Expert: Jim Avancena, CPM - 4/12/2010

Question
QUESTION: Hello,
I own an office condo in an office park mostly made up of physicians in Trenton, NJ. It's 1,000 SF and I'm trying to sell it ($140K) or lease it ($12 SF, or roughly $1,083/month), it’s a NNN lease (tenant would pay for taxes, condo fees and lease). The office layout is a bit of a problem, I have only 1 exam room and an interested chiropractor who wants to lease, would like to make renovations such that there would be 4 exam rooms. Even if this individual doesn't follow through, I'm afraid I may have to make renovations to the place so that I can make it more attractive to a future tenant. My initial thought is that we meet "halfway" and both the tenant and I pay half of the total cost of the renovations (so f.ex. if total cost is $20K, I am responsible for $10K and the tenant is also responsible for $10K). I mentioned that I don't have any cash for these improvements and that I could lower the lease for several months until my part of the renovation was paid for. He's concerned he doesn't have the money for this upfront cost either, so he's contacting a cousin who is a builder to give us an estimate of how much the improvements he wants to make would cost. If this tenant was not in the picture, I would probably try to build floor to ceiling partitions which would be quicker and less costly than a full renovation with a contractor, and also less “intrusive” so that none of the current walls be torn down. Once this potential tenant appeared, I decided to accept his floor plan as long as we go halfway in terms of financing the costs. Is halfway reasonable?? Usually the tenants make the improvements but I need to get rid of the property (either selling or leasing).
He says he's willing to buy the place (he doesn't own his current residence and he's been renting in his current place of practice), so I'm not sure if he'll eventually buy as he says and that is my first priority. He will not sign a lease where in the case I sell the place down the road to someone else, the new owner may have the possibility of throwing him out. So I'm pretty much stuck between a rock and a hard place if I enter into a lease for say 3 to 5 years, and I cannot sell to anybody who would not be able to break his lease.
Something creative I thought too was to allow some of his lease payments to go towards pay-down of the condo. My current mortgage is $900, the lease would be $1,083, and the average monthly principal pay-down for my mortgage for the next 2 years is approximately $250/month. So I think that a “credit” of $200 each month could be used towards payment for the purchase of the place; so in a year he would have roughly $2,400 credit so the sale price after that first year would be 2,400 less, $4,800 after 2 years, etc. Is there some other creative formula to attract and induce this individual to buy the place as opposed to lease for the long haul?
I am meeting this individual Sunday at 1:30 pm EST, hopefully you can answer by then.
Thank you very much in advance!

ANSWER: Alex:

WOW! Let me catch my breath after reading your text!

Maximum flexibility is what every owner, buyer, Lessor and Lessee would like to have in any transaction they are involved in.  Usually this is done through endless forms of written legal options and rights with many formal titles like "attornment & non-disturbance agreement" (this is one you might be able to make use of in your transaction), etc.  However, the arrangements made by the parties must be specific and binding, which usually means that decisions have to be made NOW, even though neither party knows exactly what they will want in the future.  Realistically, in addition to the financial terms, this is the reason that you cannot close an acceptable deal with every interested party that comes along.  

The recession has made property sales and leasing much more difficult on many levels, however, if you want to lease or sell your property, it will likely be difficult to execute a transaction where all parties get everything they want.  

I suggest that you may need to talk with an attorney in your area to review the terms of your transaction BEFORE it is executed.  Options can get very complex and lay persons often create rights and options that conflict.  You also need to discover if the Lease with Option to Purchase arrangement including a "credit" buy down feature of $200 per month you are considering is practical and legal in your area.  I bought a house many, many years ago using a Land Sale Contract that was structured like a lease with a similar sounding monthly credit arrangement toward purchase which today - many years later - would be illegal in this jurisdiction.

Good luck.

-Jim    



---------- FOLLOW-UP ----------

QUESTION: Thank you Jim! Your points are well taken.

I met the potential tenant today, he's very interested in leasing the property but we're waiting to get a quote on the costs of the improvements, and also we need to zero in on the terms of the agreement. Once we agree on those items, we can move to the next stage, which is contacting my attorney to put down the terms of the transaction.

Thank you for pointing out the "attornment & non-disturbance agreement" as well as the if the "credit" buy down of $200/mo is feasible to be included in the lease in my state of NJ; these are 2 issues I will bring to my attorney once we both agree we will go further.

Thanks again for your valuable feedback!

ANSWER: Alex-

Be sure to find an attorney that is experienced with Landlord and Tenant ("L&T") Law, or perhaps referred to as a commercial real estate lawyer.  Residential lawyers, divorce attorneys that you went to college with 5 years ago, etc. are not what you need - get a specialist.  Someone familiar with L&T law will need very little time ($$$) to determine and advise what you need to do, and that will save you money in the long run.

Good luck.  I am sorry I did not get back to you until just after your meeting time today.

-Jim

---------- FOLLOW-UP ----------

QUESTION: Hello Jim,

I was considering using my current "run of the mill" attorney, but definitely I think I'm better off using a specialist. Thanks for the advice.
Would you suggest establishing a fixed lease amount per year (adjusting every year by a certain percentage) or should I establish the lease based on a percentage of the gross of the business? This last point was raised by a friend who leased a space for a photo studio and he had to pay rent based on his gross for the previous month. In my case, I am dealing with a Chiropractor, not to get too greedy though, he says his business has been growing steadily 20%/year even in the recession.

Finally, this is my first shot at being a landlord, for a commercial property, what is the required deposit to allow the tenant to move in? He would be already spending money in improvements, so how reasonable is this?

Thanks again for your great advice!

Answer
Alex-

I beleive that your choice of terms for escalating the base rent annually will come down to your evaluation of the lessee and your own core style.

If you are conservative and prefer the sure thing, go with stepping up the base rent by a stipulated percentage each year on the anniversary date of the lease.  On the other hand, you may wish to go with researching real facts about your prospective tenant's business performance in the past combined with your own personal version of the "look him in the eye" measurement of a man.  If what you sense is good go with a percentage rent provision because you sense this chiropractor is somehow special and will have clients filling his waiting room the full term of the lease.  If he continues to realize 20% growth each year you will look like a genius with the right percentage rent terms.   

A chiropractor that I know was and is still extremely shilled and personable. He leased his first office locally and was so successful that he had to start turning away patients early in his career. I learned last year that he has nearly retired because of his continued success.   He would have been a great percentage rent lessee.

I suggest that you always hold at least a one month security deposit.  If your tenant is spending buckets of his own cash to build out his office that is the best arrangement you could have - but hold onto at least one month of rent.   Be sure that the lease requires your tenant to have any of his improvments approved by you before starting any remodeling work.   Then, don't approve any goofy artsy architectural plans your tenant may present unless you have an ironclad lease provision included that requires the tenant - at the termination of the lease - to return the premises to the same condition they were in when he started his initial construction - IF THE LANDLORD ELECTS SUCH REQUEST OF THE TENANT no later than thirty (30) days prior to the lease termination date.

A L&T attorney will advise you further regarding tenant improvements and also about select text you should have in the lease regarding LIEN WAIVERS, Fixtures, Subletting, etc., etc.

Regards,

-Jim