Leasing Law

Commercial Leasing; Tenant's, Operating Expenses & The Simple NNN Lease.

     During my day to day, I draft and negotiate my fair share of commercial lease agreements.  They range from office leases, to retail leases and industrial leases but in almost every case, especially with new clients leasing their first space, the conversation begins the same; they say "I am going to send you a simple lease that my Landlord drew up, take a quick look and let me know it all looks good"; and I respond, "Send me the lease and I'll take a look."

     Most real estate lawyers are familiar with this elusive document, the simple lease, so often described by clients eager get their business up and running and turning a profit.  Unfortunately, Landlord leases are typically one sided at best and the clauses invariably tilt to the Landlord's advantage.  

     One example of a lease clause that can be surprisingly expensive for tenants is the clause governing operating expenses.  Most tenants understand the difference between a triple net lease and a gross lease; the former is structured so that in addition to base rent, tenants are responsible for a share of operating expenses (the landlord's real estate taxes, insurance and costs to operate the building in which the premises are located) and the latter is structured so that tenants pay a single rental payment that includes everything.  In the commercial setting, triple net lease forms are very common and tenants often sign these leases without legal review and counseling.  Operating expense provisions seem simple - the tenant pays its share of the operating costs, but, oftentimes the lease language is overly generous with what may be included in the operating costs.  An example of expenses that should be excluded or at least carefully limited are capital expenses.  Furthermore, its ordinary for tenants to ask for a cap on annual operating cost increases so they can budget for the worst case scenario during each lease year.  If there is no cap on operating expenses then they can expand and increase without limit and Landlords have little motivation to keep their costs down when they can be passed through to tenants without question.  Another important concept when it comes to operating expenses is language providing the tenant a right to audit the Landlord's books.  A good audit provision should provide that if the audit reveals overcharges exceeding a certain percentage, the Landlord will be responsible for paying the audit costs. A skilled real estate attorney understands which expense categories are inappropriate to pass through their clients and can help their clients limit ballooning expenses and excess expense pass throughs.

     The key to providing useful legal counsel to tenants in commercial lease negotiations involves picking one's battles.  A typical commercial lease agreement contains upwards of 50 clauses and its possible to negotiate each one, however sending proposed revisions to all or nearly all of the lease clauses is sure to cause delays (which neither side wants) and sometimes, it can blow a deal.  Evaluating which clauses will be most important to a client begins with understanding the nature of their business very well and then focusing on the clauses that relate to their business and those which may cost them additional money above and beyond rental payments.  The expense clauses in triple net leases certainly qualify there!  

     Before signing that next "simple lease" have an attorney take a look and help you try to balance the important terms.  Its very difficult to help a tenant after they've signed the document!

End of the Wild West In Denver's Short Term Rental Market?

Cheeseman Park Winter Morning:  Copyright David C. Uhlig 2016

Tonight city council votes on two ordinances legalizing (and regulating) strs in primary residences.

     Did you know that operating a private home as an Air BNB, VRBO or as a similar short-term rental property, is currently illegal in the City of Denver? Denver’s zoning code specifies the types of uses that are allowed as accessory to residential use and in almost all cases, short term rentals of 30 days or less (“STRs”) aren’t listed.  The city’s position is that currently, these short term rentals are not allowed under most residential zone districts but the city also does not enforce the prohibition.  According to an April 7, 2016 letter to the city from the Denver Short Term Rental Alliance, to date the city has only received six (6) complaints about STRs.     One exception is that in mixed use commercial zone districts, an STR may be allowed as a “lodging accommodation” if the owner obtains a zoning permit and complies with relevant parking and building ordinances.   

     Tonight the Denver City Council is scheduled to vote on two bills: one would revise Denver’s zoning code (CB16-0261) to permit short term rentals in an owner’s primary residence; and the other, a companion bill (CB16-0262) would enact a licensing and regulatory framework for short term rentals in primary residences.  As drafted, the zoning code amendment is expressly conditional upon passage of the companion bill.  As drafted, the proposed zoning code amendment legalizes STRs in primary residences.  By preventing owners from using investment properties and vacation homes as STRs, Denver’s zoning ordinance limits owners to a single STR.  The intent to prevent investors and businesses from operating STR portfolios or STR investment properties in residential neighborhoods underlies the proposed ordinances which expressly forbid STRs operated by entities such as corporations or LLCs, joint ventures or associations.  While owners may be absent during the short term occupancy, as drafted the proposed zoning amendment expressly requires that owners live in the residence.  The companion bill would delegate authority to the Denver Department of Excise and Licensing to license and regulate STRs.  In addition to numerous other requirements, under the proposed licensing ordinance STR owners will be required to apply for a license, register with Denver Excise and Licensing and obtain a lodging tax identification number.  Lodging taxes on STRs would be the same as for a hotel room (10.75%).  Additionally, if the bills are passed, STR owners will be required to maintain fire, hazard and liability insurance at levels set by Denver Excise and Licensing, maintain a minimum level of life safety systems in a residence used as an STR, and include the STR license number in all advertisements.  The fee for the STR license will be $25.00 per year and fines for advertising without a license and/or operating without a license will be up to $999.00 per incident.

some groups think the primary residence requirement is anti small business.

     In the two-year run up to the vote, council members and staff received varying input from numerous parties running the gamut from individual homeowners and neighborhood associations to property investors and short term rental industry groups.  Much of the feedback received by the city characterizes the primary residence requirement as anti-small business and complains about the increased regulation of private property, increased taxes and favoritism toward the hotel industry.  The Denver Short Term Rental Alliance’s letter states that the primary residency requirement will effectively lock VRBO (Vacation Rentals by Owner) out of Denver and the city will be deprived of a significant tax revenue stream.  Proponents of the primary residence requirement feel it is appropriate in that it limits STRs to small businesses that generate supplementary income for homeowners and cite concerns about investors buying up entire blocks or apartment buildings and operating them as STRs in otherwise primarily residential neighborhoods.  In general, they  feel such operations would pose a risk to public health and safety and detract from the quality and vibe of Denver neighborhoods; the obvious concern being strange cars and stranger people steadily coming and going.

     A seemingly simple issue on its face, legalizing STRs in Denver has broader implications.  If the council votes in favor of these bills tonight, individual owners renting out a room or garage apartment on a short term basis, as a means of earning supplementary income will be permitted to continue doing so and now, legally, although now subject to applications, annual reporting and taxation.  Owners operating investment properties as true STR businesses, or desiring to do so, have been kicked out of the pool in the interest of protecting neighbors who own or who are traditional renters. The STR game in Denver may be more exclusive and predictable by the end of the day; and also more expensive to play.  One cannot help thinking that many STR owners will miss the days of the wild west.  

Just a Simple Lease? Think Again.

IMG_1968.JPG

Downtown Denver Early A.M. photo by David C. Uhlig

AFTER LANDING A POSITION WITH A 17TH STREET LAW FIRM I SPENT THE NEXT 5 YEARS FOCUSSED ON LEASING

     In May of 2000, after graduating from law school, I packed all my possessions into a Ryder truck and headed west. I’d recently turned down a generous offer with a reputable firm in Texas because, well, it was in Texas, and instead I started sending resumes to every law firm in Denver with over five lawyers; none responded.  It was a risky move but I was 25, full of confidence, ready for adventure and excited to finally execute on a dream I’d had since I was a kid, moving to Colorado.  I grew up around the oil business and was mentored by a couple oil and gas lawyers, so while I would’ve taken just about any job offer, in my heart I wanted to be a deal lawyer more than anything, like those early mentors.  Long story short, after a couple weeks I landed a part time job in the legal department of a national hotel company where my first assignment as a new lawyer was to draft a display window lease for a hotel. I'd arrived!  A couple months and hundreds of cover letters later, I landed a position with a 17th street law firm and then spent the next five years, day in and day out, drafting and negotiating leases: cell tower leases, office leases, storage space leases, retail leases, airplane hangar leases, trans-loading facility leases, and leases for national restaurant chains.  I used to dream about leases.  Former colleagues of mine from certain firms that shall remain nameless, who may be reading this, are currently nodding their heads – or maybe shaking them!  That story is the long way of circling back to the title of this post.  There is a statement every real estate lawyer has heard, probably more often than he or she cares to admit; “Its just a simple lease, take a quick look and let me know its okay.” As often as I’ve received the request, I’ve yet to see a “simple” lease. They may have short terms of duration, be for small spaces or involve low rental rates and I’ve definitely seem them drafted on short forms (short in both length and in thought), but leases are contracts, and like any contract, lease provisions, or lack thereof, can have serious consequences for both landlords and tenants.  Any lease, whether for a display window or several thousand square feet of space, involves many issues.  Parties proceeding on their own, without competent counsel, do so to their detriment.   

EACH CLAUSE IN A LEASE HAS AN OPTIMAL POSITION FOR EITHER SIDE AND USUALLY SEVERAL FALL-BACK POSITIONS

     Whether you are a landlord or a tenant, the lease you are considering was likely drafted, at some point, by a lawyer. While very desirable tenants may control the form of lease initially presented, its been my experience that the initial lease is usually prepared by the landlord’s attorney.  Love us or hate us, an important thing to remember about attorneys is we have an ethical duty to vigorously advocate for our clients.  That means the lawyer drafting the initial version of the lease, if competent, drafted it to their client’s ultimate advantage and in their client’s favor. Every clause in a lease has an optimal position for either side and usually several fall - back positions.  Whether representing landlords or tenants, a competent leasing attorney always asks for certain things and will know the appropriate counter-proposals to changes proposed by the other side.  So, when one chooses to go it alone, without a real estate lawyer involved, or if they engage a lawyer without leasing experience, the attorney who prepared the lease notices. The drafting attorney often reminds the soloist that they do not represent them (we always should) and asks if they have an attorney.  If the answer is “no, its just a lease”, their eyes light up!  It’s the small pleasures in life after-all.

     A few examples of leasing issues to think about follow below; it’s the least I can do if you’ve suffered my reminiscence this far.  Commercial landlords usually require personal guaranties from smaller, “mom-n-pop” tenants and its not an uncommon request of sophisticated and proven tenants.  Tenants with enough clout may be able to get around that requirement.  Even a smaller tenant may be able to negotiate some burn off or other relief in the guaranty agreement.  There are many possibilities and while it never hurts to ask; from a negotiation standpoint, it can hurt not to ask.  What does the lease say about assignment?  If a lease silent is silent about assignment and/or subletting, then the tenant is free to assign or sublet at their discretion.  Landlords don’t like that much.  Conversely, there are usually circumstances when tenants should be able to assign or sublet the space, perhaps with just an advance notice to the landlord and a copy of the documents. The landlord’s counsel won’t be surprised by the request.  What state will the landlord deliver premises to the tenant in?  When?  Is there an outside date for delivery? A landlord’s form lease is sure to specify that rent will commence upon delivery of the Premises but it might not provide for a pre-delivery inspection, not to mention consequences to the landlord for failing to deliver on time.   Landlords typically prefer to prevent dark space.  Post occupancy, what if the tenant pays rent but doesn’t open for business or ceases operations in the premises?  What if the tenant doesn’t operate during the hours the landlord prefers?  Form leases typically describe the tenant’s maintenance obligations but often contain sparse, if any, details about the landlord’s obligations.  If the landlord fails to satisfy its obligations does the tenant have any recourse other than a lawsuit for breach of contract (an expensive and thus, impractical solution for many tenants)?  I could go on but suffice to say, for nearly each of the 35 to 55 clauses in a proper arms length commercial lease there are several negotiation points and changing one clause often requires conforming changes to other provisions in the lease.  If a commercial lease is on 1 to 3 pages, or only has clauses addressing term, rental amounts and identifying the parties, such a state of affairs, while it is certainly “sloppy” is far from “simple.”  Believe it or not, I see those from time to time and when they are already signed its always bad news for the client.  Fixing such leases, or getting out of them, if possible, invariably costs the client more than it would have to negotiate an appropriate document in the first place.   

     See, not so simple, right? You should feel sorry for your real estate attorney.  Real estate attorney training is grueling and by all accounts, is similar at most big law firms: i. partner hands new lawyer a lease document and informs them whether the client is the landlord or tenant, ii. new lawyer revises the lease and returns it to partner, iii. depending on partner’s mood, new lawyer is either mercilessly berated on each counter they missed, or walked through every point he or she missed with the stern admonishment, “don’t make me show you this again” before being handed a fresh lease to review, and iv. new lawyer stays up all night and is extra careful to catch all of those changes, only to be admonished for missing a whole new set of points.   Once you start catching all of the negotiation points, you are rewarded with more leases at once and shorter deadlines!   It goes on like that for a few years, until you are dreaming about leases between being awakened by the dinging crackberry on the nightstand; remember those?  Eventually, usually after the partner observes a dangerous glint in an associate’s eye, they’ll take the associate off lease patrol and give them something more complex and humbling. However, there is always leasing work, its part of a real estate practice.

A REAL ESTATE ATTORNEY CAN IDENTIFY THE PERTINENT ISSUES AND HELP YOU FOCUS ON THOSE

     If the other party hands you a “simple” lease to execute, whatever you do, don’t go it alone, even if your budget is limited.  It’s a better use of resources to make sure the lease you sign is properly balanced than to try to fix it after the fact.  Negotiating a lease doesn’t have to be a protracted process.  If nothing else, a seasoned real estate attorney should be able to identify which issues are most pertinent to you and your business and help you focus in on those.  Regardless of how simple the space may be, or how complex the negotiations prior to the lease, there are always issues to think about in the lease, even the “simple” ones.

Thanks for reading!

Dave