Currently, my inbox is cluttered. This column helps me clear it all out and create some calm and order.
There’s only one week left in the third quarter of 2022 and 2023 is an Auld Lang Syne away. Blink and it’ll be here.
Harvested from two calls today, here are a couple of situations that caused angst.
What is a gross-up provision and why should you care? For context, this came up today in a marathon round with counsel, landlord and tenant. We are negotiating a lease with a publicly traded company and a local owner. These conversations are steeped in minutia but are typically educational.
“Depending on the type of lease, the tenant may bear all or only a portion of the landlord’s expenses,” according to Donald R. Oder, an attorney in San Diego.
In a “triple net lease,” all of the landlord’s operating expenses are passed on to the tenant. A lease may, however, contain an “expense stop” that establishes a point at which expenses begin to be passed on to the tenant. In this type of lease, expenses for a “base year” are determined – the expense stop. Thereafter, the landlord pays expenses equal to the base year and the tenant pays its pro-rata share of the rest.
For example, if a lease contained an expense stop at $10,000 (“base year” expenses), and the landlord’s operating expenses were actually $11,000, the tenant would pay the $1,000 over the expense stop. It has become more common in recent years for office leases to contain what’s referred to as a “gross-up” provision. Gross-up provisions permit landlords to “gross-up” or overstate operating expenses to simulate the building being at full capacity.
Here’s how a gross-up provision would work in the real world:
Assume the gross-up provision states that common area maintenance expenses will be calculated for each tenant as if the building was fully occupied, or at 100% capacity. Further, assume the building is currently only at 50% occupancy.
Under this set of facts, a $1,000 expense to the landlord would be multiplied by a gross-up factor of two (100% (the markup rate) / 50% (the level of occupancy)). $1,000 x 2 = $2,000 (the grossed up operating expense). The tenant is required to pay a pro-rata share based on the percentage of space it occupies – let’s assume 20%. In this scenario, the tenant’s total grossed-up obligation would be $400.
Vacancy in office buildings has crept up in the past two years. In a healthy environment, the amount of dark space in a building would be a thing. But now it is. So, pay careful attention when leasing office space.
Contingency periods
By definition, a contingency or due diligence period allows a buyer to study a purchase – on their terms – with no obligation to complete the sale if something untoward is discovered and not remedied.
Sometimes a seller passes along a vault of information which makes review and approval a snap. Other times, this becomes the buyer’s responsibility. Third-party reports such as environmental, building inspection, seismic, ALTA survey, zoning report, etc. must be ordered, completed, reviewed and approved.
Presumably, enough time is built into the purchase agreement allowing the buyer to either approve existing reports or procure and approve. But what happens if the seller is tardy in delivering the reports to the buyer? Does the approval period automatically extend?
This devil in the details caused havoc recently in a deal. We found common ground by saying the contingency period is 30 days from the opening of escrow or 10 days from receipt of the reports. Bingo.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.
