The Recapture Clause and Other Sublease Stuff

Many people ask me why, with rents so much higher today then they were a few years ago, aren't more people subleasing their space? It would seem that the opportunity to get free cash would be one that few would pass up. The truth is, subleasing isn't quite as great as it seems. There are 3 reasons for this, 1) the landlord makes it that way, 2) there's additional risk, 3) it costs money to sublease. Today I'll address the first reason.

1) In every lease I've seen, a tenant has the right to sublease and the landlord cannot "unreasonably withhold" his/her consent. However, there are many qualifications attached to this statement. Here are some common ones that may not surprise you:

• The sublessee has to have good credit


• The sublessee's use of the space must comply with the use permitted in the lease


• The sublessee must not be a current occupant of the building or any other building the landlord owns (try to get rid of this one if you can)


• The sublessee must not be someone already negotiating to lease space in the building


• The current tenant must reimburse the landlord for any costs incurred in subleasing the space


• The space cannot be advertised for less than advertised space in the building (try to get rid of this one too)


• The sublease must not allow anything that is not allowed in the overlease

Here are some other common qualifications that probably will surprise you:

• Landlord's right to recapture - In the event that the tenant delivers a signed sublease to the landlord, the landlord has the right to cancel the tenant's lease and either lease the space directly to the proposed subtenant, or lease it to someone else. Generally the landlord has a time period during which they may decide if they want to allow the sublease, deny the sublease, or recapture - 30-45 days is typical. As a tenant, you'll want to avoid the landlord's right to recapture, and if you can't get rid of it, try to reduce the review time. Let me explain why:
  1) In a good market, the market rent will be significantly higher than the rent in the lease, and likely higher than what a tenant will sublease there space for. This makes potential subtenants weary of entering into a sublease transaction. The potential subtenants could spend thousands in attorneys fees and months negotiating a sublease only to then wait an additional 45 days for a landlord to decide if he/she is going to recapture, and then have the landlord recapture! If the landlord recaptures, they may be stuck with doing a direct deal at a much higher rent than they planned, or they may have to walk away from the deal.
  2) Broker's are weary of showing a tenant space where the landlord has the right of recapture. They may put in a lot of work only to have the deal fall through, and they don't get paid for all of that work.
  3) The recapture process makes the whole sublease process take longer which means more time without rent for the sublessor.
  
  All of this said, having the landlord recapture your space isn't such a bad thing . . . it gets you off the hook for the lease and assuming you're not in the business of being a landlord this should make you happy.
  


• Sublease profit - The lease may stipulate that in the event the sublease is for a higher rent than the rent in the lease, the landlord may get all or some of the profit. This clause is critical, and it is important that you understand it. You should try to negotiate to be able to keep at least half of the profit on a sublease. Also, make sure that any profit that goes to the landlord is paid after attorney's fees, brokerage fees, improvements made to rent the space, cash allowance paid to the sublessee, and free rent offered. Finally, often times the landlord will insist that he/she receives ALL money received for the purchase of Tenant's fixtures, leasehold improvements, furniture, furnishings or other personal property over the transaction costs. This may seem completely unreasonable, but there is good reason why landlords include this clause. Sometimes tenants avoid paying profits on a sublease to the landlord by receiving large payments for furniture and fixtures. The best way to avoid handle this clause, is to say that the landlord will get his/her share of the profit made on the furniture/fixtures above the "fair market value" of said furniture/fixtures.

In my next post I'll cover risks and additional costs.

Loss Factor v. Load Factor v. Add-On Factor - More on the "Rubber Ruler"

In Loss Factor Demystified and Loss Factor Demystified - Part 2 I explained what a Loss Factor is the difference between Rentable Area and Usable Area. Since that time I've had several people ask me about other terms they've heard thrown around - Load Factor, and Add-On Factor.

First off, Load Factor and Add-On Factor are the same thing. While loss factor tells you what percentage of the Rentable Area you can't use, Load Factor and Add-On Factor tell you how much larger the Rentable Area is than the Usable Area. For instance, let's say you are considering the rental of an office. The landlord tells you that the Rentable Area of the space is 10,000 SF, and the Usable Area of the space is 7,500 SF. What is your Loss Factor, and your Load Factor/Add-On Factor?

Loss Factor: (Rentable Area minus Usable Area) divided by Rentable Area: (10,000-7,500) = 2,500/10,000 = 25%

Load Factor/Add-On Factor: (Rentable Area minus Usable Area) divided by the Usable Area: (10,000-7,500) = 2,500/7,500 = 33%

Follow Up on 1031 Exchanges

A few weeks ago I posted Part 1 of a Series on "Why TICs are good" which explained what a 1031 exchange is. As a follow up to that discussion, I recently came across this very interesting article which offers some tips on the nuances of a 1031 exchange. I won't repeat the article here, but a couple interesting things to know are:

1) Foreign properties are not considered "like-kind" for the purpose of a 1031, regardless of what they are, and

2) "Personal property may be exchanged under [section]1031. However, to qualify it must not only be exchanged for other personal property but must be exchanged for personal property of the same "like class" property or within the same product class as set forth in the NAICS manual.

Happy Reading!

Downtown Manhattan - The Best Value for Small Tenants

Now, more than ever, the Downtown office market of Manhattan provides tremendous value for small tenants. Let me explain why . . .

Post 9/11 the New York City office market took a tremendous hit. Companies fled Manhattan for the suburbs, and Downtown Manhattan was hit the hardest. Faced with high vacancy rates, Downtown office building owners had to make a tough decision. Grin and bear it, sell, or reposition. Since Class A space came way down in price, Class B and C space looked increasingly unattractive to tenants. Most Class A landlords stayed put or sold, but the Class B & C landlords mostly repositioned their buildings or sold their buildings to new owners that repositioned them. Virtually every Class C building, and many Class B buildings were converted to residential rentals and condos. This left the Downtown market with a high proportion of quality space, and much less office space - period. As a frame of reference, immediately preceding the events of September 11, 2001, the downtown market had 82.4 million sf of office space as compared to the current number of 74.8 million.

Despite the sharp decline in the quantity of office space downtown, the results of September 11 created an increasing large gap between Midtown rents and Downtown rents. Pre 9/11, rents downtown were approximately $15 less per sf than they were in Midtown (25% less). Today, they are approximately $30 less per sf then they are in Midtown (35% less). As this gap has grown, Downtown has become more and more of a value option for Midtown tenants.

So, if this is the case, why is Downtown more of a value play for small tenants than large tenants? Glad you asked . . . with the current state of the economy and the failures in the financial services industry, a lot of sublease space has become available both Midtown and Downtown. As I mentioned in a previous post, there are over 50 block of space over 100k sf available. These spaces are trading at a discount of approximately $20 below direct space. The result - large tenants that were considering a move downtown may choose to sublease space in Midtown. Unfortunately, for small tenants this is not an option. There are still very few small sublease spaces available in midtown, and those that are around are not trading at much of a discount. So, if a small tenant wants quality in Manhattan, and needs ample access to public transportation, there is no better option than the Downtown market.

The "Good Guy Guarantee" and Why It's Not so Bad

Any smart landlord will do whatever he/she can to insure that they won't be left "high and dry" by a tenant that doesn't pay their rent. The most common means of protection is through the use of a Security Deposit or Letter of Credit. The amount of this Security Deposit or Letter of Credit is inversely correlated with the credit worthiness of a tenant. To keep it simple, the worse the credit, the more security needed. Of course, certain companies with lots of money and a good track record may still be considered risky. Perhaps the best example are hedge funds. Virtually all of the billions that many hedge funds have is "tied up." The money they invest is tied up in investments, and the management fees are generally funneled directly to the partners. So, even though most hedge funds can afford expensive space in the best areas, they'll have to put up a lot of security to get it.

Now, to the heart of this post. In addition to, or in lieu of a security deposit, many landlords will insist on a "Good Guy Guarantee." I have found that there is a lot of misinformation out there on exactly what a "Good Guy Guarantee" is, so I'd like to set the record straight.

A "Good Guy Guarantee" is very simple. It says, that in the event that the tenant has to break the lease, the tenant will notify the landlord, pay their rent up until the date they vacate the space, vacate the space and return the keys. If, and only if the tenant does not abide by this guarantee, a principal of the tenant's organization will be held personally responsible. In this respect, the "Good Guy Guarantee" is a form of a limited personal guarantee. When the principal of a firm hears the words "personal guarantee," this often scares them off. The truth is, that once you realize what this guarantee is all about, it's not something to be afraid of. Truth be told, a "good guy" would not allow their company to stay in a space and not pay the rent.

I generally advise my tenants to sign a "Good Guy" (after using it as a bargaining chip of-course)and here's why. The Landlord's goal is simply to protect his or herself whenever possible. Using a "Good Guy" is a great way to prove to the landlord that you're worth the risk while reducing the amount of security that your company will have to provide. However, it's important to remember that corporate executives come and go, so your company should retain the right to substitute the guarantor at any time.

How to get a NJ Real Estate Salesperson's License - If you're a NY Real Estate Salesperson

First things first - a little known tidbit about NY commercial real estate brokers. In NY (and I believe many other places as well), if you sell or lease commercial real estate you call yourself a broker. Not an agent, not a salesperson, not a realtor . . . a broker. If you're not a "broker" you may find this odd. Why? Because most of us aren't brokers!

Truth is, there are 2 legal designations -"Real Estate Salesperson" and "Real Estate Broker" (OK, there's also "Associate Broker," but I'm trying to keep this simple). Anyway, "Real Estate Salespeople" can do all the same things as brokers, except having a broker's license allows you to own a real estate brokerage firm. Since real estate salespeople aren't limited in what we can do, and since most of us work for a firm anyway, most of us don't have broker's licenses. Whatever the case, we all call ourselves brokers!

Now that I've clarified this, I'll get on to the point at hand. I'm a licensed NY Real Estate Salesperson. I've decided that I would like to get my NJ real estate license. I thought this would be a relatively simple process. As it turns out, it's a big pain in the ass. I'll walk you through it, in case you care.

In NJ, you must meet 3 main requirements to become a licensed real estate salesperson.

1) 70 hours of accredited real estate training
2) Pass the state exam
3) Be sponsored by a license real estate brokerage firm

In NY, however, you only need 45 hours of real estate training (at least until that changes to 75 in a couple months). As a result, NY has virtually no reciprocity with other states for real estate licenses (most states require 70+ hours). So, in order to get my NJ license, I had 3 options 1) take a 75 hour course in NJ, 2) show proof of 75 hours of education from an accredited masters degree, or 3) take the NY broker course (for 45 hours) and combine those hours with the hours I spent getting a NY real estate license to fulfill the requirement. This is easier said than done. Here's how it plays out.

1) Take 45 hour NY broker course (a few hundred bucks)
2) Send a letter to the NY Department of state to apply for Certification of Licensure - $20
3) Wait to receive Certification of Licensure
4) Send in certificate of completion of NY broker course and Certification of licensure to NJ Real Estate Commission (send in certified check for $25 + certified check fee)
5) Wait to receive waiver of education requirement for NJ Salesperson's license
6) Sign up for NJ Salesperson test ($60)
7) Study for NJ Salesperson test (Buy book - $45)
8) Schlep to NJ for Salesperson test
9) Get fingerprinted at a center in NJ
10) Submit proof that you passed test, met the education requirement, got fingerprinted and have a sponsoring broker to get license

As you can see, they don't make it easier on you. Oh well, at least I'm up to step 7!

Relocation Clause - Follow Up

David Stejkowski in his blog referenced my post on the relocation clause, and made a couple of very salient points.

1) A relocation clause could even say that the landlord can move you to another building! - I wouldn't go for that.

2) A key negotiation point is to limit how many times the tenant can be relocated. I think that once is enough, but you should at least limit it to once every X number of years.

How to Water Down a Relocation Clause

Landlords like big tenants. Quite simply, they're easier to deal with, and cause less administrative headaches. They sign longer leases, they do their own work, they understand real estate, and they pay a lot of rent. Sure, big tenants have their negatives as well, but on the whole, landlords prefer them.

To that end, if a landlord has the option to move a small tenant to make room for a big tenant, they might just do it and if your lease has a relocation clause, they can! So what exactly is a relocation clause? Well, it's pretty straightforward, and generally it says, that with XX days notice, the landlord can move you to another space in the building of a similar size, and charge you the same amount per sf that you are paying now, for the new space.

Given the significant cost of business downtime, if a relocation clause is exercised, it can cost a small tenant an incredible sum of money. With this in mind, when I submit an offer on behalf of a client, I always ask if the landlord's lease has a relocation clause.

So, what if the lease I am about to sign has a relocation clause, what do I do?

In this situation, you have 2 options. The first, of course, is to demand that the clause is removed from the lease. This is often possible, but for some landlords, the relocation clause is very important. In these cases, your best option is to water down the clause. Here's how you do it.

1) These clauses generally say that the landlord may move you anywhere in the building he/she chooses. You should change the clause to say that the landlord may only move you to a location on the same floor or higher. You may also wish to request that the floor is facing the same direction and gets better or equal light and views, and has at least as many windows.

2) Few spaces in a building are exactly the same size. The landlord will want to move you to a space of "similar" size, but how do you define similar. Furthermore, the landlord will want to charge you more for your new larger space! You should demand that the space your are moved to is equal or larger than the space you currently occupy. Additionally, your "proportionate share" of the building should not go up for tax and escalation purposes, and you should pay no more than you are currently paying for rent and electricity.

3) Moving expenses - The landlord should pay for all moving expenses.

4) Downtime expenses - The landlord should pay for all expenses related to business downtime.

5) Build-out - The landlord should build out your new space to a degree of quality that is as good or better than your current space.

6) Notice date - Demand that you receive plenty of notice of the landlord's intent to relocate you.

7) Other concessions - Free rent, additional tenant installation $, etc.

It's worth noting, that the relocation clause is really not as scary as it seems. Truth be told, landlords rarely relocate tenants. It's generally prohibitively expensive and very time consuming (even more so when you include all of the restrictions we did above). Also, there is rarely one small tenant on a large floor. Relocating one often means relocating the others. Nonetheless, it's important that you protect yourself.