April 2015

Lease Interpretation Drafting the Lease

Leases come in many different forms and varieties in the commercial real estate business.  The gold standard form is the AIR Commercial Real Estate Association, a non-profit association of industrial and office real estate brokers and professionals.  They have been producing commercial real estate forms for at least 45 years.   Also, there are leases which are custom made to a particular building or business park created by the owner’s lawyers.

Whether a company uses an AIR lease or a custom made lease, the lease interpretation is the basis for the transaction.  Most real estate lawyers have great familiarity with the AIR Lease and many of its addendums. AIR has crafted many forms that will fit all areas of commercial real estate: industrial, office and retail.  These forms leave little room for interpretation. I might add that these leases are reviewed each year by outside counsel and a group of AIR commercial brokers in order to keep up with changing laws and practices.

In the event that a custom lease is utilized, the issue is interpretation and if the contract is up to date. Custom leases usually require substantial modifications in order to protect both parties, and they usually take longer to negotiate.  Recently, I represented a trucking company who leased a property owned by an insurance company. The insurance company had their own custom lease and it was a nightmare for the prospective tenant from the point of negotiations. The lease was so cumbersome that the tenant took on the task of personally reviewing it and handed me 10 pages of corrections. My first reaction was that he should stay in the trucking business and stay away from the practice of law. I strongly recommended he employ a top real estate lawyer.  The lawyer produced far more pages of proposed modifications. The end result is that the lease was consummated, but the legal fees for both sides were outrageous. However, using an attorney may have saved them much more money down the road if the lease was misinterpreted.

A major issue is when the lease does not address every aspect of the transaction. Therefore, a lease addendum must be produced. AIR has manufactured several different addendums which eliminate the need for drafting of "most" addendums.  Lawyers play a strategic role in creating additional addendums which are specific for the type of "use" intended for the space. It is the power of a good addendum which drives and clarifies the boiler plate of the lease form.

My experience as a commercial real estate broker in Los Angeles has been a good real estate lawyer is the key to avoiding disputes in lease interpretation. The lawyer should know most aspects of the way his or her client does business; as a result, the lawyer will produce the contract that will suit his or her client's needs.

DUE DILLIGENCE WHEN, WHERE AND HOW

The act of "due diligence" is simply an investigation of the property that is to be purchased or leased by the buyer or tenant prior to the signing of a binding contract. The following categories of when, where and how should provide you guides for successful due diligence.

When

The best answer for this is simply as soon as possible. The only thing you need is access to the property and perhaps insurance. Upon execution of a contract you should start the process and not wait for anything. Time is going against you and information is king! The costs at the beginning should be minimal but if not carefully performed, the costs can be gigantic!

Where

A simple question but perhaps not one you can answer readily. It should be obvious if you are purchasing an improved property then the roof, HVAC, soil, structural and paving should be inspected.

First visit the Planning/Zoning Department at City Hall and make sure the use that you intend to use the property for has the proper zoning. If your use requires a conditional use permit then you will require more contingency time in the escrow process to achieve this approval. The next step at City Hall is a visit to the Building Department and request at the counter the permit package that is associated with the construction of the building.  Make copies of all permits and "keep them". Also ask at the building department if they require a pre-sale inspection of the property which may be eye opening.

How

My personal recommendation is to employ separate contractors for each category that you intend to inspect. Therefore, you should call your favorite plumber, electrician, roofer etc.  If you do not know qualified contractors, the best place to usually find them is through your local real estate broker.

If you intend to improve or add to the property, then the employment of an architect or structural engineer can be critical in your decision making process.

Disclosure

You may be purchasing the property "as is, where is" but that does not alleviate the seller's need to disclose any inherent issues concerning the property. If the seller has not presented you with a "Mandatory Disclosure" document, then request it. If you and the seller are represented by the same broker, then demand that the broker investigate any possible issues that may be inherent with the property (it is their duty to disclose). If you do not share the same broker, then instruct your broker to request from the seller's broker to investigate any issues that may surround the property.

All of the items mentioned above can apply to the sale of the property or a long term lease. All of this information should be critical whether you are a tenant or a prospective buyer.

The last item to mention is to make sure that you take photos or even better a video of all of the property and its improvements. Place all of those materials in a safe place for possible protection in the future.

 

Water Rationing The Real Cost to Commercial Real Estate

California commercial and industrial offices have been able to conserve water mostly without severe consequences since 2009 during the drought; however, mandatory water conservation has now been ordered by Governor Brown.  It does not seem that anyone is immune from this critical shortage of water; as a result, costs for many commodities will be going up in California.

Governor Brown has drafted mandatory water conservation for all residents and businesses in California on April 1, 2015 to be voted on in early May.  The Urban water suppliers such as the Los Angeles Department of Water and Power (DWP) and other water supply companies in California will be mandated to reduce water consumption by 25% compared to water use in 2013.

This means the water suppliers must now report monthly to the State Water Board the use of residential and commercial sector water starting in June 2015 through February 2016.  The water usage will be compared to the same time period in 2013.  The State water board will assess suppliers’ compliance for both monthly and cumulative water usage reductions.

In the case the water usage has remained the same or increased, the water distribution company will receive a letter ordering them to stop non-compliant activity.  After that if they don’t reduce water consumption to their customers, the distributor will be given fines of up to $10,000 per day by the State Water Board.

Beginning June 1, 2009 the water suppliers were asked to support a voluntary 20% reduction in water use.  The DWP implemented a mandatory water conservation program to their customers to reduce water consumption by 15%.  Residential commercial and industrial businesses that do not reduce their water use pay more for their water and receive higher water bills.  Those who do reduce their water consumption by 15% receive lower water bills.

In addition, the DWP implemented Commercial rebate programs such as replacing toilets, landscapes and irrigation nozzles and sensors to reduce water usage for their commercial and industrial customers, and a similar program for residential customers. 

A good portion of my career has been dedicated to the industrial side of commercial real estate. Therefore, I am dealing with companies that actually produce a product or a service industry that needs water. If the price of water goes up without reducing other expenses than the price of the service or product must increase. Obviously, this is a fairly simple concept.

Azteca Dye and Laundry based in Downtown Los Angeles is a clothing dye house and wash house for jeans that create stone wash, grinding, distress, tints, pigment, echo dye and other washing and dying techniques for clothing designers.

They are having a difficult time reducing water use mandated by the DWP since water is a big part of their service.  As a result, they have been hit with surcharges by the DWP in the past.  They have not passed the added expense to their customers yet; however, they are not sure what’s going to happen with the new mandatory conservation being implemented by the State, according to Karina Rueda, the Office Manager.  They are waiting to hear from DWP first.

Now how can a company survive with increasing costs and less demand for their products or services? Companies may try to reduce their operating costs such as reducing their rent or the size of their facilities. Azteca has two facilities one in Downtown and another in Compton.  Since rents are not easy to reduce because tenants may be locked into long term leases.  Subleasing or default on their leases may be unpleasant options for companies.  These potential increases in the cost of water may impact commercial real estate negatively and cause prices to decrease.

The scenarios mentioned above are realistic and may have dramatic effects on the value of commercial real estate in California. During the recession, commercial real estate was reduced in value by 20-30% in the Los Angeles basin.  Just when the economy in California is starting to expand again after the recession, we are faced with circumstances that may drag down the real estate market.

The City of Los Angeles was once the motion picture capital of the world until municipalities withdrew incentives to this industry and raised City and State taxes. The film industry dealt with this issue by moving out of the State and in some circumstances out of the country.

“When I was in litigation and in need of an expert on commercial property management, my co-counsel immediately recommended Lee Segal. He was extremely knowledgeable, responsive and proactive when it came to identifying and gaining valuable perspective on key issues. His credibility as an expert was instrumental in my case; I would not hesitate to work with him again in the future.”    
Lisa Pan, Biernat Law Group