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Lease Strategies

Product Overview

This LARG contains the following items:

Thoughts About Frustrating Rollovers and Takeovers, and the Lease Clause Critique: A Sampler of Provisions to Combat Rollovers and Takeovers Operating Costs, Direct Costs and Common Area Maintenance Costs.

Number of Single Spaced Pages: 12





This LARG looks at strategies and clauses designed to thwart rollovers (when a tenant fails to renew an existing lease and vacates) and takeovers (when a competing third party landlord assumes the financial obligations of a tenant's lease to induce it to move from its existing premises to new space). The first part discusses some specific contractual provisions the landlord might consider to frustrate rollovers and takeovers. The Lease Clause Critique contains several pro-landlord clauses drafted to make takeovers more difficult, and to make rollovers more unlikely.

Thoughts About Frustrating Rollovers and Takeovers

Some years back, the Wall Street Journal ran a front page article about "rollover risk" and what it means for the owners of office buildings across America. To illustrate the problem, the story cited 1 Brickell Square, a Miami office building owned by Equitable Life. Although that building is now more than 90% leased, the real problems for the owner may begin to surface as the leases in the building expire, permitting the tenants to move out to snap up sweet deals offered by competing landlords. The financial community refers to this threat as "rollover risk"--it is a major problem for landlords and their lenders in a market with a 26% percent vacancy rate (like Miami).

Of course, such problems may start long before the respective leases are up for renewal. Credit tenants do not have to wait for their leases to expire to move to new space. Depending upon the economics of a proposed deal for new space, many aggressive landlords are only too happy to assume the obligations of the tenant's old lease to induce it to move into their new space.

Such takeover deals (so called because the new landlord "takes over" or assumes the financial obligations of the tenant under the old lease) will continue to stalk good tenants in markets with high vacancy rates until such markets regain some sort of supply and demand equilibrium

Workout Deals

The WSJ article focused primarily upon the rollover risk to the owners of buildings with existing financing, and to their lenders. Mortgages made several years ago were based upon (i.e., secured by) the leases negotiated for the particular property. As those leases come up for renewal in markets with high vacancy rates, the tenants will either make new deals for other space and vacate their former premises, or will negotiate much cheaper rent which reflects the current market for office space.

And, it is highly likely that the cash flow for such properties will decline and may become inadequate to pay scheduled debt service which was the product of rosier cash flow projections. That generates a workout problem for the owner and its lender, and maybe a story for the WSJ.

The Art of the Possible

But what about deals that are being done today? What can an office landlord do to frustrate both rollovers and takeovers of existing leases for their properties? As much as they would like, landlords are not in a position to wave a wand and summon the return of tighter market conditions.

Today's weak markets make for intense competition among lessors of space and make for very independent tenants. Such conditions have stimulated a spate of articles in industry journals about the art of retaining tenants, the importance of quality of service by the landlord, strong personal relationships between the landlord and the tenant, the need to meet the tenant's organizational requirements for space, and the like.

These issues are important to the task of retaining tenants. But to fight rollovers in markets with high vacancies, the landlord ultimately needs to provide a financial incentive for the tenant to remain in its present space when its lease comes up for renewal. With regard to takeovers, the landlord needs lease provisions which give it enough contractual leverage to have the chance to deter a takeover when one rears its head. How can that be done when the lease is negotiated?

Fighting Rollovers and Takeovers

The provisions cited below cannot work magic, or make wholesale changes to imbalances between supply and demand in the particular office market involved. However, they may affect the economics of an individual deal enough to obtain a favorable outcome for the landlord. Some specific suggestions which should help the landlord deter takeovers and prevent rollovers include the following:

  • Can the landlord include an anti-takeover provision in the assignment and subleasing clause giving it the absolute right to withhold its consent to such a transfer, perhaps by making takeovers an exception to the general requirement that the landlord must be reasonable with regard to lease transfers proposed by the tenant? Depending upon the law of the particular jurisdiction in which the property is located, and the judicial affection there for doctrines such as the implied covenant of good faith and fair dealing, such a provision may require special recitals or very narrow drafting, or both.
  • Can the landlord beef up the alterations clause to require the tenant to restore the premises to its original condition if the tenant fails to remain in possession for the initial term plus the periods covered by renewal options? Depending upon the level and condition of the leasehold improvements, this restoration obligation could affect the tenant's decision to vacate the premises prior to the expiration of the initial term plus the renewal periods.
  • Can the landlord negotiate a provision which requires the tenant to reimburse the landlord for "unamortized" expenses if the tenant fails to exercise its renewal options?
  • Can the tenant be required to reimburse the landlord for any free rent received by the tenant at the commencement of the term if the tenant fails to exercise any of its renewal options?
  • Can the landlord include a lease provision designed to frustrate takeovers by expressly providing that the landlord shall not be required to recognize (i.e., provide a nondisturbance agreement for) any sublease entered into by the tenant (or its successor), whether or not in conjunction with a takeover deal? The unavailability of recognition agreements will likely hinder the subleasing activities of any competing landlord pursuant to a takeover of the tenant's lease. If a prospective subtenant fails to obtain such a recognition agreement, it exposes itself to the loss of its leasehold improvements in the premises if the lease is terminated since the sublease will also terminate.
  • Can the landlord consider granting renewal options to the tenant at less than fair market rental for the premises to induce the tenant to renew when the time comes? After payment of leasing commissions, leasehold improvements, lost rentals attributable to vacant space, and other transaction costs associated with signing a replacement tenant, a renewal at 85% or 90% of fair market rental might not seem so bad to the landlord.
  • Can the landlord extend the amount of notice the tenant must give to exercise renewal options (e.g., to at least a year), so that it will have more time in a weak market to locate a replacement tenant if the tenant doesn't renew?
  • Is it possible for the landlord to expand the abandonment and vacation clause in the lease to define specifically the time required to constitute a vacation of the premises by the tenant, to shorten that amount of time (e.g., to five days), to require the tenant to give the landlord prior written notice of vacations intended by the tenant, and to give the landlord the express right to injunctive relief in the event of a vacation?


End of Excerpt