Commercial Real Estate

At some point in the life of a business the company will need to acquire a larger work area.  Many factors play into the equation as to when and where a company should relocate, and each aspect of the situation needs diligent attention.  It is important for the company to know what is expected, and often required, by the tenant to fulfill the lease agreement.    Every aspect of business life can be found or is affected by this legal document; items like hours of operation, proper signage, employee parking and even repair liabilities are all encompassed in the lease.  So often a business owner will get into a lease agreement without a full understanding as to what is being signed.  The implications of this decision, whether good or bad, can have a profound impact on the welfare of the company and likely to stick around for years into the future.  Proper research into the market and current real estate trends are as important to a small business owner as it is to a growing family, however, instead of looking at school districts the business owner may be more concerned with population density and how it relates to your target market.  Taking your business out of your home is a great milestone and can prove to be an exciting step for the company, but be aware of all of the intricate details that lay hidden in signed documents.  Know the document and be familiar with all every clause – just as the lease can provide restrictions on you and your business it can also serve to protect you when a dispute arises.

The Lease

From a bird’s eye view, leases in regard to their structure, are market driven; what is generally accepted in one city may or may not be customary in another.  This being said, it is important for a business to understand every aspect of a new lease.  Be aware of what your new landlord requires you to pay for.  For example, in an office building the landlord may expect you to help fund the maintenance of the common lobby.  This ideology stems from the fact that the common area will be used by everybody’s visitors and thereby the financial responsibility falls on you to help foster an impressive appearance.

Economics is the driving force behind this decision: Marginal Cost vs. Marginal Benefit.  If the decision comes to it, a small business owner needs to take into account what “extra” return will he obtain for how much “extra” cost.  When the extra cost is greater than the extra benefit, then optimization is reached.  Benefit, however, especially marginal benefit, may not always be easy to quantify.  How do you put a price on convenience, luxury, or any other amenity?  Many realtors often try to value these intangibles; however, they are usually subjected to market conditions and personal preferences.  One realtor may find a particular feature especially attractive and valuable whereas the next will not.

Be aware of all the ways a landlord my try to bill you for unforeseeable costs.  Most leases are structured in such a way that the tenant is responsible for all expenses except for the roof and exterior walls.  The best example of this can be seen in a CAM or common area maintenance.  This cost to upkeep lobbies, hallways, elevators, parking lots, and the like is usually apportioned to how much space each tenant takes up in the building.  It is not uncommon to ask to see the  expense budget and schedule for these costs.  Knowing what you are liable for prior to signing on the dotted line is the best way to eliminate any unexpected costs during the life of the lease.

Extra attention should be paid to the particular type of commercial real estate.  Retail in a busy district of town will fetch a different premium than a warehouse on the outskirts of town.  Landlords know that space in these busier areas is limited and therefore seize the opportunity to capitalize on this demand.  Usually this price is negotiated on a square-foot basis and paid annually.

It is generally advised that a small business should sign a lease with the shortest duration for added flexibility.  If business is not doing well then it has the option to relieve itself from rent sooner, or, by contrast, if the business is doing very well it has the ability to expand.  In either case the business has the capability to move laterally.  In this current market landlords are very willing to make concessions to lure renters into their space.  With that in mind, everything is negotiable and if you’re willing to sign a longer term the more willing the landlord should be to work with you.  Furthermore, realize just how much power you, the tenant, has.  Even if you are currently in a lease you still have bargaining power.  According to Andy Fried of Kennesaw State University “given the time and cost involved, most landlords will be reluctant to sue a tenant that is forced by circumstances to break a lease” and also, “it takes time to find somebody new, and when they find somebody, they’re going to want free money.”  Landlords are usually willing to work with you to ensure that you are able to stay in the space for a longer period of time.  The longer a space sits unoccupied the more money the landlord is paying from his own pocket.  These costs out of pocket only grow exponentially when legal fees are added to the mix.

Lease Type

Leasing agreements come in many different forms. The most basic lease is a flat/fixed lease. This type of lease includes one flat fee or rent payment once per period in a fixed amount of time. A lessee knows what they owe each month and when the lease will end, both of which are terms that are defined in the contract. A gross lease is a somewhat different than a flat lease. A gross lease still includes a flat monthly payment, but may also hold the tenant responsible for paying electrical, air conditioning, water, and other expenses. The landlord pays for all other operating costs and upkeep.  The lease can include an escalation clause that would allow the landlord to increase rent to offset increased costs in upkeep. An escalation clause can usually be utilized at the end of a year’s lease and can be an agreed upon amount or tied to an external indicator. A variant of the gross lease is a step lease. A step lease has increasing rates of rent built in to the lease at specific intervals of time. The increases are based on estimates rather than actual data. A net lease holds the lessee responsible for a base rent plus either a share or the entire balance of extra expenses. All increases in rent are based on actual cost increases rather than estimates. Rent can increase at any time and may also include the taxes incurred on the property. If tenants are sharing a building, they will be held accountable for their proportional share of the property. A triple net lease includes all these provisions with taxes and insurance included in the rent costs. The tenant is responsible for all operating, maintenance, and repair costs. A percentage lease is an alternative.  In a percentage lease the tenant pays a base amount plus a percentage of their gross income or simply a percentage of gross income each month with no base.

When signing a lease, there are quite a few terms that one needs to be familiar with. A build-to-suit agreement is when a landlord and a new tenant agree to a lease and the landlord assumes the obligation of outfitting the space to the tenant’s requirements. This type of lease may also be referred to as a build out. Early termination clauses allow for tenants to get out from some or all of their lease agreement before the lease runs out, with the prerequisite that certain requirements are met. An appraisal is accomplished by a government approved entity for tax purposes. Default is a failure to pay rent for a term or the breach of terms of a lease. Force Majeure are forces that cannot be controlled or resisted, such as weather damage and arsons or riots. HVAC refers to the heating, ventilation, and air conditioning systems of a building. Leasehold improvements are improvements to the property which are paid for by either the tenant or landlord. A letter of attornment is presented when the landlord sells the property and directs the lessee to pay their rent to a new owner. A letter of intent signals a prospective renter’s interest in renting or buying a property. Operating Expenses, which have been talked about in the previous paragraph, are the actual costs of operating a property.  Operating expenses include utilities, repairs, maintenance, property taxes, and insurance premiums. A tenant at will is a tenant who resides in a particular building and pays rent, but has no formal contract, or their contract has run out and tenant has not yet been evicted.  It is important for lessees and leasers to be familiar with the special terminology that is unique to lease agreements so that their requirements are met and their risks are minimized.

Lease Convention in Texas

Texas has on its books certain laws regarding commercial leases to insure that every party in the lease has protection within the lease structure.  There are two types of leases in Texas.  A periodic tenancy is one where the tenant commits to a space on a month-by-month basis.  The arrangement lasts continuously until either the tenant or landlord has given notice of termination.  Periodic tenancies are common for things like calendar shops, Halloween stores, or other seasonal industries.  Opposite to periodic leases are the term leases.  Under a term lease a tenant will stay in a space for a longer period of time. While stability is an advantage, the tradeoff is responsibility.  Because the landlord cannot ask you to leave in such a short notice, you will usually be obliged to other financial responsibilities in the property’s upkeep.

Security deposits are another item listed in Texas law.  Under both lease durations the landlord may ask for an increase in deposit; however, to be fair to the tenet the landlord is required to give advanced notice.  A periodic lease requires one rental period plus one day.  A term lease requires that no changes be made to the deposit until it is time to renew the lease.  In both cases, the landlord has 30 days to return the deposit minus the cost of any repairs that were beyond normal wear and tear.  All construction expenses must be itemized and given to the former tenant.

The majority of statutes in Texas deal primarily with restricting landlords and their actions.  This is to insure the safety and well-being of the general public.  Through things like zoning and building codes all levels of government has the opportunity to regulate a landlord’s actions so long as they are justified by promoting public prosperity and safety.

Signs and Parking

A sign is likely to be the most important element of business’ corporate identity.  There is a wide range of signage materials, which can include: plastic, neon, metal, and wood, among others.  Depending on location and permits, sign placement can make a impact on style and visibility.  A sign can be free standing, on a wall, projecting over the door or on a roof.  Sign permits are required by most municipalities as they provide legal permission to display a sign and can be obtained from the Planning and Developing services department in city hall.  Before manufacturing can begin, it is a good idea to check local zoning laws.  “Many cities and suburbs have sign ordinances that restrict the size, location and sometimes the lighting and type of sign used” (Signage 1). Based on the developer of the business’ location, additional regulations beyond the local laws may restrict certain types of signage.  “To avoid costly mistakes, be sure to check regulations and secure the written approval of your landlord before you invest in a sign” (Signage 1).  A large majority of entrepreneurs will need professional assistance regarding signage because they typically do not have experience in this area.  The cost of a sign varies greatly depending on the materials and type of sign.  Buying directly from a fabricator can cost as little as $500, but one runs the risk of not meeting zoning requirements.  If one hires a designer, they will pay a design fee in addition to fabrication costs, but one will have a better guarantee that the finished product will work (Signage 1).

Specifically in Bryan/College Station, if an identification sign is requested, a minimum of two hundred fifty landscaping points must be allotted per sign. The sign may not exceed one hundred fifty square feet per sign face as measured by an imaginary rectangle of vertical and horizontal lines that contain all extremities of the copy and logo. The sign height cannot exceed fifteen feet (Building 3-28).  These regulations are put into place to ensure that the city will have some sort of continuity throughout.  Without these regulations the business owners will have free reign over city aesthetics.

A parking lot is any area covered by asphalt, concrete or other material designed and suitable for the purpose of parking vehicles as approved by the Project Review Committee or Planning and Zoning Commission.  Written in the landlord/tenant lease agreement, the landlord may have the right to leave designated parking spaces unreserved (first-come, first-served basis) or reserved.  However, regardless of the lease agreement the parking lot must also comply with Americans with Disabilities Act of 1990.  One of the stipulations associated with this act is that a certain amount of handicap parking per parking spaces.

In Bryan/ College Station, a description and diagram of the location including parking availability, street access, location and amount of spaces to be utilized and signs to be displayed are required.  Upon accepted application, the business owner will receive a permit regarding the above parking considerations.

Certificates and Permits

It is important to note that a Certificate of Occupancy must be obtained before a commercial space can be legally occupied.  Prior to receiving a certificate, which is issued by the city, the commercial space will be subjected to several inspections given by their respective city departments.  Issuance of a Certificate of Occupancy is dependent on the successful completion of these inspections.  In fact, commercial structures in College Station must be inspected by the building construction, planning, engineering, fire, electrical, sanitation, environmental services, and drainage departments before the structure can be awarded a Certificate of Occupancy.

Included within the government of the city of College Station are several city departments, each with a specialized set of regulations that commercial buildings must meet before they can be approved.   For example, before the building construction department will approve a commercial building all fees owed to the city must be paid and all relevant building violations must be solved.  The site must be ”clean and free of construction debris”, all signs must be permitted by Planning and Development Services, dumpster screening must be installed, and all parking spaces must be striped, along with a multitude of other regulations.  The environmental services department specifies that grease traps must be a minimum of 1,000 gallons.  They also require backflow preventers to be tested and the test report must be received by the department.   Sanitation requires dumpsters to meet certain inside dimension standards.  Gates must be installed with locking mechanisms and must be able to open 180 degrees.   The fire department has a particularly long list of requirements, for obvious reasons.  Fire lanes must be marked in accordance with city ordinances and fire hydrants must face those fire lanes.   The city drainage department requests that temporary erosion devices be removed from commercial sites and that sewer inlets be free of construction debris and silt.  Finally, the electrical department asks that all easements be dedicated and that relocations fees be paid.  These are just a small sampling of the requirements required by the many city departments.  More information concerning inspections can be gleaned by contacting the respective city departments and by using the “building codes” section for the city’s website.

College Station requires that a building permit be acquired before most construction projects can begin.  New buildings, remodeling, and renovation projects all require building permits.  The document acts as a legal authorization for a project to begin and helps to ensure that a building is constructed safely.  Before a project can begin, an application for a building permit must be filed with the city’s building division.  Contractors are required to pay a fee and to register with the city.  Subcontractors, who are paid to complete a part of the construction project, are also required to pay a fee and register with the city.  Additionally, subcontractors must obtain specialized building permits for their work.  For example, plumbing projects such as the repair of a plumbing system, require a plumbing permit.

Local to College Station

In our quest to find information pertaining to commercial real estate within College Station we decided to contact a local real estate brokerage firm.   We initially contacted the Oldham Goodwin Group LLC, which is a local brokerage, development, and management firm.  Mr. Travis Ward is an associate of the Goodwin Company who specializes in office and industrial properties.  Luckily for us, he agreed to conduct an over-the-phone informational interview.

Mr. Ward began the interview by giving a broad overview of the real estate environment of Bryan/College Station.  Initially, he mentioned some of the chief concerns for new lessees in College Station.   According to Mr. Ward, zoning laws in C.S. are especially strict, with the Northgate area being the most highly regulated.  College Station’s strict signage regulations are also a concern to commercial lessees.   Apparently, the city only allows businesses to select from a collection of 270 tones and only three of those tones may be used on one sign.  Mr. Ward mentioned that rumors of a Hooters Restaurant being banned by the city for refusing to paint their building maroon instead of orange are in fact false.  There is no specific ban on burnt orange being used on signage within College Station.

The first thing that Mr. Ward examines when he is reviewing lease terms are the parking provisions.  The city regulates the types and number of parking spots for different categories of businesses.   For example, restaurants are considered “high intensity use” and are therefore required to have more parking spots per square foot of space.   The term “high intensity use” is used to identify businesses that host higher than average numbers of people per square foot of area.   A typical retail store would not be considered “high intensity use” and would therefore be required to have fewer parking spaces per foot of space.

Recently, the price per square foot of rental commercial properties in College Station has dropped significantly.   Mr. Ward believes this shift can largely be attributed to the large inventory of vacant office space currently on the market.  He believes this large supply of unused space can be explained by business owners being unsure about future profits and therefore being apprehensive about investing in the higher priced leases that accompany higher quality commercial space.  Currently, class A real estate in College Station rents for about $18 per square foot per year.  This figure is a gross rate which includes all bills.  He estimates that the total range in College Station is about $12-$20 per square foot.  On average, Bryan property rents for slightly less than College Station, owing to College Station’s newer properties and better visibility.  He also mentioned that both cities have significantly lower prices than Houston or Dallas.

Mr. Ward went on to explain in detail the types of leases that he commonly works with.   Gross leases, which require the landlord to cover all expenses, are tilted in the tenant’s favor because the landlord is responsible for growing expenses.  Triple net leases, which hold the tenant responsible for expenses such as utilities in addition to rent, are usually used for the renting of retail space.  These leases are in the landlord’s favor because they leave the risk of rising expenses in the tenant’s hands.   Some of Mr. Ward’s clients insert an escalation clause within a triple net lease that requires the landlord to cover some of the rising expenses if they grow over a certain percentage.   Mr. Ward also referred to a “base year expense stop” in which a base year is selected and that year’s taxes are defined as the amount that a landlord might be responsible for covering in future months.  The tenant is responsible for any increase over the base year’s tax amount.  Mr. Ward mentioned that build to suit leases are much less common than other types of leases.  In his experience, these leases tend to be more expensive, with the tenant being required to agree to a longer lease term, typically ten years or longer.

When considering a new leasing space, a tenant should take into consideration whether the landlord has a provision for a tenant improvement allowance.  These allowances are usually given for first generations spaces (never before used) and tend to run around $25 per square foot.  The purpose of the allowance is to help the tenant develop the property so that they can successfully operate their business.   Second generation space usually has a much lower tenant improvement allowance.   It should be noted that before any serious improvements are made to the inside of the building the lessee must obtain a building permit.  Additionally, if improvements are made to the extent of adding new covered space, a site plan review must be completed, during which the lessee must present their construction plans to the city.  Mr. Ward mentioned that that this is a time consuming process and should be avoided if at all possible.

Our over the phone informational interview with Mr. Ward was very enlightening.  We were able to glean some very useful information relating to the specific rules and regulations that govern commercial real estate in College Station.  He also gave us a good picture of the status of the real estate market within the city.

Bibliography

“HOW TO: GET A GOOD DEAL ON A LEASE.” Inc 31.4 (2009): 57-60. Academic Search Complete. EBSCO. Web. 4 Oct. 2010

Rackow, J.. (2008, May). A Form Shopping Center Lease. The Practical Real Estate Lawyer, 24(3), 19-47.  Retrieved October 5, 2010, from Accounting & Tax Periodicals. (Document ID: 1480250051)

“Texas Commercial Real Estate Law .” WebLocator. Weblocator L.L.C., 2008. Web. 5 Oct. 2010. <http://www.weblocator.com/attorney/tx/law/b18.html#txb182100>.

“Building Regulations.” 6 Oct 2010. <http://code.cstx.gov/ElectronicFile.aspx?docid =456081&dbid=1>.

“Business Regulations.” 6 Oct 2010. <http://code.cstx.gov/ElectronicFile.aspx?docid =466057&dbid=1>.

“Signage  and Sign Permits.” Entrepreneur. 6 Oct 2010.  <http://www.entrepreneur. com/encyclopedia/term/82632.html>.

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