9 Real Estate Clauses to Watch Out For
A real estate clause for a property I was investigating gave me sticker shock. I could easily calculate and understand the present value of a stream of loan payments for purchased space, and its comparison to monthly rental amounts on leased space. What surprised me was that the add-on charges alone for space owned in an office building could exceed the all-inclusive lease expense. The culprit was common area maintenance (CAM) fees.
I learned that the expenses for maintenance and periodic improvements of commercial space (office, industrial, or retail) can be high, especially for properties with expansive common areas and manicured grounds. These expenses may be shared among property owners or passed from developers and landlords to tenants.
Developers selling new space and landlords leasing existing space will rightly protect their financial interests. Preserve your financial well-being by being aware of their techniques. Here are some fairly standard clauses to consider as they can add significantly to your business’s operating costs:
1. Common Area Maintenance
Whether a business leases or owns space in an office building, industrial park, or other space, CAM fees may be charged. Similar in concept to homeowner association (HOA) fees, these cover expenses to maintain common areas such as lobbies, elevators, kitchens, break rooms, and restrooms.
Proper upkeep is essential to sustaining desired aesthetics and preserving property values, so developers and owners are not likely to skimp here. They may forecast these expenses and charge flat fees based on estimates, add a percentage to base rent, or use another formula.
These fees may be referred to as a load factor, indicating the allotment of cost based on the square footage that your business occupies.
2. Rent Escalation
Lease agreements typically include clauses that allow the landlord to charge more than the originally agreed-upon monthly rent to cover increasing costs of building ownership and operations. There are several types of escalation clauses that specify the method of calculating this incremental increase.
Generally, the lease agreement should include just one of these types of clauses, such as CPI Escalation or Operating Expense Escalation. The CPI escalation calculates increases based on the consumer price index, theoretically reflecting higher costs throughout the economy and easily tracked so that your business can verify the reasonableness of these charges.
Operating expense escalations reflect actual increases in the landlord’s costs. These may be associated with security, housekeeping, insurance, property taxes, facility repairs, maintenance, and utilities. This approach should require tracking and reporting of these fees with indication of the amounts that have risen above base amounts. This type of escalation seems reasonable but may serve as a disincentive to cost control.
3. Special Assessments
The cost of improvements to infrastructure, such as major upgrades to heating and air conditioning systems, parking lots, and sidewalks, may be passed along to tenants or part-owners, separate from CAM fees.
4. Hours of Operation
Leases for retail space in particular may require that businesses observe certain hours of operation including extended hours during holidays and special events. Staffing with qualified employees may overload payroll expenses, especially if foot traffic is not particularly heavy for your business.
5. Design and Other Operating Requirements
Complying with requirements that are aimed at standardizing the overall look and feel of a property can add expenses. These specifications are most likely relevant to leasing of retail space and may cover issues such as signage, merchandise displays, and posting of exchange polices. There may also be restrictions relating to day-to-day operations such as timing of inventory restocking and methods of trash disposal.
6. Add-On Charges for Sales
Retail leases may require payment of add-on charges equal to a percentage of sales that exceed a certain level or break point. These fees may run 3-15% of sales after the business’s volume has reached this designated amount. Compare your forecast with this threshold to anticipate whether your business will incur these charges, which will significantly erode profit margins.
Obviously, your business should already be tracking and reporting sales for internal purposes; nevertheless, having to prepare sales reports for your landlord requires expending hours to generate a report in a standard format and adhere to a schedule. Sales reports and supporting documentation may be audited and being out of compliance makes your business subject to deficiency fees.
7. One-Time Charges
Signing a new lease or purchase agreement may trigger start-up fees for administrative set-up, announcements relating to your business’s opening, and links to your website from the property’s website. These may have exorbitant mark-ups; for example, a website link on a mall directory may incur a fee of over $500.
8. Build-Out Fees
Property developers and landlords will often need to customize spaces for tenants. If your business is expected to pay a hefty amount for lease or purchase, then you may feel that basic build-out (e.g., installation of lighting) should be included at no charge or a flat fee. Developers and owners may think otherwise. Check allowances for build-outs because getting the space into working condition may be much higher than expected.
Landlords will often require insurance coverage at designated amounts as a way to ensure protection for your company and theirs. Generally, you may be asked to carry liability and property insurance to cover potential claims for property damage or on-premise personal injury.
After considering all the benefits and all of the costs of a real estate purchase or lease, make your decision about what your business needs and can afford.
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