Of Fitness Clubs and Landlords

I joined a gym the other day; actually, I rejoined the gym.  I really intend to use it this time.  Apparently, to lose weight and get in shape you need to go to the gym and not just join it.  Who knew?  Anyway, the whole process of signing a contract with the gym ticked me off.  I cut a deal with the manager to pay a zero initiation fee, get the first 6 weeks free and then have a very favorable fixed monthly payment for the year. I was assured that there were no other costs.  When I went to sign my contract the next day, there was a $45 “processing fee” and a $39 annual “rate lock” fee.  These had never been disclosed to me.  Apparently, it costs $45 to take my contract and put it in the filing cabinet.  As to the rate lock fee, they wanted me to pay $3 more per month than we agreed to so that they don’t screw me again next year by charging me more than we agreed to up front.  I refused to pay either fee because it wasn’t the deal upon which we agreed.  This game of hidden charges and profit centers happens all the time in commercial leasing and tenants end up overpaying.

Below are some of the biggest hidden profit centers and sources of deal erosion in leases:

  1. Landlord supervisory fees.  Typically, a tenant will negotiate for an improvement allowance to build out new space or renovate existing space.  The negotiations can be tough and every dollar counts.  Unfortunately, when a tenant finally negotiates for a $40/sf allowance, it may really only be a $38/sf allowance.  Landlords typically require that tenants pay them a 5% “supervisory fee” in connection with any alterations to the premises even if the Landlord is not doing the work.  They claim that they need to be reimbursed for reviewing plans and “coordinating activities in the building.”  The problem is that (1) the amount of work, if any, required of the landlord is rarely related to the cost of the work, (2) the landlord is not incurring any additional costs because the building engineer is already a salaried employee of the landlord and his salary may already be partially passed through to tenants as part of Common Area Charges and (3) supervising work in its building is part of the landlord’s responsibilities in owning a building.  Tenants shouldn’t pay it.
  2. Mark-ups on utilities. Many landlords who collect utility costs from tenants will impose a servicing fee or markup on the utility company’s cost.  In NYC, it’s not uncommon for landlords to say they charge between 105% and 110% of utility costs to the tenant.  It’s a profit center for the landlord over and above the rent that was agreed to.  The rent and management fee should represent the landlord’s sole source of fees and profits;  they should not be making money on pass throughs.
  3. Real Estate Taxes. Many jurisdictions offer property owners discounts of 2-3% on tax bills if payment is made early.  Landlords typically collect monthly installments of the taxes from tenants so they have the money in hand when the taxes are due and can take advantage of these discounts. The problem is, some landlords include the full tax in the annual CAM statements even though they benefited from the discount. Tenants should insist on early payment by the landlord and receive the benefits of this discount.
  4. CAM Charges. Most landlords effectively have the ability to overcharge for operating expenses and taxes without repercussions. Furthermore, they severely limit the tenant’s ability to find out about these overcharges because they severely limit who the tenant can engage to review and challenge these annual expenses.  Typically, a landlord will tell a tenant that (1) they are only entitled to a refund if the overstatement of expenses exceeds 3% or more of what was actually due, (2) the tenant must challenge the statement within 30 to 90 days or it forever waives that right, (3) the tenant must engage an expensive CPA who charges him an hourly rate or fixed fee to review the statement and (4) the landlord is not responsible for reimbursing the tenant for the cost of the audit unless it overcharged the tenant by 5% or more. In sum, unless the tenant is overcharged by a lot, it’s not worth challenging the bill.  That makes no sense.
  5. Growing Buildings.  In my 30 years in real estate, I’ve seen several buildings magically grow without the benefit of new construction, but have never seen one shrink.  I’m no biologist, but I know buildings don’t grow by themselves.  When rents are flat or falling, one way to grow cash flow is to miraculously determine that your building is now 103,500sf instead of 99,700sf.  This can happen via an inflated add-on factor (the factor which is applied to the usable square footage of a building to derive the “rentable square footage” upon which the rent is based) or a “re-measurement” of the building.  Don’t accept these changes unless the rent now, and forever in the future, is adjusted down proportionately to reflect the change.  Make sure your architect validates all measurements.
  6. Rent Escalators. Typically, in a gross rent deal, the tenant will pay for any increases in operating expenses and taxes after the first year. Thus, if it agrees to a $25/sf gross rent, $7 of which is for operating expenses in the first year and $3 of which is for taxes, and in year two operating expenses are $7.30 and taxes are $3.15, it will pay $.45 more in year two ($7.30-$7 plus $3.15-$3)in addition to any escalations in the quoted base rent.  The problem arises when the base rent is also subject to a percentage escalator. For example, in the above hypothetical, if the gross rent is subject to 2% annual increases (i.e., $.50 in the second year- .02 x $25/sf), the tenant is, in effect, paying double escalations on the operating expenses and taxes component of the gross rent.  That’s double dipping and should be addressed.
  7. Late charges. Many landlords attempt to impose late charges on rent payments.  The justification is that there are administrative costs of chasing down the rent.  That may be fine if the fee is a fixed dollar amount that is reflective of the value of the administrator’s time to send off a letter or make a phone call.  However, when the rent is $50,000/month and the late fee is 5% of rent, that’s a profit center.  I would gladly make follow up phone calls and send out late rent notices for $2,500 a pop.  That’s just a penalty, especially when it’s on top of late interest payments.
  8. Administrative fees for Tenant requests.  Often, the landlord will require a healthy fee to process requests for sublet and assignment approvals or review of plans. The landlord’s time is very valuable and it seems that the rent and management fees don’t cover these normal owner tasks.  It’s interesting that the same leases typically require the tenant to deliver estoppel certificates and attornment agreements to the landlord, its lender and prospective purchasers whenever the landlord requests them.  Apparently, the tenant’s time is not as valuable as the landlord’s because I’ve never seen a landlord agree to reimburse the tenant for these tasks.

Landlords are not bad people, and neither are health club operators, they are simply in the business of growing revenues in a world where competition is keen.  When rents (or monthly membership rates) are stagnant or declining, creative business people need to find ways to create new profit centers.  With respect to many of the above hidden profit centers in leases, the justification often given by landlords is that “we’ve always done that” or “all of our leases have that.”  That’s not a good enough answer or justification and there’s always a first time for everything when something isn’t fair or right or when a tenant has other options and, therefore, leverage.  Think outside the box and protect your economic deal.  Think of it this way, if you stop your landlord from getting fat, he’ll save money on gym dues.

For more information contact Glenn Blumenfeld http://www.tactix.com/team.php#Glenn

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