From Confusion to Confidence...The Reconciliation Process Explained

If you’re a small shop owner accustomed to seeing reconciliations, the end product you’re sent is probably an invoice with a few calculations and a bottom line number due to or due from the landlord.  If you’ve ever questioned aspects of the reconciliation it can be hard for the landlord’s representative to explain, and therefore even more difficult for the tenant to understand. This is especially true if there is a significant amount of money at stake or if things start to get emotional.  My goal is to expand on the first entry of my blog (Tis the Season: CAM Reconciliations), which I recommend you take a few minutes to read over if you haven’t already. 

The better you understand the mechanics of reconciliations the better you will be at productively discussing these issues with the Landlord.  Nobody wants to find out they owe their landlord more money than they expected to, but at least that frustration won’t be compounded by a lack of understanding. 

At the end of the calendar year (or sometimes the landlord’s fiscal year) the landlord looks back at their operating statements to see the exact amount of expenses in each category on their ledger.  Some common examples are line items such as:

  • landscaping
  • parking lot repairs
  • pylon sign repairs
  • administrative expenses
  • management fees
  • utilities, etc. 

 They will also include real estate taxes and insurance in most cases.  These should be actual expenses paid by the landlord during the time frame included in the reconciliation, and the landlord should have copies of invoices or backup that coincides with these expenses. How much they’re willing to share of that backup, if any, will depend on your lease and landlord.  For use in this example we are going to assume the total of the landlord’s annual CAM expenses is $50,000.

In a standard NNN lease tenants pay their “pro rata share” of expenses.  Usually this is calculated by dividing your space’s square footage by the gross leasable area (GLA) of the shopping center, but there are many variations of pro rata shares so read carefully when reviewing this lease section.  

Also, a tenant’s pro rata share can vary between the NNN categories, so just because your share of CAM is one percentage doesn’t automatically mean your share of taxes are the same. For example, if the tenant rents 1,000 square feet and the sum of all rentable space in the shopping center is 30,000 square feet, then their pro rata share is 1,000/30,000= 3.33% of the expenses. 

Now that we know the total amount the Landlord spent on CAM for the shopping center, and the tenant’s pro rata share, we have two of the three necessary variables for the reconciliation.  The final piece is finding the total annual amount that the tenant paid in CAM and calculating the difference between what was paid and what is owed. 

 Let’s say a tenant paid all 12 months of CAM and it was $100 each month, so the total paid in was $1,200.  Going back to our prior number the total annual CAM expenses for the landlord were $50,000. The tenant’s pro rata share of that would be $50,000 x 3.33%= $1,665, but they already paid $1,200 during the year, so the tenant owes the landlord $1,665 – $1,200= $465 for CAM.

It’s important to understand that in a perfect reconciliation with no unexpected expenses, the result should be zero.  However, in practice, that will almost never be the case. Many services such as landscaping are contract services with a negotiated rate for the year, but items like snow removal, utilities or other variable expenses cannot be perfectly predicted.  

Another factor to consider is that some leases base their estimated NNN reimbursements based on budgeted numbers, and some use the prior year’s actual numbers. There are positives and negatives to both ways of calculating the reconciliation, but you should know what your lease stipulates to understand your landlord’s calculations.

Once you receive your reconciliation invoice there are a few steps you should take to insure the accuracy of the billing and potentially save yourself money.  If the management company is a large operation with many properties, your invoice could easily be one of thousands they send out, and they are subject to error.  

First, verify that the amount the landlord is showing they received matches the amount of reimbursements you paid in for the year. If you’ve incurred late fees and had other billing issues this may be easier said than done, but it is so important.  

Second, make sure that the pro rata shares they are showing match your pro rata shares as dictated by your lease. 

Third, make sure that the arithmetic is correct in the equation of your pro rata share minus what you paid in.  

Lastly, you need to verify the total expense amounts.  Add up every number you are provided and make sure they tie in properly to each expense. Go online to your city or county tax site and make sure that the tax amount you were billed is correct for the current year. I’ve seen these steps result in hundreds or thousands of dollars of mistakes, make sure you are not one of them, because if you don’t then nobody else is going to.

By: Chris Burnett

10 Reasons to Sell Your Hotel - Despite Strong Fundamentals

I spend a considerable amount of time talking with hotel owners and investors, and they are a cheery group these days. For most, their hotels are performing very well, and cash flow is flush. Things are going so well, they aren’t feeling motivated to sell (and many are actively looking for new acquisitions). I hear it all the time, fundamentals are strong, yield is great and tax implications of selling are daunting. Still, I find myself wondering: are we/they missing something? While I appreciate the appeal of riding the wave, there are some factors that merit consideration — not to be contrarian, just thoughtful.

10. Brand Dilution

Marriott now has 30 brands. Hilton, Choice, IHG, Wyndham and Hyatt all have a dozen or more. I was at a hotel investment conference recently and the brand execs were asked the obvious questions – when is enough, enough?  To no surprise, their answer was – never! Now, I am a believer in the brands, don’t get me wrong. And, on some level, they are correct. With international growth as a priority, on a macro level they are far from saturating the market. However, if you talk to the owners I know, they’re concerned. Not about the macro level power of the brand, so-to-speak, but about their local markets. 

On a micro level, these brands are dropping in on top of each other and there’s no denying it. While there is replacement of old product and some inducement of new demand, I believe it foolish to subscribe to the train of thought that it’s okay to continue adding new inventory on the same brand reservation systems and expect that everyone wins.  Time will tell — but in the meantime, I suspect there will be some losers.

9. Added Competition in a "Shared Economy"

Hoteliers aren’t really afraid of Airbnb per se, but they sure don’t love it. Inventory is inventory, and when property owners can add to it on a whim, the aggregate incremental impact is real. Don’t believe me? Log on and check your local market. Ask yourself, if you took those rooms out of circulation, would it help hoteliers? I’m not a rocket scientist, but you get the idea. Recently valued at $31 billion, this competitor has staying power (not to mention the other platforms and yet-to-be conceived disruptors that will come with new technologies).

8. Inflation is Real

Hoteliers see it first hand: Labor and OS&E costs are on the rise, and brand expectations continue to be enhanced. Many markets are seriously talking about (or have instituted) an alternative minimum wage. Threat of trade war is in the news every day. Every owner I talk to, without exception, says their managers cost more and it’s hard to find/retain the good ones. Barring some type of economic slowdown that will loosen the labor markets and bring a wave of new competition for OS&E goods, I don’t see this changing anytime soon. I won’t even mention technology costs, franchise and commission fees, or construction costs, other than to say, they are high and climbing.

7. Interest Rates are Inching Up  

Yep, that’s what happens after a decade or so of favorable rate environments.  What’s that saying? “All good things must come to an end?” While there is some evidence to show that interest rate increases do not necessarily cause values to drop, I suggest to you that, if true, it’s probably a short-term reality. Fundamentally, if interest rates go up and capitalization rates stay flat or go down, Wall Street makes less money. Do you really think that’s sustainable? Me neither.

6. Cash on the Sideline 

In spite of all nine of the other reasons I note, there are plenty of buyers in the market.  And, while I may pen a compelling case to be a seller, I could (and do) make a strong argument to be a buyer also.  There is tremendous wealth in this country, thanks, in part, to a more favorable tax environment. I’m also not an economist, but there are billions of dollars in equity looking for a place to park and earn yield. Hotels, generally, provide better than average returns (for those who have the necessary risk tolerance). For sellers, this is good news – there is an active buyer market.

5. PIPs!  

Just ask any Hampton Inn owner in the country about PIP costs and you will get an earful. It’s no secret that the costs of brand-required reinvestments can be huge. The most challenging issue is they’re somewhat unpredictable. Sure, owners know generally when the next one will be due, but the standards are constantly changing and, as such, the costs are too.

4. History Repeats Itself

I don’t recall much from college, but if memory serves, there were some charts in economics courses that pretty clearly showed markets to be cyclical. Hoteliers who have been in the business for a while remember the late ‘80s (not the music, think S&L) and the early ‘00s (the dot com boom/bust) and the late ‘00s (not the iPhone introduction, the great recession). I won’t break out the charts, but I do believe each of those eras had some pretty dramatic highs and lows. And, I suspect most would agree that the lows were more painful than the highs were enjoyable. Surfers love riding a good wave, but most would prefer to avoid the close out when the wave crashes overhead and slams you into the reef.

3. 1031 Exchanges

Most hoteliers I know who are hesitant to sell in the current environment convey a sense of uncertainty about what to do with their proceeds and a strong desire to avoid Uncle Sam on capital gains and depreciation recapture.  Well, that’s why some folks a long time ago thought up this great idea of deferring certain taxes to incentivize reinvestment in real estate. If you can’t find a property suitable for reinvestment because the pricing is too rich for your blood, well, that’s probably when you should start feeling great that you were a seller.  Uncle Sam will get his share one way or another – sometimes it’s okay to take your lumps and be thankful for the net proceeds.

2. Low Inventory, Aggressive Pricing

I spend virtually every day trying to find assets for clients to purchase, and I can tell you first-hand that the market is tight — the inventory of quality assets for sale is low. Serious buyers who have capital to deploy are ready, willing, and able to pay a premium because they need to generate yield. This drives up pricing, whether based on capitalization rate, revenue multiplier or per unit — we are regularly seeing trades at valuations that make your head spin.  

Having said that, buyers are still selective and quick to pass over investment opportunities which don’t check all their boxes. It’s the well-located, well-maintained, Marriott and Hilton flagged properties which are hardest to find and most competitive to acquire when they do come available.  With strong macro fundamentals in lodging, even lower tier properties are achieving much higher pricing today than during a stagnant or declining market. It’s a good time to be a seller.

1. Buy Low, Sell High

Sound familiar? Perhaps the most fundamental principal in economics seems to be overlooked by many owners in the current markets. The market is high. Don’t trust me? Read up on it yourself. Pick any credible source and I suspect you will find that most lodging forecasters think we’re either at or approaching the top of the cycle. Need I say more?

To clarify, I’m not saying it’s definitively time to sell your hotel; nor am I saying it’s a bad time to buy. There are plenty of good reasons to buy/hold. I’m merely suggesting it might be a good time to take a strategic look at your portfolio and the various factors that drive exit strategy… you may find some enthusiasm about selling after all.

Originally published on socialtables.com on May 17, 2018

By:  Edward C. Denton

Farm Fresh Closings and Bi-Lo Bankruptcy: What it Means for Nearby Shop Owners

Thousands of small business owners across the country have woken up sometime recently to a headline that the major store in their shopping center just went out of business.  Most recently, it was Toys R Us on a national scale. 

Locally and regionally it’s the recently announced sale/closure of Farm Fresh, a regional grocer that has been in the Coastal Virginia area for many years.  Another is the bankruptcy filing by Southeastern Grocers whose brands include grocers Bi-Lo, Winn Dixie and a few others. 

Each of these impacts multiple locations within secondary and tertiary markets, such as Virginia Beach and Chesapeake.  If you are a small business owner in a shopping center where the main attraction is suddenly out of business, what can you do?*

Protecting yourself in a lease is similar to insurance — you want to make sure you’re covered before the occurrence of a bad event. 

I’m not going to sugarcoat it, there’s probably nothing you can do if this has already transpired, except learn a hard lesson for the future…unless you negotiated a co-tenancy clause into your lease, in which case that may be your only direct recourse (i.e.: your insurance policy).

What exactly is a co-tenancy clause and how can it protect you? 

Like I said, it’s an insurance policy…a co-tenancy clause provides some form of recourse for tenant in the event an anchor tenant “goes dark”.  

The idea here is that you, small business tenant, picked the location in part because of its proximity to the big business tenant who is attracting a lot of people, who will in turn see and (hopefully) patronize your store because of its convenient location.  

If aforementioned big business (ie: Farm Fresh) closes and all their former patrons are now going to the other shopping center with the competing grocery, then your small business is likely to suffer.  Hence, the need for an “insurance policy”(aka: co-tenancy clause) in your lease that requires the landlord to provide some relief if the big business shutters.

Okay, but what exactly is an anchor?  

Well, that’s debatable — and therefore negotiable in every lease.  Typically, an anchor is one of the largest tenants in a center, occupying a significant square footage or percentage of the overall property.  

It is usually going to be a household name people are familiar with in your market, and one that drives a lot of traffic (i.e. grocery stores, sporting goods, household goods, hardware, etc.).  The definition will be specifically articulated in your lease by either naming the tenant explicitly or listing the square footage requirement or some other criteria that won’t be left open ended.

And, what happens if the anchor tenant goes dark?  

The level of protection and severity of consequences is also negotiable and may range from discounting your rent to changing your rent to a percentage of your gross sales in lieu of fixed amount, or the tenant may even have a right to terminate the lease entirely.  There will typically be a caveat that the Landlord will have a specific time frame to re-lease the space to another anchor tenant, but if that doesn’t happen within said timeframe the tenant likely would have the right to invoke the co-tenancy clause. 

I encourage everyone to go through your lease and look for a section related to Co-Tenancy, so you can be prepared if you find yourself in this unfortunate position.  If you don’t see that heading you may want to check the default section or any termination clauses to see if there is relevant language buried in there. Next time you’re up for renewal or opening a new location, maybe this is something you should consider asking for…like an insurance policy, you hope you never need it, but it’s nice to know you have it just in case. 

I think most landlords would rather concede some form of co-tenancy clause rather than risk losing your tenancy.  On the flipside, if the Landlord isn’t willing to concede this, maybe there’s reason to be concerned with the health of the anchor tenant?

*Editor's note: The author is not an attorney, and this is article is not intended as legal advice.  As a real brokerage estate firm, we recommend our clients engage legal counsel for preparation of lease agreements, purchase and sale agreements, and to advise on property rights and landlord/tenant matters.

Originally published on Alignable.com on April 17, 2018

By: Chris Burnett, Commercial Sales & Leasing, Denton Realty Company

Tis the Season: CAM Recs

As we approach the end of the first quarter, tenants on “net” leases are preparing to deal with annual operating expense reconciliations from their Landlords.  If you are a commercial real estate tenant and don’t know if you’re on a “net” lease, or don’t know what I mean by a reconciliation, you could be in for a surprise.  If you are paying any one or combination of Common Area Maintenance (CAM), Tax, or Insurance to the Landlord then you’re on some form of “net” lease.  For the context of this article I’ll be focusing on CAM relative to retail leases, although many of the same principles can apply across other asset classes.

So, what is this Common Area Maintenance you’re paying for, and why is it being reconciled? My own quick definition of CAM is maintenance, repair (and often replacement) of portions of the shopping center that are for the benefit and use of all tenants in the center and their patrons.  Reconciliation refers to the adjustment required at year-end to make the sum of the CAM estimates you paid (or were billed) equal to your share of the total CAM expense for the property.  If you’re wondering why I’m not quoting some official source or dictionary definition…guess what?  Common Area Maintenance is already defined in your lease and will vary widely, so it doesn’t matter how I define it as much as it does how your Landlord and your lease define it.  As they say, the devil is in the details, and you may be shocked by how much gray area lies between the lines of your lease.

This is often a hectic time of year for both Landlord and tenant; there may be multiple things happening at once.  You may be getting new estimates that change your monthly payment, and on top of that getting billed for the difference in those payments.  At the same time, you’re getting these reconciliations and invoices and it can quickly get overwhelming, especially if the numbers are not in your favor.  This is an exhaustive topic that I plan to continue covering in more detail, because the process can be as simple or as complex as your Landlord or management company makes it.

I envision this as the first introduction into a series of entries that will provide insight and knowledge to help business owners.  I also expect following topics to be more specific and targeted, but we needed a starting point.  If you’re frustrated, or something doesn’t make sense and the Landlord isn’t responsive, I may be able to help.  Let me discuss what options, if any, you might have.  If you would like to learn more about this and other topics that are of benefit to commercial tenant’s then I urge you to follow this page, give it a like, and share it with others.  The depth and scope of these entries will depend largely upon the feedback of you.

By: Chris Burnett, Commercial Sales & Leasing, Denton Realty Company