How Long Should You Stay in Your Commercial Lease?

Lease Term, Renewal Options, Lease Purchase Options

Part 2 in Series – “10 Lease Traps & Tips for the Small Business Owner”

When contemplating new lease space, the small business owner understands the need for flexibility. The term, or length of time, you will remain in the leased space is a chief concern of any entrepreneur. You don’t want to be forced to look for new space after only a few years, on the other hand, you want to be able to leave if after a period of time you learn the space is not right for your business.

One of the most important aspects of a lease for the small-to-medium sized business owner is flexibility. How much space do you need? Will you grow? Was your initial assessment too ambitious?

Lease Term – Most commercial landlords will insist on a lease term of at least 3 – 5 years. Depending upon your industry, this very well could be a good place to start. For example, if you’re looking for office space, the initial investment on fixtures and other start up costs can be minimal; conversely, if your space is going to be used for heavy manufacturing, just getting the machinery situated can be a huge expense, warranting a longer term lease.

Renewal Options – The more the better. Renewal options allow you to choose to remain in a space, usually under the same lease terms, or to look for a new space after the term has expired. One term that often does change is rent. You’ll want to either include a percentage rental increase for the renewal term, attach the increase to a Consumer Price Index, or agree to negotiate using the future “market rate”. A renewal option doesn’t do you any good if you don’t exercise it per the lease’s requirements – be certain to develop a system to calendar the date by which you must provide notice to your landlord.

Lease Purchase Options – Sometimes it makes more sense for a tenant to own their space rather than pay rent. While this decision inevitabely involves important tax consequences, it allows you to test drive the property before buying. It also gives you the ability to build some equity towards the purchase price if the lease is properly negotiated; meaning, you need to make certain some portion of your monthly lease payment will be applied to the purchase price. The potential downside of a lease purchase option is that the landlord will probably make you pay a premium for it. Again, be certain to calendar the date by which you must give notice to landlord in order to exercise your option.

Part 1 in Series – “10 Lease Traps & Tips for the Small Business Owner”

It’s a Great Time to Become an Urban Business Dweller

With downtown St. Louis office vacancy now at 19%, landlords are being forced to compete aggressively and find creative ways to market their office properties.

Landlords have found they also have to create major incentives for tenants: everything from rent concessions to significant tenant improvement allowances.

If you are looking at moving your business, or if you are opening a new office, your best bet may be a move to downtown St. Louis.

Now may be a good time to be looking! Read more in this article from the St. Louis Business Journal.

Illinois Considering Substantial Changes to Improve Foreclosure Process

Chicago Tribune reports Illinois considering changes to its foreclosure process, potentially affecting any one of the approximately 70,550 foreclosures pending in the State.

Condominium Assessments and the Recession

Why Bankruptcy and Foreclosure Aren’t Always the End of the Line in Missouri

The past decade saw a surge in condominium, loft, town home, and other multi-unit developments, in both urban and suburban areas. Urban revitalization resulted in renovated commercial and industrial buildings for loft developments, and baby boomers and empty-nesters have been drawn to the convenience of maintenance-free living provided by multi-unit developments in cities and suburbs. The recent recession and ensuing economic climate has impacted the real estate market and construction industry particularly hard, and many unfinished developments suffered as a result. However, the down turn in the economy poses problems for existing, fully occupied, and even well-managed buildings too.

Traditionally, the payment of condo fees or assessments by a unit owner was a priority, just like the payment of a mortgage. As increasing numbers of unit owners face job loss, reduction in pay, or other financial hardship, this tradition is falling fast, and payment of condominium fees and assessments has become less of a priority.

Other than headaches for building management and board members, delinquent condo fees and assessments pose a variety of dilemmas for multi-unit developments. Legal and practical ramifications of increasing delinquencies include the inability to obtain loans for capital improvements, a loss of services for the buildings and grounds, and an obstacle to sales of existing units.

Condominium associations and boards have long relied on collection lawsuits to compel delinquent owners to pay, and, ultimately threaten the sale of the unit by foreclosure of the condominium’s assessment lien. Increasingly, this litigation option is becoming less viable. The recent and continuing onslaught of foreclosure sales and personal bankruptcies strip the building management of the power to collect through litigation. However, all is not lost when a unit is subject to foreclosure or an owner files bankruptcy, and it is important that associations and boards are aware of their rights in these situations.

Foreclosure

In Missouri, and in approximately half of the states, lenders have the right to foreclose on a delinquent borrower through a non-judicial “power of sale.” Power of sale gives the lender the right to provide notice of foreclosure proceedings and sell property on the courthouse steps. Foreclosure sales by lenders threaten to extinguish assessment liens against a condominium unit that are imposed by operation of the building’s governing documents and Missouri law. In most cases, the lender will buy the property back and will become the new owner of the unit. In these cases, the sale price at foreclosure will likely be less than the loan value, and there will be no surplus for other lien claimants, including condo associations.

It is important for the board to know whether the foreclosing lender made a purchase money loan, that is, a loan used by the owner to purchase the property from a previous owner, or rather a refinance loan. The Missouri Condominium Act gives different treatment to condominium assessment liens and their priority over purchase money loans as opposed to refinance loans. In some cases, building associations can assert priority over the lender for all or part of the unpaid assessment lien. This means that the lien may survive the foreclosure and can be enforced against the lender or other subsequent owner. In any event, the subsequent owner is responsible for payment for fees accruing post-foreclosure.

It is also imperative that building management and the board are mindful of the building indenture and bylaws, and ensure that the provisions concerning assessment lien priority are consistent with those protections provided by the Missouri Condominium Act.

Bankruptcy

A unit owner’s bankruptcy, while initially causing collection problems, does not always result in the removal of an assessment lien. Most personal bankruptcies in the United States today are Chapter 7 cases, meaning that the owner’s assets are liquidated in order to pay creditors. As soon as a Chapter 7 case is filed a condominium association must cease collection activities against the property owner for the past debt. However, the assessment lien against the unit may remain as an encumbrance against the property. This means that in the event of a subsequent sale or refinance after the bankruptcy, the delinquent assessments may be paid at closing, even though the association cannot pursue the owner for those delinquent assessments directly.

Depending on the equity in the unit after a mortgage, the assessment lien, and any other liens against the property, the Bankruptcy Court may allow an assessment lien or other liens to be reduced or eliminated all together, in order to provide value to creditors. Of course, many lenders will begin foreclosure proceedings after an owner has filed bankruptcy, with permission from the Court.

It is also important to remember that even when an owner files a Chapter 7 bankruptcy case, monthly fees and assessments payable after the date of the bankruptcy filing may be collected from the unit owner, and may result in an assessment lien which can be enforced through litigation.

Some individuals file Chapter 13 bankruptcies, which are reorganizations of their financial affairs. These owners will propose a plan to the Bankruptcy Court to repay their debt over a period of three to five years. In many Chapter 13 cases, the delinquent assessments will be paid to the building over time.

Bankruptcy cases can vary widely, and building managers must keep abreast with the status of the case, the effect on the unit, and whether or not a claim for assessments should be filed.

Conclusion

Bankruptcies and foreclosures can seem ominous to building managers and boards seeking to recover delinquent assessments from owners. However, these circumstances do not necessarily preclude the recovery of unpaid accounts. Multi-unit developments are not always doomed to the fate of helpless victims in these scenarios and the management should respond to bankruptcy and foreclosure notices with an investigation of the circumstances in order to evaluate the options that remain and how the building’s rights can be enforced both in the immediate and long term future.

Cash-for-Keys Strategy Gaining Momentum in St. Louis

Interesting article in today’s St. Louis Post-Dispatch on the Cash-for-Keys program. The Cash-for-Keys program is designed to entice tenants residing in bank-owned, foreclosed upon properties to willingly vacate the property for a pre-negotiated sum. The tenant receives some amount of money for leaving, the bank saves money by avoiding litigation to remove the tenant. What the article fails to mention is that the bank needs to properly document the Cash-for-Keys transaction to ensure the tenant actually vacates by the agreed upon date.

Missouri Historic Tax Credit

Currently, the Missouri legislature is debating on whether to restructure the state’s historic tax credit program given the state’s budget crisis. Governor Nixon apparently believes that the state’s historic tax credit programs are large and have been usurping state funds that could go public schools, colleges and universities. Therefore, his administration believes that these programs need to be reformed to free up cash flow for other state programs. Governor Nixon’s administration has proposed creating new statutes for six separate state historic tax credit programs with discretion on the amount awarded, whether to award any amount at all, whether to award any or all of a particular year’s credits allocation and whether to cap certain tax credits at $314 million a year. No rules or regulations have been set in place for the Missouri Department of Economic Development to even make these types of determinations which will only serve to complicate the process even though the current process has been recognized as a national model.

In 1999, The Wall Street Journal published an article entitled “In St. Louis Developers Bank on Tax Credits” wherein the author called the Missouri Historic Tax Credit program “a national model.” The article explains “the Missouri program provides state income tax credits for 25% of eligible rehabilitation costs of approved historic structures. The credit which has no cap applies to both residential and commercial buildings and can be used in conjunction with the 20% federal historic tax credit. In addition, the state tax credit is transferable: Mercantile Bank (now US Bank) has set up the Missouri Tax Credit Clearinghouse to buy and sell credits.” Rehabilitation construction projects such as Cupples Station, the Chase Park Plaza and projects on Washington Avenue and surrounding areas in downtown St. Louis would not have taken place without these tax credits. Without these tax credits, these properties would most likely continue to be an eye sore for the community and definitely not creating new jobs nor increasing state and local government revenue.

The Missouri Growth Association (MGA) and St. Louis University performed a ten year study with regard to Missouri’s historic tax credit programs. In March 2010, they released their conclusions which revealed that the Missouri historic tax credit program contributed to the creation of over 43,000 Missouri jobs with average salaries of $42,732, $669 million in newsales, use and income tax revenues which directly benefited the state and local governments as well as $2.9 billion in private investment in Missouri. According to the Missouri Department for Economic Development, Missouri Historic Tax Credit projects created 4,900 Missouri jobs in 2007, which according to David Listokin of Rutgers University Center for Urban Policy Research, equals 38 jobs per $1 million invested or more jobs than highway or new construction projects. Moreover, the Missouri Department of Economic Development noted that from 1998 – 2008 over $4 billion of investment had been leveraged throughout Missouri as a result of the Missouri Historic tax Credit Program as well as $858 million being invested in 2008. In addition, the Missouri Department of Economic Development has concluded that over 66 communities in Missouri have taken advantage of these historic tax credit programs.

According to the Downtown Community Improvement District (2009), St. Louis City alone has 5,000 new residents as a direct result of Missouri’s Historic Tax Credit programs which caused the city to have its first population increase in fifty years. All of these new residents as well as visitors are paying new local taxes to the state and St. Louis City.

The discussion of removing or capping Missouri’s Historic Tax Program would have zero effect on the 2010 budget since historic tax credits have already been approved for this year. Any change to the Missouri Historic Tax Credits programs would only affect future state budgets. If the state historic tax programs are changed, developers would then analyze the cost to renovate a historic building with the potential revenue. In addition, changes to the programs or uncertainty in the programs will cause more problems for developers in terms of financing a project. At this time, developers are having a hard time financing projects as a result of new internal lending policies and procedures. Many lenders are requiring anywhere from 40% percent equity to 100% collateralization in order to obtain a loan. If the state has a stable historic tax credits program, a developer can leverage those funds to aid in financing a project.

While Missouri is debating whether to institute significant changes to the Missouri Historic Tax Credits programs which was deemed “a national model”, Kansas removed its historic tax credits cap. Further, Iowa increased their historic tax credits cap and Illinois is organizing a historic tax credit program. If Missouri wants to continue to grow jobs, grow revenue for state and local governments as well as increase private investment; particularly, when the country and the state are hopefully coming out of a significant economic recession, the Governor and state legislators need to think long and hard about altering a extremely successful state historic tax credit program which is not only the envy of many other states but has been recognized on a national level.

What are you really paying for – net, gross, or modified gross leases?

When choosing your leased space, you need to be certain you’re comparing apples to apples. Your decision to enter into a lease without understanding the significance of the type of lease may have a drastic financial impact on your company. The three most common types of commercial leases are: net, gross, and modified gross.

Net Leases: Net leases allocate building costs and responsibilities between the landlord and the tenant. The most common type of net lease is the triple net lease (“NNN”). With a triple net lease, the tenant pays taxes, insurance, and maintenance in addition to the monthly rent. If the building is newer, in good repair and you, the tenant, are going to be the only tenant in the building, this may not be a bad option. In exchange for the higher level of building responsibility, the tenant’s monthly lease payment is usually lower. Also available are single net leases (“N” – tenant pays monthly lump sum plus property taxes) and double net leases (“NN” – tenant pays monthly lump sum plus property taxes and insurance). With a N or NN lease, the landlord is generally responsible for all other operating expenses.

Gross Lease: A gross lease is the opposite of a triple net. With a gross lease (sometimes referred to as a “pass-through” lease), the landlord will pay for all repairs, taxes, and insurance in exchange for tenant paying a fixed lump rental amount each month to the landlord. True gross leases are relatively rare outside of the residential or multi-unit retail context; but, when available, relieve the tenant of some of the risks usually associated with property ownership. The flip side of a gross lease is that your monthly rent will be higher than a comparable NNN lease – the landlord will, when it determines the monthly rent, factor in future repairs, taxes, and insurance.

Modified Gross Lease: On the scale of allocating responsibility for the property, a modified gross lease falls somewhere in between a NNN lease and a gross lease. In real life, many leases are within this category. The landlord may agree to pay for real property taxes and major repairs (roof, foundation), but the tenant is responsible for insurance and minor repairs (windows, paint). The key is to negotiate and understand each party’s respective level of responsibility prior to signing the lease, and then decide whether the “great deal” on this property aligns with the small business owners’ risk tolerance.

When looking at your lease for the first time, it is important to remember that often these terms are negotiable. In any event, before you sign on that dotted line, be certain you know who’s paying for what.

10 Essential Lease Traps & Tips for Small Business Owners

You’ve made up your mind, you’re going to take the plunge. You’ve crunched the numbers, lined up staff, and found the perfect location to open your own small business. You meet with the landlord, negotiate rent, and move in… life is good.

Minutes after making your first sale, you notice the ceiling is leaking in aisle 2 over the new cashmere sweaters, the A/C stops working on the first 95 degree day of the year and your selection of artisan cheeses is about to spoil, and you just received notice from a bank that they are foreclosing on your landlord and you need to be moved out in 10 days! As a small business owner, you know these things happen everyday. The key is to recognize these concerns before you sign the lease and to plan accordingly – not only will this approach give you protection, it will force you to understand what exactly you’re getting your burgeoning company into.

This 10 part series will start at the beginning and walk you through some of the most important, and often overlooked, aspects of a lease agreement for the small business owner. Whether you’re opening a restaurant, selling high fashion, or just working from cubicles, all of these lease issues must be addressed for your small business to thrive:

1. What are you really paying for? – Triple Net, Gross, and Modified Gross Leases.
2. How long should you stay? – Lease Term, Renewal Options, Lease Purchase Options.
3. What is the landlord going to fix? Landlord’s Duty to Repair.
4. Who’s on the hook for the lease? Personal Guaranty.
5. Making the space right for your business. Tenant Improvement  Allowance.
6. The best neighbors are those you aren’t competing against. Exclusive Use Clauses.
7. Will the city let you do what you want to do and where you want to do it?
   Intended Use & Zoning.
8. The building burned, flooded, and the city wants to take my leased space to put in a coffee house. Casualty Loss, Insurance, and Eminent Domain.
9. Does my landlord really get to hold onto my security deposit forever? Security Deposits and Sunset Clauses.
10. Bank foreclosure on your landlord. SNDAs.