deals, they made all these deals with these landlords to terminate leases by year end. We didn’t terminate them. And so we said file, and time went on. And it took a while before they ended up filing. And I’m trying to even remember if they actually filed or they just had an orderly liquidation of all their stores. But the problem was if they didn’t pay you rent, no one had Acena. Very few leases had Acena. But, you know, if you went to court, it was like, okay, Dress Barn owes you X, there’s a real entity behind Dress Barn, how much money does dress barn actually have? But you couldn’t pierce that and go up to Acena. Because you didn’t have that.
Karly Iacono 36:57
What a protection for the retailer, to spin it off like that into those different entities and not have them on the lease. But from a landlord perspective. It’s definitely higher risk.
Chris Ressa 37:06
I mean, but they would tell you, like that was like 1000 store chain. So it’s better than most of your leases. That’s what most would say until it’s not because business goes bad. So I think the spin off is interesting right now that whether it’s ecommerce or some other spin off that they want to do.
Karly Iacono 37:32
All right. Another thing to pay close attention to.
Chris Ressa 37:37
Yeah I think the assignment provision is getting negotiated more than has in the past because retailers want flexibility and landlords want to make sure we’re doing a deal with you, right. We don’t know who the next person is. We’re spending the TI the Landlord Work on you.
Karly Iacono 37:56
Your business, your entity and not the next one. So yeah, it’s always flexibility versus security. Yeah, it’s the fight in the balance. All right, we have two more. The next one is environmental indemnification. Now, this gets a little legal on the the provisions and how it’s written and what the protections are. So we’re gonna go kind of quickly, but I do think it’s important to bring up and this is really more relevant depending on the use. If you have a gas station, obviously, there’s going to be more concerns over time, then if you have a clothing store. So how strong this indemnification language is, or even if it’s in your lease at all, I think does really kind of connect to what type of lease, what type of use that you’re talking about. So we’ve seen some language, especially in the gas station space, that’s very strong, that the operator has complete obligation for anything during their period of operation.
And some even looking backwards, they’re taking over the site, they’re clean, and they’re certifying to the next person that at this point, everything is clean. So you’re basically protected as a landlord for everything from that point back. Some language is not so strong. And there’s a little more ambiguity about who’s responsible for what over time. So aside from gas stations, which is an obvious one, where else are some other higher-risk uses from a US perspective? How are you looking at environmental indemnification, when does this really become a discussion point in your your office?
Chris Ressa 39:28
I mean, you took all the uses out dry cleaner and gas.
Karly Iacono 39:32
I want to make you think.
Chris Ressa 39:34
So I think ,
Karly Iacono 39:37
Car washes. I mean, I can come up with more.
Chris Ressa 39:39
Before I answer that, are you seeing this provision change value at a property
Karly Iacono 39:48
I’m seeing it kill deals, so it’s not that we’re pricing it in. Although if we have really strong indemnification language, we will usually bring that up in the marketing if we can in some positive way, but that’s less frequent. Usually it’s deep into the deal, or maybe there were some historic wrecks, but everything’s fine now. And then there’s no indemnification moving forward. It depends on the risk profile of the buyer, but I’ve seen that kill deals.
Chris Ressa 40:13
Got it. I would say, most of the non-invasive uses, this is a provision that is pretty amicable between parties in the lease. The attorneys usually can get through this, I think it the biggest thing, especially in redevelopments is asbestos. Is there asbestos in the space? How are you going to handle that? Whose responsibility is that all that gets dealt with? I think that’s different than ground-up development, which is usually what’s in the ground versus what’s in the walls. The older the property, the more common asbestos is, but as we know, asbestos will start at some point to be less and less because properties get redeveloped. It gets taken out, it’s been removed, but it comes up still.
Karly Iacono 41:11
Im actually looking at a property now with asbestos concerns, and we’re getting quotes on how to remediate it. And what does this look like moving forward.
Chris Ressa 41:18
We do that all the time, we have to remediate all the time. It’s tricky, and what is remediation mean in that marketplace?
Karly Iacono 41:30
Okay. So maybe not such a sticky or controversial provision unless you have a use that would demand further discussion. Okay, great. Let’s move on to our last point, which is right of first refusals or right of first offer slightly different than the leases. We see these all the time on single-tenant deals, especially fast food deals, you know, certain tenants kind of demand more than others.
From my perspective, it’s not been an issue, if it’s on the shorter side, 15 days, 21 days, when it gets to be 30 days or longer, really tough, really tough, because you’re now holding up that buyer in an unknown situation, especially if it’s a 1031 exchange buyer, they have set timelines, they’ve got to ID, they need to know if this is going to go forward or not. So it does become an issue for the deal process. If you get on the longer side, shorter ones we’re very used to dealing with. Do you offer now that I would say on the shopping center side, it’s probably completely different. Your small shop space, they’re not gonna have a row for on the entire center, right? Very
Chris Ressa 42:35
That’s just like any other buyer, in my opinion, what’s the difference?
Chris Ressa 42:35
Very few leases have ROFR’s? Yeah. Even on our, you know, freestanding parcels where we want to flip them out, or even if we don’t want to sell them, I don’t remember the last deal where we where we gave a ROFR to a tenant, there’s not one coming to mind I think they’re really tough for a landlord to swallow. So, it’s been very few and far between where we’ve given them. What the ROFR would typically would look like, what we see a lot is maybe a tenant with the right of first refusal to lease the space next door. Right, that happens. But the problem with the ROFR on a sale, right is, to me, is less about delaying the existing buyer albeit that’s a problem. But it’s more about what if they exercise the ROFR and then they don’t close?
Chris Ressa 43:15
To me, the difference is that they killed your one deal, it’s one thing to delay the deal. You can work within a delay, right? It’s 21 days, it’s 30 days, this is not great. But like, I could finesse this and figure it out. But it’s one thing, you had a live person who was going to close, and then that died for a deal that didn’t that’s my biggest challenge with it. There’s more, but that’s my biggest because, they really have a lot of leverage at that point, especially if you need to sell, and they know you need to sell and then they retrade you, and you can’t go back to your original buyer.
Karly Iacono 44:24
It becomes a timing issue. Do you want to start the marketing process again, but that could be any buyer tying up a deal, right? To me, it’s just another buyer at that point. And there are some advantages to selling to the tenant because they already know the property, it’s less due diligence usually, but in that case, you could tie it up, they could mess up your other deal, but that could be any buyer also.
Chris Ressa 44:47
Yeah, but you’re forced into that one, right? You didn’t have you didn’t have you have a choice like you did with the other buyer.
Karly Iacono 44:56
I will say I have seen this come up very few times where the tenant does exercise, extremely rare. It’s every buyers concern if there is a ROFR like, oh my goodness, I’m gonna get tied into this deal, I’m gonna be waiting and then they’re gonna exercise I’m gonna lose the deal then what? It is such a small percentage of tenants that exercise ROFR’s because they just really don’t want to own the real estate, in most cases doesn’t make financial sense. Few exceptions, we did do a Dunkin maybe a year ago where they exercised the ROFR, it was one of the fastest easiest deals we’ve ever done. Dunkin corporate bought it. We closed in like two and a half weeks, and it was done. And they paid the market price that we had gotten the other offers for, basically list price. Yeah. And they were happy about it. But that’s one of the absolute exceptions.
Chris Ressa 45:41
Because that’s a genuine exception. Clearly what that meant was, they originally wanted to own it. The landlord won’t sell it themselves. So they said okay fine, if you ever want to sell it, I want a bite at the apple. It seems like so cordial and genuine. When we’re talking about it like this, it just rarely happens that way. So when they went to market, they said, Yeah, I’ve wanted to buy this. Since I’ve been attending for the last five years. I’ll buy it from you. And then you sold it two weeks.
Karly Iacono 46:12
And that is like a 1% chance. Yeah. So really great when deals like that happen. But, I think the takeaway here is limit the ROFR timeline if you have to give it as part of your negotiation, right, give the tenant as little time as possible. And in most cases, it’s really not as big of a deal in the deal process that everyone worries it is.
Chris Ressa 46:32
So this is one, I don’t know if you could tell me how much it impacts value. But I would say it impacts liquidity in the market, because there are definitely buyers who won’t pursue a deal if they know that tenant has a ROFR.
Karly Iacono 46:45
I have not gotten pushed back on 15 days, even 21 days when you start hitting 30 days. It’s a problem. Yeah. So if it’s short, I think you can get around it. You start the process as early as possible. The longer it goes, then yes, it can be a deal killer.
Chris Ressa 47:01
Got it.
Karly Iacono 47:02
Okay, keep them short. If you gotta get them. That’s the message here. All right. We covered so much good content today. We really appreciate everyone tuning in to our lease provisions that affect the value of your retail properties. As always, feel free to reach out to Chris or I with any follow up questions or thoughts. We’d love to hear from you. And that was What’s in Store with Karly and Chris. We can’t wait to see you all again very soon. Thanks so much, Chris.
Chris Ressa 47:28
Thank you.