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COMMERCIAL LEASE PITFALLS

Alan Whitson, RPA

Today's soft commercial real estate market has created many opportunities for
savvy companies, yet, with opportunity comes risk. And it's a situation that
most managers will soon face. Because every year seven percent of the nation's
commercial real estate leases expire; and according to a recent NACORE study
almost 80 percent of major US companies are planning to relocate or expand
their facilities within the next three years.

Even companies not looking for space must be careful. Many buildings that are
now renting for less than $25 a square foot were built based upon projected
rents of $30 to $45 a square foot. Forcing landlords to become increasingly
creative in finding ways to maximize their cash flow.

A common trap for tenants is the annual increase in operating costs or "pass
throughs." Originally designed to protect the landlord against increases in
utilities, property taxes and operating expenses. Now, landlords see pass
throughs as a profit center.

While operating costs vary by geographic area, in most major U.S. cities they
run from $7 to over $9 per rentable square foot per year. Overcharges of a $1
or more per rentable square foot are common.

When multiplied by the term of a tenant's lease and the number of leases in a
landlord's portfolio this amount can grow to an astonishing figure. As we
uncovered for one client. Their landlord had understated the base year
operating expenses by $250,000. Then overstated the building's square footage
by 25,000 square feet when adjusting the operating costs to 100 percent
occupancy. A nickel here, a nickel there and presto - an extra million dollars
in the landlord's pockets!

Even for small tenants this can mean substantial extra costs. During a lease
review for a 3,500 square foot branch office, we found the landlord had
overcharged $9,500 for operating costs in the first two years of their five
year lease. Overcharging tenants 10 to 15 percent is not uncommon, but here it
was 38 percent. In the audit, we found another item that allowed us to
negotiate a rent reduction of $60,000 for the remaining three years of their
lease.

PITFALLS, LAND MINES AND BOOBY TRAPS

Lurking inside almost every tenant's lease are loopholes, traps, major
ambiguities, and dozens of issues that were never discussed. Buried among the
legal rights and obligations are hidden costs, unreasonable risks and outright
mistakes that could have expensive consequences. From the tenant's standpoint
they are poorly drafted. The language is unclear and important clauses
omitted.

Even the most sophisticated of companies, architects, attorneys and
experienced real estate professionals can overlook the most basic item. That's
what happened to a major financial services firm that leased several floors in
a major office building. After moving in, they learned that their gross lease
didn't include janitorial service. It was irrelevant that gross leases in that
city's first class buildings usually included cleaning services. "If it ain't
in writing, you don't get it," was the landlord stand. The firm is now paying
an extra $100,000 a year for cleaning.

The need for landlords to fill their buildings in this weak market has given
many tenants the opportunity to cut their rent and move into new buildings.
Still, for the unprepared there are some very costly pitfalls.

When the developer of a Times Square high rise offered a major New York law
firm a lease that was $10 per square foot less than their old lease, they
moved into 423,000 square feet at Broadway and 47th Street in late 1990. Yet,
unable to lease any of the other 33 floors of the 42-story high-rise near
Times Square in Manhattan, the project soon became financially strapped. As
the grime slowly built up on the windows, other signs of deferred maintenance
appeared. Elevators were slow to arrive, landings were bumpy and call buttons
didn't work. The heat was out for weeks in the early spring of 1991 and work
stopped on the building's exterior. Then, the partnership that owned the
building declared bankruptcy. In 1994, the building was finally sold for half
its construction costs.

Since foreclosures have become a fact of life, your landlord today may not be
your landlord tomorrow. That's why so called boilerplate issues like
subordination, non-disturbance and attornment are important to tenants. When
lenders take back a building - they can legally tear up leases and evict the
tenants. That was the case when a North Carolina bank took back an office
building in Nashville and evicted 15 tenants. Why would a lender evict rent
paying tenants? By giving the tenants the boot, the bank could then sell the
four story building to a major tire manufacturer, that was relocating its
headquarters to the area, and get a "non performing loan" off their books and
keep the government off its back.


AVOIDING THE LEASE FROM HELL

Landlords are in the business of leasing space. They have calculated every
angle far before any negotiations with help from: asset managers, attorneys,
financial analyst, property managers, real estate brokers, risk managers,
architects, space planners, engineers and contractors.

Tenants, on the other hand, often do not have the financial, professional or
personnel resources commanded by the landlords. Despite their expertise and
success in their core business, they are in foreign territory and outnumbered
when it comes to dealing with the maze of fine print and legalisms in a lease.

A lease is a very complex document that often contains hundreds of small
agreements. Sometimes, just changing one or two words can be the difference
between a fair lease clause and trouble.

Here are a 25 questions from the book; "327 Questions To Ask Before You Sign A
Lease." They can be used to find costly loopholes and uncover potential
problems when negotiating a new lease. You also can use them to review your
existing leases. A review can expose thousands of dollars in overcharges for
operating expenses, tax assessments, errors in calculating CPI adjustments,
security deposit interest, and lots more.

All the questions can be answered either yes or no. A no answer is a red flag,
warning you to take steps to protect yourself. The idea of using a check list
may seem simplistic. Yet, it is a very effective tool for making sure nothing
is overlooked and prevent problems.

Does the lease specifically state the square footage of the premises?

Is the total rentable square footage of the building specifically stated?

Is the tenant's pro rata share based on total square footage in the building
instead of the square footage leased by the landlord?

Do the base year expenses reflect full occupancy or adjusted to full occupancy
(for example, the base year real estate taxes are low because they are based
on an unfinished building)?

Must the landlord provide a detailed list of expenses prepared by a certified
public accountant (CPA) to support the increase?

Does the lease clearly give the tenant the right to audit the landlord's books
and records?

Is any increase in operating expenses due to of another tenant's "particular
use" excluded from operating expenses? If the tenant's use is limited to the
use stated in the lease and no other use. Does the lease provide for: "except
concerning an assignment or subletting, in which event any change in use
required by the transferee shall be subject to the prior written consent of
the landlord, which consent shall not be unreasonably withheld or delayed?"

Is there a dollar limit on the tenant's obligation to make changes to the
premises to comply with all municipal ordinances and state and federal statues
after the commencement date?

If the landlord becomes aware of any hazardous substances, hazardous materials
or hazardous wastes in the building or the premises is the landlord required
to give the tenant prompt notice?

Are the janitorial service standards specified in an exhibit, such as emptying
waste baskets nightly, washing the exterior windows once a quarter?

If the services are interrupted, does the lease define the remedies available
to the tenant; money damages, rent abatement or lease cancellation?

Is the landlord, required to complete or correct the "punch list" items within
30 days or be in default?

If the landlord does not meet its responsibilities for repair and maintenance,
can the tenant make the repairs upon 10 days notice (or without notice in an
emergency), and deduct the costs of the repairs from the rent?

Does the lease say any repairs, alterations or other improvements required by
any governmental authority that is required of the building in general, or
similar buildings or uses in the area of the building, shall be done at the
sole cost and expense of the landlord?

If the landlord fails to notify the tenant of the assessment (or reassessment)
in sufficient time to permit the tenant to contest the assessment, can the
tenant exclude any increase resulting from the assessment from the taxes the
tenant pays?

If the tenant is seeking to sublease only a portion of the premises is the
landlord precluded from recapturing the entire premises?

Is the landlord required to obtain nondisturbance agreements from current and
any future lenders? Is the landlord required to subordinate its contingent
interest in the tenant's personal property and fixtures to the tenant's
lenders?

Does the lease say any lease modifications requested by a lender cannot alter
the basic business terms (rent, location, term)?

Can the tenant use an umbrella or blanket insurance policy that also covers
other premises owned or leased by tenant?

Is the waiver of subrogation unlimited, instead of limited only to the amounts
of insurance proceeds received?

Does the lease clearly define how disputes are decided?

Is everything the tenant negotiated, such as free rent, increased tenant
improvement allowance, caps on operating expenses increases, stated in the
lease and its exhibits?

If the lease is subject to mortgagee approval, is the lease automatically
void, if the tenant does not receive written notice by a certain date that the
lease has been approved?

Real estate often represents a firm's largest single financial commitment, and
its largest annual expense other than payroll. It can have a major impact on
earnings for many years. Avoiding just one trap can save thousands or maybe
millions of dollars each year. In today's economy, one cannot afford to be
caught unprepared. The stakes are too high.

Alan Whitson, RPA is CEO of the B. Alan Whitson Company, a Newport Beach
California firm that serves the real estate needs of many well know
organizations. His 20+ years of experience encompasses over 25,000,000 square
feet of facilities around the world. Whitson regularly speaks at colleges and
professional meetings. He is the author of numerous articles on corporate real
estate and economic development. The following books and software are
available from the B. Alan Whitson Company:

327 QUESTIONS TO ASK BEFORE SIGNING A LEASE    The perfect "insurance policy."
An easy to use tool to uncover potential lease land mines before they explode.
Use it when negotiating new leases or while reviewing existing ones. The 327
yes or no questions cover the 65 topics found in most leases. A "NO" answer is
a red flag warning you to take steps to protect yourself.    $11.95

BUILDING OPERATING COSTS    It's not uncommon for landlords to overcharge
tenants 10 to 15% in their annual adjustments for building operating costs.
Covers pro-tenant strategies for allocating costs, setting base year amounts
and expense stops. Includes model lease addendum on diskette.    $11.95

WHAT'S THE RIGHT MOVE?    A company's location is a competitive weapon. Its
key to a company's success. The wrong one can lead to disadvantages that can
plague a company for years. The right one can improve profits and strengthen
your company's competitive advantage. Covers issues you'll need to address,
picking the right site, should you lease or own, how to get workers to move,
tips for hiring new workers, and making your move user friendly.   $11.95

BOTTOM LINE    This software lets you compare up to five leases quickly and
easily. Just fill in the blanks and get presentation quality reports and
charts. Do sophisticated what if analysis in minutes to help you negotiate a
better deal. Find out if renewing a lease or moving is the best option. This
easy to use software works with your existing Excel or Lotus for Windows
spreadsheet.    $129.95

TENANT IMPROVEMENT COST BOOK FOR OFFICES 1994    This new book by Marshall &
Swift will answer your questions about doing a tenant improvement project even
the ones that come up after 10 years in the business. An all-inclusive
reference tool for anyone working in any aspect of tenant improvements, from
novice to veteran. It puts the data you need at your fingertips in an easy to
use format, so you don't have to hunt for it, miss an important detail or find
yourself in the dark at any point in the process.    $95.95

SMART MOVES MANUAL & SMART MOVES SOFTWARE    The complete guide to moving an
organization. Avoid major mistakes and problems commonly encountered when
moving to new facilities. Three pounds of planning strategies, procedures,
forms and crucial activities. Includes easy to use software to keep track of
important tasks, control costs and make sure everything gets put in the right
place.    $119.95

INSIGHT    A quarterly newsletter specifically designed to deal with all the
issues affecting corporate real estate and its cost effective operation. Each
issue gives you in-depth coverage of a single topic. A working tool that shows
you exactly how to solve a specific problem. Information to help you control
costs, avoid lawsuits, safeguard employees, and the latest insights on how
your company's facilities can increase employee productivity.    $23.00 a year

Shipping and Handling is $6.75.
We ship via UPS - so we need a street address.

For more information you contact us at:
    B. Alan Whitson Company
    1300 Bristol Street North
    Suite 140
    P.O. Box 9229
    Newport Beach, CA 92658-9229
    [phone]
    [phone] FAX
    AWHITSON
    [e-mail]