In the Spotlight: Be on the Lookout for More 'Icebergs'

The landlord was unaware that a right of first refusal to purchase part of a shopping center is interpreted in five different ways across the United States. In the landlord's home state, the landlord was prohibited from selling the shopping center itself without first offering to sell the pad site to the tenant ' even if the pad site was an integral part of the shopping center. A court entered a judgment nullifying the landlord's contract to sell the shopping center and required the landlord to sell the pad site to the tenant. In many cases, this first refusal legal interpretation could severely limit a landlord's ability to sell a shopping center and, consequently, would reduce the overall value of the property.

Fast-Food Fight?

Giving a tenant a blanket right to use the common areas of the property can prove costly. In one case, a landlord gave a small restaurant in his strip center the right to use all common areas, reserving the right for him to relocate the common areas. When the landlord started construction of a competing fast-food store on the parking lot, the existing restaurant sued to stop the construction and won.

The landlord defended on the grounds that he was using only 36 of the 100 parking spaces. He procured additional parking spaces at an adjacent property for the use of all tenants, saying he was merely relocating the parking. Yet, the court prohibited the landlord from building the new store on the grounds that the restaurant's lease gave the tenant an easement over the entire parking lot. The judge ruled that the landlord had a right to relocate, but not diminish, the parking at the shopping center. Because of the restaurant's common area use clause, the landlord could not build any additional stores in the common areas.

Other tenant rights that can present significant problems include exclusive use, expansion and renewal rights. In still other cases, a landlord may fail to include an “essential lease” provision.

Costly Oversight

The value of every commercial property is heavily dependent on the ability of a prospective purchaser to finance the purchase of the property. Generally, lenders appraise the stream of income from the tenants and the value of the property as collateral in the event of a foreclosure. However, if a landlord does not include certain key provisions in each lease, the lender's appraisal of the property will plummet. For example, virtually every lender will require the right to the first claim for payments due from the owner.

Without a subordination clause, existing tenants get the first claim against a property and all future lenders' loans would only be repaid after the tenants' claims were satisfied. Consequently, without the subordination and other lender-related provisions, a prospective purchaser's ability to obtain favorable loan terms may be significantly diminished. If it is more difficult to use property as collateral for a loan, the number of potential purchasers and the sales price may also be dramatically reduced.

Know the Law for Smooth Sailing

Any of these problems can reduce the value of property by 10% to 20% or more ' and even prevent the sale of property altogether. While most landlords consider the everyday problems, they should not let these real estate icebergs sink the value of their property.

Know the law. Know what to avoid. Know what you need to include in your leases ' and you will sail right past those icebergs.

Landlords frequently run into unexpected problems ' which I call “icebergs” ' with their tenants, some of which were discussed in last month's Spotlight, ie, hazmat remediation. Here are a few more icebergs to watch out for.

Right of First Refusal

A less obvious, but potentially more damaging real estate iceberg is the grant of special rights to tenants. In one case, a tenant of a pad site requested, and the shopping center owner provided, a right of first refusal to purchase the tenant's pad site if the pad site was ever offered for sale. When the landlord entered into a contract to sell the entire shopping center, the tenant sued for the opportunity to buy its pad site.

The landlord was unaware that a right of first refusal to purchase part of a shopping center is interpreted in five different ways across the United States. In the landlord's home state, the landlord was prohibited from selling the shopping center itself without first offering to sell the pad site to the tenant ' even if the pad site was an integral part of the shopping center. A court entered a judgment nullifying the landlord's contract to sell the shopping center and required the landlord to sell the pad site to the tenant. In many cases, this first refusal legal interpretation could severely limit a landlord's ability to sell a shopping center and, consequently, would reduce the overall value of the property.

Fast-Food Fight?

Giving a tenant a blanket right to use the common areas of the property can prove costly. In one case, a landlord gave a small restaurant in his strip center the right to use all common areas, reserving the right for him to relocate the common areas. When the landlord started construction of a competing fast-food store on the parking lot, the existing restaurant sued to stop the construction and won.

The landlord defended on the grounds that he was using only 36 of the 100 parking spaces. He procured additional parking spaces at an adjacent property for the use of all tenants, saying he was merely relocating the parking. Yet, the court prohibited the landlord from building the new store on the grounds that the restaurant's lease gave the tenant an easement over the entire parking lot. The judge ruled that the landlord had a right to relocate, but not diminish, the parking at the shopping center. Because of the restaurant's common area use clause, the landlord could not build any additional stores in the common areas.

Other tenant rights that can present significant problems include exclusive use, expansion and renewal rights. In still other cases, a landlord may fail to include an “essential lease” provision.

Costly Oversight

The value of every commercial property is heavily dependent on the ability of a prospective purchaser to finance the purchase of the property. Generally, lenders appraise the stream of income from the tenants and the value of the property as collateral in the event of a foreclosure. However, if a landlord does not include certain key provisions in each lease, the lender's appraisal of the property will plummet. For example, virtually every lender will require the right to the first claim for payments due from the owner.

Without a subordination clause, existing tenants get the first claim against a property and all future lenders' loans would only be repaid after the tenants' claims were satisfied. Consequently, without the subordination and other lender-related provisions, a prospective purchaser's ability to obtain favorable loan terms may be significantly diminished. If it is more difficult to use property as collateral for a loan, the number of potential purchasers and the sales price may also be dramatically reduced.

Know the Law for Smooth Sailing

Any of these problems can reduce the value of property by 10% to 20% or more ' and even prevent the sale of property altogether. While most landlords consider the everyday problems, they should not let these real estate icebergs sink the value of their property.

Know the law. Know what to avoid. Know what you need to include in your leases ' and you will sail right past those icebergs.