LEASE AGREEMENT REFERENCE GUIDE 1010: RETOOLING THE TAX CLAUSE FOR DEFLATIONARY PERIODS $24.95
RETOOLING THE TAX CLAUSE FOR DEFLATIONARY PERIODS
This LARG focuses upon an old friend--the real estate tax clause. The decline of commercial real estate values in the US over the last five years or so makes this an ideal time to re-examine tax clause boiler plate. The first section in this issue looks at some of the likely effects of falling commercial values, and how they might affect the commercial lease. The second part lists a number of tenant considerations concerning the tax clause. The third section contains a pro-tenant real estate tax rider, and the Lease Clause Critique features an "integrated" tax and operating cost clause drafted from the landlord's perspective.
Drafting Real Estate Tax Clauses For A Deflationary Environment
The free fall in commercial real estate values which started in the mid to late 1980's has already put many local governments in a fiscal jam of epic proportions. Traditionally, such local governments have raised their revenues almost exclusively from real estate taxes paid by residential and commercial property owners. The decline in commercial property values means that residential owners will be forced to pay more of the total tax pie to maintain the same level of local government services, unless such governments take the politically risky course of either raising taxes or cutting services. At least, those are the conclusions of two recent Working Papers published by the Urban Land Institute (see the end of this article for the exact titles and ULI details).
The ULI projects a 32% drop in US commercial real estate values between 1989 and 1994 on a global basis. Although the precise amount of decline varies by market, this computes to a 25% drop in real estate taxes paid by commercial owners and an increase of 40% for the average residential owner during that period. It also means that the residential share of real estate taxes will increase from 65% in 1989 to 73% in 1994, with a corresponding drop in share for commercial owners.
Getting Out the Crystal Ball
But what does all this mean to commercial landlords and tenants, and to the real estate tax clauses in their leases? Plenty. Specifically, it is likely that:
The titles of the Working Papers published by ULI mentioned are: "The Impact of Declining Property Values on Local Government Finances" (March 1993), and "The Effect of The Collapse Of Commercial Property Values on Local Government Revenues and Tax Burdens" (May 1993). ULI's address is 625 Indiana Avenue, N.W., Washington D.C. 20004-2930.
Tenant Talking Points for the Tax Clause
Tenants generally encounter pro-landlord real estate tax clauses in leases they negotiate and sign. In some cases, landlords use integrated operating or CAM cost clauses which incorporate real estate taxes as part of operating or CAM costs. In other cases, the tax clause stands on its own as a separate section of the lease. In response, many tenants have developed their own riders designed for use with pro-landlord forms (see the following section for an example).
Notwithstanding the landlord's approach, the definitions contained in the real estate tax clause are critically important for both the landlord and the tenant. Frequently, such clauses provide that numerous items which are not actually real estate taxes are to be included within the definition of taxes, making such items subject to reimbursement by the tenant. In reviewing the real estate tax language in the lease, the tenant should focus upon the following issues: