Sofia: I am sitting here with TD&A’s broker and one of the principals, Art Putzel. Art is a licensed broker in six jurisdictions: DC Delaware, Maryland, Pennsylvania, Virginia, and West Virginia. A CPA, and a former Deputy Director for Economic Development in Baltimore County. Art’s Education includes a BS in economics and a BS in Urban Studies from MIT, and an MS in urban planning from Johns Hopkins University. And today we have the opportunity for Art to speak about mistakes tenants make when signing a lease. Welcome.
Art: Thank you. First of all, I’ll say that all those qualifications enabled me to take a lot of continuing education every two years. That is one of the privileges of that. Thank you.
Sofia: To start, what is the most common trap use or trap you see tenants fall into with leases?
Art: Okay. So let’s talk about leases versus sales or purchasing. I always say that the difference between leasing something and buying something is the difference between having breakfast with somebody and marrying them. I mean, you could have breakfast with Genghis Khan and probably have a very interesting breakfast because he was a very interesting guy. You might not want to marry him. If you buy a property, you have a relationship for a couple of months, you buy the property and you’re done. If you lease, you could have a relationship for five years, 10 years, 20 years, 30 years down the road and that lease becomes a marriage contract.
I think you said, you know, what are the most common pitfalls? Generally it’s not understanding, truly understanding what it is. You’re signing examples are, what really are you leasing? If you’re leasing a 2000 square foot, let’s say a 2000 square foot freestanding building, meaning it’s not part of a shopping center, you know, are you leasing the inside of the building? Are you leasing the inside and outside of the building? Are you leasing everything inside the sidewalk? Are you leasing the entire parking lot and the building? You know, because the definition of premises in the lease defines what your responsibilities are. You know, if you’re responsible for all the repairs to the premises, if it’s everything inside the walls, it’s one thing, if it includes the parking lot and the dumpster and everything else, it’s another thing entirely.
Another pitfall is, in a lease where you are responsible for costs other than the basic rent. What are those costs? You know, how are they defined? How carefully are they defined? How well do you understand what you’re paying for? That’s a start.
Sofia: So when you see these common pitfalls, and you try and advise your clients the best way possible, are they responsive in terms of, you know, accepting your feedback?
Art: Generally. And really, it depends on the client. We represent a fairly significant range of clients and you would probably say that Starbucks, Party City are perfectly capable of reviewing lease terms on their own. They’re big boys. They understand.
On the other hand, If you Sofia, were leasing your first store because you’ve always wanted to sell knick knacks. you’re probably not that familiar with reading a 60 page lease and understanding what’s in it and you have to find someone you trust and hopefully your broker, your agent is somebody that you trust.
Sofia: So, in talking about these common pitfalls, you find, are there any laws or regulations that protect clients per se?
Art: So, of course, there are laws, there are things that you could put in a lease that are actually contrary to public policy and therefore not enforceable. But in general, I would say that the difference between commercial real estate, leasing and sales and residential sales primarily.
There is another thing I say a lot, at the risk of offending people, the presumption under the law is that in commercial real estate transactions, both parties are sophisticated business people represented by competent counsel. The presumption of a residential real estate transaction is that everybody is a neophyte deserving protection from themselves.
So are there laws that protect tenants from the kind of pitfalls we’re talking about? No, there aren’t. It’s really a matter of negotiation and the time to negotiate before you sign the lease.
Sofia: That’s very interesting and kind of brings me to my next point because, you know, from my knowledge and just overseeing so much of the work other agents do, I always see and hear the word LOI. But LOI, you know, means letter of intent – that doesn’t necessarily protect the client who happens to be the tenant, correct?
Art: An LOI doesn’t protect either party. The idea of an LOI, which is not common in the residential real estate industry, is a letter of intent. It’s something that is negotiated between the principals or between the principals and their agents, which lays out the basic business terms and depending on the nature of the parties and the transactions, a letter of intent could be one page long or, you know, 10 pages long and in tremendous detail.
The letter of intent is just what it sounds like. It’s a letter of intent. Usually, there’s a paragraph at the end that says no matter what it says above, this is not binding. The purpose of a letter of intent is to get the parties to agree on the business terms before everybody starts spending money on attorneys to draw up a lease.
Because I’ve said this even before I got into the real estate industry that if two parties agree on the concept involved, you can generally find the words to put that on paper. If you don’t agree on the concepts involved, you can spend, you know, six iterations trying to come up with the words and you’ll never get there because there’s no agreement. So the letter intent is an attempt to get the basic concepts on paper.
So then you hand it to an attorney and say, draw me a lease and hopefully when somebody reads a lease, they don’t go… my G-d, that’s not what I intended.
Sofia: Thank you for clarifying. We just talked about, you know, the common pitfalls you tend to find in clients. But what are the top ways tenants can avoid falling into, you know, these lease pitfalls, right?
Art: Obviously, it’s in our enlightened self-interest to say, “hire an agent that knows what he’s doing to represent you.” Some attorneys that are familiar with commercial real estate are very good and can do a lot to protect you, but you really need somebody that knows what they’re doing. For some of these things, I lean on real estate attorneys all the time, but some of these things, they don’t have experience with. You know, most of them don’t have experience with administering common maintenance clauses and leases. They’ve written them but they’ve never actually administered them. And I’m sort of a hybrid. I spent part of my time being a broker and part of my time being in our management company administering leases. So I’ve seen things where the attorneys have negotiated something and then it’s left up to the clerks to actually implement it.
We spent a lot of money in the development we did, where Target had owned a parcel that we had sold them, but there was a reciprocal easement agreement among us and we spent a lot of attorneys’ money negotiating that agreement. And several years later, I was talking to somebody – we were trying to determine whether or not a certain expenditure was permissible under the agreement, – and she said to me something equivalent to, “We have 775 stores. We don’t do it differently for you.” And I said to her “Well, if somebody had said that during our negotiations, we could have saved a lot of money on attorneys.”
Sofia: Yep. Wow. You know, I find that there are so many similarities between the common pitfalls you find in tenants and the laws and regulations, because at the end of the day, the common pitfalls you’re finding are ultimately, you know, due to the laws and regulation is, is my assumption correct?
Art: So as I said, when we started, it’s… what are you leasing? You know, what are the premises that you’re leasing? There’s no law or regulation that says that, you know, if you sign a lease for 2000 square feet that you’re also responsible for the sidewalk in front of your store that has to be specified, you know. Are you, you know, are you responsible if you have a store in a shopping center for shoveling the walk in front of your store when it snows? Presumably, that has to be determined in the lease. There’s no law that I’m aware of one way or the other that governs that, similarly, having a cap on your cam expenses, there’s no law that governs that.
So a lot of these things are just a matter of negotiation and understanding the implication of various things in there. And, you know, if you’re the tenant, I would say, you know, read the lease. Some leases are a lot easier to read than others. We have a client right now who I won’t identify who had an attorney – they’ve now changed attorneys – but the attorney wrote a nearly impenetrable lease. I mean, it’s very, very difficult to read. Very long, very intimidating, particularly for the kind of tenants that are in their space, but it’s incumbent upon them to get an advisor who can read it and say, yeah, you can live with this or no, you can’t live with this. You know, you should try and negotiate this away.
I can tell you that when my son was leasing an apartment in New York City, I said, “Send me the lease. I’ll look at it. I will tell you whether you can sign it or not.” I said it’s “New York City, You know, apartments are in demand, you’re not going to get them to change it. So I’ll just tell you, yes, you can sign it. No, you can’t.”
Sofia: Thank you for clarifying. And speaking about the avoidance of falling into these, the lease pitfalls, what is the worst situation or difficult or challenging situation you’ve ever seen a tenant in due to the lease?
Art: That’s a tough one to come up with the worst. I can come up with some examples and you asked me this question before and I was thinking about it. One of the examples is us. We signed a lease for our office and the lease had in it that we are responsible for our pro rata share of the operating expenses for the building above the base year, which means that we’re responsible for our share of whatever the expenses increase by.
So we were here for five years and there has been a significant increase in expenses, and we’re negotiating an extension of our lease. So I was clever enough to say, “Look, I want to reset the base here.” So we reset the base here, which was very clever of me. We happened to reset it to 2020, which was essentially the year that we renewed. Well in case people don’t know, there was a pandemic in 2020 and the building was basically shut down for the year. The operating expenses were very low. So then when we got our bill for 2021, which the operating expenses increased over 2020, there was a substantial increase over 2020 because 2020 was very low.
So, you know, it, I looked at it and said, I was, you know, I was too smart by half for my own good. If we had set the base here for 2019, we would have been in a lot better shape. I’ve seen situations where it actually works the other way. Where a tenant negotiates it, their operating expenses will increase by more than 5% over the previous year. And one year, the landlord for whom we manage got a great deal from a landscaping and snow removal company, it was just starting out. So costs went down dramatically.
That year, two years later, that company was out of business and costs went back up. But that tenant benefited from the fact that the cost had dipped one year and now they’re restricted to 5% per year forever. So these are the kinds of things. There’s no law one way or the other. It’s just having experience – being able to read the text and having enough experience to know what it means. And these things are, you know, in several places in the lease.
I’ll give you a big example. We managed for the landlord and I thought this was unconscionable, but I did save a subsequent tenant in a different place money on this very issue – it’s common in shopping centers for tenants to pay their pro rata share of the costs of maintaining the common area, the insurance and the real estate taxes. And the way leases were written for this one tenant was that the tenants would pay their pro rata share of the least square footage. Ok. And I’m not sure that any real estate attorney is gonna pick up the difference, the significant difference in a long paragraph, between least square footage and leasable square footage.
But just to give you an example, if you have a food lion center with a 35,000 square foot food lion and 15,000 square feet of small stores, you have 50,000 ft. If you have a 5,000 square foot store in that shopping center, you’re paying 10% of the cost of plowing the snow, sweeping the center, et cetera. If Food Lion were to suddenly leave, they come to the end of their lease or Food Lion has a strategic bankruptcy and says we don’t want this store anymore, they leave. Now, all of a sudden, you have 5000 out of 15,000 square feet. If you’re on least square feet, not leasable square feet, now you’re paying a third of the cost of plowing the parking lot instead of 10%. That’s a significant difference and it’s one word, it’s one word in a lease.
And I was asked to, I actually volunteered to review a lease for a liquor store for a friend of mine and I picked that up and said you can’t live with this. You know, this is not only something you can’t live with, it’s not fair.
Sofia: Yeah. Yeah, wow. I mean, I cannot imagine the challenge and everything he went through during that time. You know, I feel that just like I mentioned about these common pitfalls and tenants trying to avoid, you know, these issues, everything goes hand in hand.
So what exactly could happen if a tenant needs to break the lease early for whatever reason? Are there, you know, are they required to pay the remaining amount of their term? And, and does that, does that event, does that even, you know, kind of conflict with the Agent’s Commission? How does that all work out?
Art: That’s a lot of questions. You can break it into different pieces. And, if I haven’t done it before in this conversation, let me say I’m not an attorney, I don’t play one on TV, and I did not stay at a Holiday Inn Express last night, so I am not qualified to provide legal advice. The short answer is if you signed up for a certain term, you’re obligated for that term. Then it comes down to, how did you sign the lease? Did you sign the lease in a corporate name or the name of an LLC or did you sign it in your personal name? If you signed it in your personal name, did you sign it, you know, together with your spouse? If you signed it in a corporate name, did you guarantee it? And then there’s the question of, you know, how much have you been talking to your landlord? Yeah, you know, have you been honest about the difficult times you’re having, you know, why are you leaving?
There’s a million reasons, you know. Is your landlord a jerk? That’s an important question. Is it worth going after you? You know, we have a tenant that I just met with on Sunday and we’re just letting her leave. She owes my client like $14,000, but it would probably cost us $6,000 just to go after her and get a judgment and there might not be anything there. And is it really important that we ruin her life? You know, any more than it already is because she had to walk away from a business? So, it’s what they call a facts and circumstances thing.
I mean, legally, yes, if you signed a three-year lease without the opportunity to cancel it early, then the entity that signs the lease owes the remaining term. That’s the fundamental answer. And how does it affect the commission? In theory, you know, the real estate agent is not the guarantor of the lease.
We try to get paid upfront, but there are times where you might say to the client look, you know, ok, you paid me for a three-year lease. The guy left after a year and a half. I’ll credit you a year and a half worth of commission against the next deal. But it’s again, it’s facts and circumstances, you know, how many jerks are involved in the deal, et cetera?
Sofia: Which type of leases are generally the best for tenants, in your opinion?
Art: Well, the best for tenants is probably the worst for landlords. Leases run in terms of shifting the risk. So on the one end, you have what’s called an absolute gross lease, an absolute in that situation, the tenant is paying the rent, the agreed upon rent and everything at every other cost is the landlord’s responsibility. Ok?
In an absolute net lease, which is typical if somebody’s leasing a freestanding building, or even building a freestanding building on a leased piece of ground, then the tenant is responsible for all the costs, all the extra cost, the maintenance, the insurance, the taxes.
So, you know, best for the tenant is for the landlord to be responsible for everything, and best for the, you know, I won’t say worst for the tenant because you go into your eyes open, you have an idea what the taxes are going to be. You have an idea what the insurance is going to be. You hopefully have an idea what the common area of maintenance is going to be and you may be able to negotiate a better deal if you’re willing to take more of the risk.
Let’s say you’re looking at a $20 a square foot rent plus cam taxes and insurance and you expect those cam taxes and insurance to equal $5 a foot. So you expect to pay $25 a foot total. Well, if you try to shift that to the landlord and say I’ll give you $25 a foot, but you’re responsible for all the costs, the landlord may say, “You know, I really want $27 a foot because you’re asking me to take the risk,” whereas the tenant might get away with $20 a square foot plus $5 of extras if he’s willing to take the risk. So there’s no better or worse. Everything’s a negotiation and evaluation.
The important thing is not having hard and fast rules. The important thing is understanding the implications of what you’re signing, what decisions you’re making, et cetera.
Sofia: So this kind of goes into, you know, my next question that I have is what if the landlord finds that the timeline the tenant is looking for is not in the criteria they are wanting, but the tenant is pushing because they like that space. And also what if the agent decides what lease they think is best for them, but then again, the landlord does not really accept that type of lease. How does that work out? Does that play out?
Art: OK. So those are, those are two different questions, one has to do with the timeline. And to some extent, it is what it is. If you’re the tenant and you need to be in the space by June 1st and I’ve got a tenant in that space and I can’t make it available until December 1st, and you’re not flexible, then we can’t make a deal. I mean, it’s very, very simple. I can’t, you know, I can’t put two tenants in the same spot, so that’s easy.
You sit down and you talk, you say, you know, is there some way we can do this? If you absolutely have to have this space and I can’t deliver it till December 1st, is there something you can do in the interim? Can you operate out of your house? Can you operate out of a temporary office space or whatever? I mean, there, there may be solutions. I mean the solution to most problems between two people or two parties is to talk about it. See if you can find a solution.
The other question was about, just give me a couple of words.
Sofia: Just what if you know the agent provides what lease they think is best for the tenant?
Art: Usually you start with the biggest, the bigger dog in the fight. Ok. So when we were developing a shopping center in Winchester, Virginia, we were dealing with Circuit City and Bed Bath and Beyond. They were a lot bigger than Trout, Segall & Doyle at the time. When we were dealing with the local tenants who were taking 2000 square feet, Trout, Segall & Doyle was the bigger party, the bigger dog in the fight.
So we started with our lease and you negotiate from there. But it’s all, it’s all a negotiation and both parties have the power until a deal is made. I mean, the tenant can walk away. There’s a lot that goes into it. You know how in demand is the space? If you’ve had this space on the market for three years and you finally got somebody that’s willing to take it, you’re gonna give more concessions than you will, if you put the space on the market last week and you got six people fighting for it.
So, most leases, if the two parties are sophisticated, it’s going to end up being some sort of a hybrid. It’s uncommon for somebody to sign the lease without negotiating changes to it. And if they do, my experience is, if somebody just says “Fine, I’ll sign it,” it’s because they don’t really care what’s in it because they don’t necessarily intend to live by what it says anyway. So that’s it. I’d rather have somebody, you know, negotiate every sentence because it means that it’s important to them and they know that they’re bound to what they sign.
Sofia: Well, this is incredible information – so much insight. Thank you very much for taking the time to speak with me about mistakes tenants make when signing a lease. I think having a better understanding of mistakes tenants make when signing a lease is crucial for everyone, regardless if you’re looking for a space or not. Because I feel knowing this type of information is only going to benefit the person at the end of the day.
So I really appreciate it.
Art: Yeah, I do want to say, you know, I’m, I’m not crazy about, you know, mistakes, traps, pitfalls. This is an area where most people aren’t experienced. You know, if you go in and your doctor advises you that you need a surgery on your little toe, if you don’t understand all the implications, it’s not necessarily a mistake for you, it’s not a trap.
It’s just, you don’t know what you don’t know. So, you know, my advice would be get somebody that you trust and we talked about this the other day. People do business with people that they know, they know and trust and that’s what you need – hopefully somebody who knows what they’re doing. That’s everyone at TD&A.
Sofia: Yeah. Ok. Well, thank you. Thank you. I appreciate it.