Assignment vs. Subletting: What’s the Difference?

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According to the Bureau of Labor Statistics, 20% of small businesses fail in their first year, 30% fail in their second year, 50% fail after five years, and 70% of small business owners fail in their 10th year in business. Yikes! Despite these grim statistics, commercial leases are generally a minimum of 5 years and contain severe, default penalties. In some cases, landlords will require the tenant to personally guarantee the lease, effectively using the tenant’s personal assets, i.e. home, as collateral to secure the lease.

Most tenants understand the implications of defaulting on their lease and enter into the agreement, eyes-open, and with every intention of abiding by the terms and conditions. The road to hell (and default) are paved with good intentions. Economic downturns, lost contracts/clients, sequestration, etc. can disrupt even the best laid plans; leaving tenants struggling or unable to meet their monetary obligations under their lease. In such cases, tenants’ most powerful tool/strategy to avoid default is to sublease or assign their lease.

Most, if not all, commercial leases contain Assignment and Sublease provisions and while the specific language and conditions can vary there are general, shared principles. Subletting and assigning are similar in that they both involve a transfer of the tenant’s right or interest in the lease that allow another (3rd) party to occupy the leased premises. Under the terms of most lease agreements the original tenant will remain responsible for the terms of the lease in the case of either a sublease or an assignment. This means that the landlord can proceed against the tenant in the case of a default by the subtenant or assignee; including but not limited to, rental payments, damage to the leased premises, etc. As a result, it is in both the tenant and landlord’s interest to carefully vet the proposed subtenant or assignee.

If subleases and assignments are similar in that they essentially allow the tenant to “rent out” their space to a 3rd party, what’s the difference?

Under a sublease, the tenant is either (sub)leasing a portion of the leased premises for the remainder of the lease term, all of the leased premises for a portion of the lease term, or a portion of the leased premises for a portion of the lease term. Subleases do not necessarily indicate financial hardship on behalf of the tenant or a likelihood of default. In fact, in some cases, companies may choose to lease more space than needed upon the lease commencement date in order to reserve the space for future growth. This is more common with large companies, i.e. Google, that can afford the lease payments but may seek to reduce expenses by subleasing the unused space. Another situation in which a tenant may request to sublease their space is in the case of a downsizing, consolidation, etc. where the they no longer need their entire space but do not want to move and can offset their rental obligations by renting the unused portion to another party.

Under a lease assignment, the tenant transfers all of its rights and responsibilities under the lease to the assignee along with its right to occupy the entire leased premises for the remainder of the lease term. A lease assignment is a much more serious request on behalf of the tenant than a request to sublease the space. While not always the case, a request to assign the lease may indicate that the tenant is unable or unwilling to continue to make lease payments and is likely to default on its lease then or at some point in the future. As stated earlier, most leases require the original tenant to remain liable for the lease (payments, responsibilities, etc.); however, with lease assignments the landlord may release the tenant and enter into a direct relationship with the assignee. The landlord’s decision will be based on a number of factors, most notably the financial strength of the assignee and the difference between the contract rent and market rents. Assignments are not necessarily indicative of financial trouble and can simply be the result of tenants relocating or consolidating; resulting in them no longer needing the leased premises.

Recapture & Profit-Sharing Provisions

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Most commercial leases contain Assignment and Subletting provisions which allow the tenant to (sub)lease a portion of or the entire leased premises to another party, known as an assignee or subtenant/sublessee. In most (if not all) cases, landlords must consent to the sublease or assignment. Language governing that consent can range from “in landlord’s sole discretion” to “not to be unreasonably withheld, conditioned, or delayed.” In addition to required consent, two of the most important rights available to landlords under the Assignment and Subletting section of the lease are Recapture provisions and Profit-Sharing provisions. They allow landlords to maintain control of the space/property and mitigate the impact of below market lease rates thereby allowing them to maximize the resale value of their asset.

Recapture provisions allow the landlord to terminate the lease and retake possession of the leased premises. There are a number of “triggers” that allow the landlord to exercise their right, including but not limited to, events of default, failure to maintain a certain gross sales revenue (in cases of percentage rent), etc. but in this case we’re focused on the instance in which the tenant requests the right to sublet or assign the lease.

Profit-Sharing provisions require the tenant to share any net profits from subleasing or assigning the leased premises. Generally, it’s 50/50 and the key term is “net” profits, which means that the tenant’s expenses in procuring a(n) subtenant/assignee, i.e. brokerage commissions, free rent, improvement allowances, and other considerations are subtracted from the gross rental value.

There are multiple issues for the landlord to consider when determining which right to exercise. Certainly the recapture right provides greater control over the space, but profit-sharing may be preferable in certain cases. The goal is maximizing value and/by minimizing risk.

Who secures the lease? Who’s the tenant? Who’s the proposed subtenant/assignee? Does the tenant have a personal guaranty? How much time is left on the lease? Is this an assignment or a sublet? What’s the difference? Why is the tenant seeking to sublease or assign the lease? What is the opportunity cost of releasing the premises? These considerations are intermarried but form models for decision-making.

The landlord’s primary goal is to collect (at least) the contract rent from the lease. The stronger party financially is the one with the greatest likelihood of doing so. If Google leased more space than it needed initially and requests the right to sublet a portion of their space, the landlord will prefer to share in the net profits from a sublease rather than recapture the space, regardless of the difference between the market rent and contract rent. In many cases though, landlords will need to consider the financials of two relatively similar parties. Generally, the minimum requirement for consent to a sublet/assignment is that the proposed subtenant/assignee have a financial net worth/strength equal to the tenant at the time of lease commencement. In cases where two parties are comparable financially the difference between market rents and the contract rent will govern the landlord’s decision.

Related to the landlord’s primary goal of collecting rent is the risk of default. The reason behind the tenant’s request to sublease or assign the leased premises is another key factor that landlords must consider. In the previous case, there is little to no risk involved. Large companies like Google will sometimes lease more space than they need at the time in order to extract maximum concessions from the landlord, take advantage of economies of scale, and ensure room for future growth. In such cases, companies may choose to sublet their space until they need it. Conversely, many (if not most) requests to sublease or assign the lease are the result of lost contracts, decreased revenue, declining profits, etc. and can foreshadow default. If market rents are higher than the contract rent in such cases the landlord should choose to recapture the space.

The opportunity cost associated with recapturing/releasing the space takes into account the previous two considerations and the difference between the contract rent and market rents, as well as market concessions. Depending on the condition of the space, the tenant’s proposed improvements and the associated costs, and current market tenant improvement allowances, the landlord may choose to simply take 50% of the net profits from the sublease/assignment.

Another closely related and crucial element is the time remaining on the lease term and whether the tenant is seeking to sublease or assign the lease. If there is not much time left on the lease, i.e. less than one year, the landlord may choose to recapture the space to secure a long(er)-term tenant when market rents exceed the contract rent. In the case of a sublease for a portion of the space for a portion of the lease term, the landlord may choose to simply share in the profits under the presumption that the original tenant will reoccupy the subleased space within the lease term. If a tenant is requesting to assign the lease the landlord will carefully consider the reason behind the request when making its decision.

The guiding principle for landlords/owners is to maintain control over their property by providing themselves with the most options/rights to manage changes in the market or their tenant’s financial condition. A property’s net operating income (NOI) sets the benchmark upon which it will be valued, but the risk associated with that income determines the capitalization rate to be applied, which ultimately establishes the property’s market value. The higher the NOI  and the lower the risk/cap rate the greater the value.

Montgomery County Submarkets Q3 2019

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Bethesda/Chevy Chase

  • RBA: 12,312,159 SF
  • Vacancy Rate: 12.1%
  • 12 Month Net Absorption: 16,500 SF
  • Average Asking Rent: $39.39
  • 12 Month Rent Growth: (1.2%)

Pre-leasing and new construction are the main themes of the Bethesda/Chevy Chase submarket. JGB Smith delivered 4747 Bethesda Ave in August 2019. This 5-Star office building was 80% leased prior to this and, in addition to serving as JBG’s new headquarters, will host Booz Allen Hamilton (65,000 SF), Host Hotels & Resorts (55,000 SF), and Orano (22,000 SF). Carr Properties will deliver another 361,000 SF, 5-Star Building at 7272 Wilson Ave in August 2020, which was already 60% leased in Q1 2019 with tenants such as ProShares (55,000 SF), Fox 5 (60,000 SF), and Enviva Partners (80,000 SF). Another 1,300,000 SF is under construction of which nearly 1,000,000 SF will be occupied by Marriott International, Inc. that is moving its corporate headquarters to 7750 Wisconsin Ave, set to deliver in January 2022.

Interestingly rent growth was negative this quarter, but this mostly the result of negative net absorption in the submarket’s 3-Star and 1 & 2-Star properties. Rent growth was actually positive for 4 & 5-Star properties (1.3%) and should continue to rise as new, trophy office space comes on the market. The strong demand evidenced by strong pre-leasing and new construction should continue but it will likely be marked by a flight to quality and an increasing disparity between average rents for 4 & 5-Star properties and 1, 2, and 3-Star properties.

North Bethesda/Potomac

  • RBA: 11,240,588 SF
  • Vacancy Rate: 15.1%
  • 12 Month Net Absorption: 74,000 SF
  • Average Asking Rent: $30.33
  • 12 Month Rent Growth: 1.3%

The woes of the North Bethesda/Potomac submarket can be attributed to large scale, government agency relocations and consolidations. The submarket has struggled to fill blocks of space vacated by the FDA, National Institute of Allergy and Infectious Diseases, and the National Cancer Institute. Vacancy levels hit 20.5 in Q2 2015 but have been gradually declining since and are at their lowest in over 5 years. Just as things were starting to look up, Marriott, the submarket’s largest tenant, will be vacating approximately 800,000 SF when it moves into its new headquarters at 7750 Wisconsin Ave (Bethesda/Chevy Chase submarket) in January 2022. This move will have a devastating impact to the submarket’s fundamentals; causing the vacancy rate to skyrocket and pushing rents down. The one bright spot and a bit of sweet revenge was ABT Associates relocation from the Bethesda/Chevy Chase submarket to 6130 Executive Blvd in Q1 of this year. The 130,000 SF lease deal had a notable impact on the submarket’s vacancy rate, but with new construction in neighboring, Bethesda/Chevy Chase, the North Bethesda/Potomac will be hard pressed to compete with demand with its aging inventory and lack of access to public transportation.

Rockville

  • RBA: 10,835,109 SF
  • Vacancy Rate: 10.8%
  • 12 Month Net Absorption: 62,000 SF
  • Average Asking Rent: $30.18/SF
  • 12 Month Rent Growth: 2.8%

At first glance, Rockville’s fundamentals look strong. The vacancy rate is below the metro average, and the past 12 months saw approximately 62,000 SF of net absorption with a corresponding 2.8% growth in rents. Despite these positive metrics the submarket has still not recovered from the Great Recession and is particularly vulnerable to large-scale, move-outs from government tenants. The submarket’s demand is driven by government agencies and the federal contractors that want to be close to them. Combined they account for over 40% of the office space in Rockville. Relocations by government tenants, such as the National Institutes of Health vacating 115,000 SF last year, have an oversized impact on a submarket such as Rockville because government-related businesses that support such agencies will seek to relocate as well to be in close proximity. Still Rockville is a Biotech hub with the U.S. Department of Health and Human Services occupying nearly 1,200,000 SF. If it can maintain this reputation is should be able to continue to attract companies in this rapidly growing field.

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You Are Now Entering… the HUBZone

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HUBzones are “Historically Under-utilized Business” zones located within qualified census tracts; qualified non-metropolitan counties; lands within the external boundaries of an Indian reservation; qualified base closure area; or redesignated areas. The HUBZone program was created in 1998 by the HUBZone Empowerment Act. Its primary goal was/is to incentize businesses to operate and create jobs in historically, economically downtrodden communities/areas by requiring federal agencies to set aside more than 3% of their budget in the form of prime contracts for HUBZone certified small businesses. HUBZone certified companies benefit from preferential treatment in the form of set-aside contracts and 10% price evaluation preference in full and open contract competitions.

The Small Business Administration (SBA) administers the program and establishes the requirements for businesses to qualify as HUBZone certified. First, a company must qualify as a small business under SBA guidelines as based on size requirements established by the North American Industry Classification System (NAICS). Second, the business must be at least 51% owned and controlled by a U.S. citizen(s), a Community Development Corporation, agricultural cooperative, Indian tribe, or Alaska Native Corporation. Third, the company’s principal office must be located in a HUBZone. “Principal office” is defined by as location in which the greatest number of employees work. Because this excludes contract sites maintaining HUBZone certification can be especially challenging in the DC metro area.  Finally, 35% of the company’s employees/total workforce must reside in a HUBZone. Under the current rules, businesses must re-certify their HUBZone status every three years; however, there is no limit to the number of times a company can re-certify as long as they continue to qualify under program’s existing requirements.

The SBA has a HUBZone map on its websites that allows one to search a specific address to see if it is located within a certified HUBZone:

https://maps.certify.sba.gov/hubzone/map

Despite the billions in federal contracts available to HUBZone certified companies, the program, like the areas it attempts to aid, has been historically underutilized. This is because the rules and requirements have made compliance difficult to achieve and maintain, and sudden changes can cause a company to no longer be in compliance; rendering it ineligible for the program. The two biggest compliance challenges are the requirements for the company’s principal office to be located within a HUBZone and for 35% of its employees to reside in a HUBZone. An issue that is further compounded by the continuous and unpredictable movement of HUBZone areas and boundaries.

The SBA has proposed three changes to the HUBZone program requirements to address these issues:

  1. Freezing HUBZone maps until the 2020 census after which maps will be updated every 5 years. The new regulation would also provide companies with up to 3 years to move to a new HUBZone if their principal office and/or employee’s residence loses its designation as a result of changes to the HUBZone map. That’s a total of 8 years to relocate to a new HUBZone, which is more than enough time considering most commercial lease terms are 5-10 years.
  2. Changes to rule requiring 35% of employees to reside in a HUBZone. Current regulations require an employee to live in a qualified HUBZone for at least 180 days or be a currently registered voter in that area and be hired by the company before that employee will count towards the HUBZone/Non-HUBZone employee mix. Under the proposed change, after such period, the employee will always count as a HUBZone employee as long as they remain employed by the HUBZone certified company, even if that employees moves to a non-HUBZone area or their residence loses its HUBZone designation.
  3. Changes to the eligibility requirements for contract awards. Currently companies must be HUBZone certified at both the time they bid on a contract and at the time the contract is awarded. The proposed rule change would only require companies to certify or recertify their HUBZone status once a year (by its annual recertification date) thus eliminating the need to prove compliance at either the date of bid and/or time of award.

So, what does this mean in the context of real estate investment? For one, because the purpose of the HUBZone program is to revitalize economically depressed areas, they increase the likelihood for increased rents and property appreciation. Secondly, landlords with properties within a HUBZone can use this status as a marketing tool to attract prospective tenants. The allure of billions in federal funds could be the deciding factor in a competitive market and the financial stability/prosperity from multi-year government contracts reduces the landlord’s risk of tenant defaults. With changes to the rules that have caused the HUBZone program to be historically under-utilized, itself, property owners and residents of HUBZone areas should begin to see the fruits of the program’s intended purpose.

Route 7 Corridor & Leesburg/West Loudoun Submarkets Q3 2019

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Route 7 Corridor

  • RBA: 4,688,075 SF
  • Vacancy Rate: 7.2%
  • 12 Month Net Absorption: 26,900 SF
  • Average Asking Rent: $28.17
  • 12 Month Rent Growth: 0.9%

With only 4,688,075 SF of total inventory, the Route 7 Corridor is a relatively small submarket; however, fundamentals are strong. The submarket’s “age” differentiates it from other, similar size submarkets. The average age in Ashburn is 35, a statistic only surpassed by the average age of its office buildings: 15 years (median age is 13 years). In fact, the submarket does not have an office building that was built before 1990 and over 40% of its inventory is comprised of 4 & 5-Star properties. The average rent for the submarket is $28.17/SF but this is a little deceptive as 3-Star properties account for 56.6% of the inventory with average rents of $25.08/SF ($7.44/SF lower than the average rent for 4 & 5-Star properties). The submarket’s vacancy rate is well below the metro average at 7.2% with 4 & 5-Star properties lower still at 6.1%. Based on this it’s not surprising that over 103,000 SF of 4 & 5-Star space is currently under construction with another 195,000 SF proposed. Fundamentals should remain strong despite this new supply as the submarket is likely to see increased demand with the delivery of the 2nd phase of the Silver Line metro and continued expansion of notable projects like One Loudoun.

Leesburg/West Loudoun Submarket

  • RBA: 3,829,925 SF
  • Vacancy Rate: 7.6%
  • 12 Month Net Absorption: 7,700 SF
  • Average Asking Rent: $26.49
  • 12 Month Rent Growth: 0.6%

The Leesburg/West Loudoun submarket encompasses South Riding, Leesburg, Purcelville, Aldie, Middleburg, and Hamilton. Despite spanning such a large area the submarket only has 3,829,925 of total inventory. What’s interesting is that this is comprised of 346 individual properties while its neighbor, the Route 7 Corridor, has over 850,000 SF more inventory which is spread over only 81 properties. The median age and size of the submarket’s inventory is 41 years and 4,900 SF with over 65% of the office product located in Leesburg. Despite its distance from public transportation, the submarket has experienced continuous positive net absorption since 2011; resulting in a vacancy rate that is well below the metro average at 7.6%. The average market rent for the submarket is $26.49/SF; however, nearly 83% of the submarket is comprised of 1 & 2-Star and 3-Star properties which have average rents of $25.75/SF and $25.22/SF respectively. Of the many “cities” that make up the Leesburg/West Loudoun submarket, South Riding may be the most promising and primed for commercial development. The recent expansion of Route 50 has improved east-west transit and Route 28 and Loudoun County Pkwy provide convenient north-south access.

It’s Unreasonable to be Unreasonable

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As mentioned in previous articles, every commercial lease is unique. Landlords have their standard lease agreements, which vary based on asset type, i.e. office, retail, etc. and by individual property within the same asset type, i.e. freestanding retail vs. strip center. Even leases for the same property will differ based on the tenant and the specific deal terms. On top of that, leases are subject to further customization based on the tenant’s/broker’s/attorney’s review and negotiation of individual lease provisions. Despite this, most commercial leases have a similar structure and governing practices that are common. Because of this there are certain standards that should be verified in each lease or inserted if absent in the initial draft. The standard of “reasonableness” is perhaps the most important.

A relatively minor case in which a reasonable standard should always be applied is for attorneys’ fees. Many leases require the tenant to pay for the landlord’s “attorneys’ fees” if the landlord must enforce any of the lease provisions against the tenant or review any tenant requests such as subletting the premises. Particularly in contentious situations where there is a dispute between the tenant and landlord, legal fees can be significant. Landlord’s do not necessarily have an interest in incurring unnecessary or excessive attorney’s fees, but in the absence of a reasonable standard there is nothing limiting their ability to do so and pass the expense along to the tenant. In this case, “reasonable” does not have a strict or set definition, but such a standard imposes a requirement on the landlord to justify such costs if contested.

Reasonableness is most important in cases where landlord’s approval/consent is required. In commercial leases such cases include but are not limited to signage, assignment/subletting, and alterations to the premises. Regardless, in each and every case, consent/approval should not be “unreasonably withheld, conditioned, or delayed.”

The initial draft lease may already include this standard but, because most leases are landlord-sided, it’s likely that the standard is that “consent shall be granted or withheld in landlord’s sole discretion.” Another possibility is that “consent shall not be unreasonably withheld.” This is certainly better than the previous standard, but the addition of “conditioned” and “delayed” are important distinctions that should be included.

Having consent not unreasonably “conditioned” imposes a reasonable standard on the factors guiding the landlord’s approval. Some leases will explicitly list the conditions governing the landlord’s approval. In such a case tenants/brokers must review and assess the reasonableness of said conditions. Common examples include minimum requirements of financial strength (often the same as tenant at the time of lease signing), impact on building systems, other tenants, and/or building (aesthetic and/or reputation); etc. Reasonableness should be based on an objective standard but must also be viewed through the lens of the tenant’s business/use, plans, i.e. selling the business during the lease term, etc.

It is important to not have consent unreasonably “delayed” because of the old adage, “Time Kills All Deals.” As is the case with the conditions guiding consent, many leases will provide specific timeframes in which the landlord must respond to tenant requests. These must also be evaluated both objectively and with an understanding of the time required for the landlord to consider and process the tenant’s request. A key example in which unnecessary/unreasonable delays could negatively impact the tenant is in the case of a requested sublet or assignment. The tenant’s proposed subtenant may have a required sublease commencement date due a lease expiration date, contract, etc. and if landlords are not required to respond in a timely manner/within a reasonable timeframe, the tenant may lose the deal.

After the initial adversarial nature of the LOI/lease negotiations process, relationships between tenant and landlord are generally good and reasonableness governs the relationship. Communication and ample notice are good practices that can prevent many of the issues that reasonable standards protect against. Still, tenants should require a reasonable standard in every leases and landlords should be amenable to this standard. It’s unreasonable to be unreasonable.

Landlord-ing 101: CAD Files

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CAD stands for Computer Aided Design. In the context of commercial real estate, CAD files are essentially digital blueprints/drawings/schematics that allow architects to more easily manipulate and design buildings/spaces. Because CAD files come in both 2D and 3D formats they can be used to create simple floor plans to in-depth, walkthroughs of imaginary spaces. Previously, architects/engineers were forced to use paper drawings which were not easily modified, shared, or understood. Basically, CAD files make life easier for everyone involved in the space planning, design, and construction process.

The importance of CAD files cannot be understated, but it can be measured based on asset type. The owner of a single office condo may not “need” CAD files depending on how they choose to manage their asset; meaning whether or not they choose to obtain permits for any alterations (whether they’re required or not). If owners/landlords opt to perform any work without the required permits they are at risk of potential ADA (Americans with Disabilities Act), fire/life safety, etc. violations and in addition to fines may be required to remove the alterations without compensation.

On the other end of the spectrum, for landlords with multi-story, multi-tenant office buildings, CAD files are an absolute must. In order to appeal to the greatest number of potential tenants, landlords must offer the greatest number of square footage options. There are a number of code requirements that govern how spaces can be demised, but one of the most important is ingress/egress requirements. This is specifically related to fire safety and refers to the maximum allowable distance to an exit. By using CAD files, architects can easily measure distances from anywhere on the floor to the nearest available exit and thus create a “blocking” plan which shows how the floor can be divided into individual, smaller suites.

Even if a floor is not multi-tenanted, CAD files allow architects to easily and quickly create “test-fit” plans, which represent their interpretation of the tenant’s desired floor plan/layout. If the initial plan is rejected by the tenant the architect can simply modify the existing plan until they create one that works. Because CAD files have dimensions they can also be used by the tenant’s furniture provider to digitally furnish the office with accuracy. Tenant’s can see exactly what their space will look like furnished before the space is even built and furniture ordered. They can even add digital employees.

Despite their importance, some buildings/spaces do not have CAD files or, for whatever reason, they’re unavailable to a new owner. In this case, one of the first orders of business should be to have CAD files created for the entire building. Time kills all deals and if a prospective tenant is considering multiple spaces the time required to have CAD files created, after the fact, and a test-fit performed could be the factor that causes the landlord to lose the deal. Furthermore, when marketing a property it is in the landlord’s interest to be able to present the most (code compliant) options possible. CAD files are absolutely necessary if landlords want to effectively market and lease their space. They provide owners with the information they need to estimate the cost of tenant improvements, which in many cases is the driving economic force behind the deal.

Have a Nice [Business] Day!

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Every tenant is unique. Two tenants may be in the same business/industry with the same number of employees, years in business, etc., but their financial situation, growth/strategic plans, etc. may be different. Tenants/companies are as unique as the people that comprise them.

On the other side of the transaction, every landlord is unique. There are buy and hold landlords as well as buy and flip landlords. Like tenants, landlords have different financial situations. Holding periods and financial strength are only two factors that combine to create the framework; governing landlord decision-making.

Every commercial real estate deal is unique because of the nearly infinite combination of unique tenants and unique landlords. As a result, every commercial lease is different. Certainly landlords have their standard lease agreements, but these are unique one, because the tenant, space, etc. are unique. Secondly, while most commercial leases contain the same provisions, i.e. Events of Default, Subordination, Assignment/Subletting, etc. they are subject to negotiation and, depending on the tenant’s leverage, (broker’s) negotiation skills, etc. may look markedly different when an executable document is finally reached.

Commercial leases are full of legal jargon and paragraph-long sentences that require thorough, in-depth review. Still there are certain changes that should be made to every lease. One such example is changing “days” to “business days” or vice versa. This is a relatively easy change but, as in all things, there are subtleties involved. The importance of “days” in a commercial lease is that they establish notice and grace periods. They govern the timeliness of the landlord and tenant’s responsibilities to the other.

First, it’s important to understand what a business day is. As one may reasonably intuit, business days are typically Monday through Friday. The exceptions are federally recognized holidays, i.e. Thanksgiving, Labor Day, etc. An important distinction must be made for retail tenants whose business may primarily be conducted on the weekend.

Second, it’s important to distinguish between timeframes for “days” and “business days.” For example, 5 business days is essentially the same as 7 days (one week). Thirty days (one month) is essentially the same as 20 business days. If the intention is a week then there is no reason to change the language. If the landlord initially proposes “10 days;” however, tenants should request 10 business days to provide themselves with a minimum 2 weeks. Business days are of primary importance when considering the impact of weekends and holidays. For example, if a tenant is required to execute an estoppel certificate within 10 days versus 10 business days and the landlord provides notice on the Friday the week before a long weekend, the tenant may be in serious risk of default. Two weekends and a full week equals 9 days, add a Monday holiday and the 10 day period has expired. What if the tenant is on vacation and does not receive the notice until they return? If the tenant had simply negotiated 10 business days they would have had an additional week to execute the document thus saving themselves from default.

Another example, where business days can be to the tenant’s detriment, is in the case of service interruption and rental abatement. In this situation, business days can negatively impact the tenant. For example, if the landlord is willing to concede to rental abatement if services are interrupted for a period of 3 business days, rental abatement starting on the 4th business day, the tenant should change “business days” to “days.” Three business days, if spanning a long weekend is actually 6 days. That means the tenant would be without critical services for nearly a week before they are entitled to rental abatement and, as mentioned previously, this could be devastating to a retail tenant.

General rule of thumb, you want your party/client to have as much time as possible and the other to have as little as possible. All of this should be grounded in reasonableness and based on an understanding of each party’s business. When it comes to timeframes for responding to the landlord, tenants should always change “days” to “business days” to prevent unintentional defaults due to weekends and holidays. Conversely, in situations where the landlord must respond (provide consent/approval) or remedy a default, make a repair, etc. “business days” should be changed to “days.” Lastly, tenants should seek uniformity in their various timeframes, again to prevent confusion and unintentional defaults.

*I generally recommend 5 business days before late charges are assessed for nonpayment of base rent and 5 business days after written notice of nonpayment of base rent before it becomes an event of default. Ten business days are sufficient for such cases as estoppel certificates, subordination agreements, restoration of the security deposit, etc. Finally, in the case of nonmonetary events of default, 20 business days or 30 days are reasonable.

Route 28 Corridor Q3 2019

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Route 28 North Industrial Submarket

  • RBA: 35,287,627 SF
  • Vacancy Rate: 3.7%
  • 12 Month Net Absorption: 1,800,000 SF
  • Average Asking Rent: $12.65
  • 12 Month Rent Growth: 4.5%

The Route 28 North Industrial submarket may be the strongest in the DC metro area across every asset class. Even with 2,000,000 SF delivering in the past 12 months the vacancy rate only increased by 0.3% in that time and is well below the market average at 3.7%. The submarket saw 1,800,000 SF in positive net absorption over the same period and a staggering 4.5% growth in rents. Over 1.1M SF is set to deliver in the next year with an additional 694,000 SF proposed. This area is also known as Data Center Alley with one of the largest concentrations of data centers in the nation/world with nearly 70% of the world’s internet traffic flowing through the corridor. The submarket has AOL to thank for the infrastructure that eventually led Amazon, Google, and Microsoft to purchase hundreds of acres for future development. In addition to this, the submarket’s proximity to Dulles International Airport, location in the richest county in the nation (Loudoun), and major north/south and east/west highways (Route 28 and the Dulles Greenway respectively) have all combined to create the region’s largest industrial submarket with seemingly unlimited potential.

Route 28 North Office Submarket 

  • RBA: 10,348,741 SF
  • Vacancy Rate: 16.3%
  • 12 Month Net Absorption: (115,000 SF)
  • Average Asking Rent: $26.52
  • 12 Month Rent Growth: 0.8%

Route 28 North’s office and industrial markets’ fundamentals are in stark contrast and tell a story that began before the Great Recession. Before 2008, Loudoun County planners had a much more optimistic outlook for area’s office demand, as evidenced by the prevalence of land zoned PD-OP (Planned Development Office Park). Over the years the submarket became known as Data Center Alley and demand was primarily for industrial uses. This quietly created prime conditions for a surge in office demand in the submarket. Amazon, Google, and Microsoft have invested heavily in the submarket and with the completion of the Silver Line in late 2020, developers will have the opportunity to transform the office market into mixed use, transit-oriented office projects that attract both international and regional companies that support and/or collaborate with the tech giants.

Route 28 South Industrial Submarket 

  • RBA: 11,780,111 SF
  • Vacancy Rate: 8.2%
  • 12 Month Net Absorption: 126,000 SF
  • Average Asking Rent: $12.96
  • 12 Month Rent Growth: 4.2%

The Route 28 South Industrial submarket is a smaller, older version of its northern neighbor; however, its fundamentals comparatively strong. The past 12 months saw a 1% drop in the vacancy rate, 126,000 SF of net absorption, and a 4.2% growth in rents. Despite having a vacancy rate that is above the metro average (8.2% vs. 6.6%), the submarket commands an average rental rate that is $0.31/SF higher than Route 28 North. There are no projects proposed or set to deliver in the next 12 months which should cause vacancy rates to continue to decline. Further evidence of the submarket’s health is the average and median submarket cap rates in the past 12 months: 6.3% and 5.4% respectively.

Route 28 South Submarket Office 

  • RBA: 14,330,215 SF
  • Vacancy Rate: 15.2%
  • 12 Month Net Absorption: 210,000 SF
  • Average Asking Rent: $28.25
  • 12 Month Rent Growth: 0.7%

Route 28 South’s office vacancy is above the metro average, but this is not necessarily reflective of the overall health of the submarket. It does, however, reveal its vulnerability to large move-outs as UNICOM’s move in 2018 increased the submarket’s vacancy rate by a brutal 3.2%. The submarket’s inventory is nearly evenly split between 4 & 5-Star and 3-Star properties, but the differences in average rents and vacancy is anything but even at $31.70/SF vs. $25.21/SF and 13.9% and 21.5% respectively. Peterson Companies delivered 480,000 SF in September 2018 (for a government tenant) and there is 125,000 SF set to deliver in the next 12 months with another 170,000 SF proposed. The presence of large (3-letter) government tenants should generate consistent demand from government contractor tenants and, barring any large-scale move-outs, should contribute to a continued improvement in submarket fundamentals.

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Delaware Statutory Trusts… Delaware

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Delaware Statutory Trusts (DSTs), otherwise known as an Unincorporated Business Trust, are legally recognized trusts that allow (1) accredited investors to (2) defer capital gains through a 1031 exchange and (3) invest in a fractional interest in (4) large, institutional quality and (5) professionally managed commercial properties. While DSTs are created by filing a Certificate of Trust with the Delaware Division of Corporations, the business purpose for which they are formed is not restricted to the State of Delaware. Trusts are fiduciary arrangements that allow a third-party, known as a trustee, to hold assets on behalf of a beneficiary or beneficiaries. In this article, I will break down the various components of a DST and explain how, for some investors, they can be an excellent alternative to a traditional 1031 exchange.

(1) Accredited investors

Delaware law does not require DSTs to be registered with the Securities & Exchange Commission (SEC), which is why they are only available to accredited investors. Private trust agreements govern the relationship between the trustee and beneficiaries; including distribution of the trust’s assets, voting rights, etc. There are no regulations or restrictions on the format or phraseology of the governing agreement or limits to the powers of the trustee. As a result, investors must be sophisticated enough to analyze and understand the terms of the trust agreement so that they can accurately calculate their projected return, identify the risks associated with the existing language, and determine whether or not to invest in the particular entity.

(2) Defer capital gains through a 1031 exchange

Delaware Statutory Trusts invest in real property and ownership interests are available for purchase to accredited investors, many with minimum investments as low as $100,000. Because DST real property assets are held for investment purposes they qualify as “like-kind”/replacement properties under Section 1031 of the Internal Revenue Code. Therefore, investors can defer capital gains by reinvesting the money in a DST through a 1031 exchange.

(3) Invest in a fractional interest

The traditional 1031 exchange requires a seller to reinvest capital gains into a “like-kind” property or properties of equal or greater value within certain time limits and, while the timeframes don’t change, DSTs allow investors to take the entirety of their gains and pool them with other investors’ funds. For example, if an investor has $100,000 of capital gains they could invest in a DST investment valued at $10,000,000, effectively purchasing a 1% interest in the asset. Investors are not partners but rather individual owners within the trust and, as a result, receive their percentage share of cash flow income, tax benefits, etc. Liquidity is a potential issue as many investments have long holding periods (5-10 years) and owners’ ability to transfer or sell their interests may be prohibited or limited by the trust agreement.

(4) Large, institutional quality

Because DSTs allow investors to pool funds they are able to invest in properties that were previously only available to the ultra-wealthy and to large institutions such as pension funds, insurance companies, etc., hence the term “institutional quality.” Examples of such investments include hundred plus unit multi-family apartments, high-rise office buildings, industrial projects, shopping centers, etc. The stability and diversification inherent in such properties is reflected in their price tag.

(5) Professionally managed commercial properties

A major reason that property owners may hesitate to sell an investment property despite positive market conditions is that they do not want to pay capital gains taxes but also do not want to have to find a replacement property that they have to manage. They don’t want to be a landlord anymore. One of the greatest features of Delaware Statutory Trusts is that they are held, managed, and administered by the trustee. This is another reason DSTs are reserved for accredited investors. The quality of the “professional management” is paramount to the success of the investment. Trustees should be qualified and vetted by investors to ensure their competency and experience. Ideally, trustees are sufficiently connected and knowledgeable to be able to identify analyze investments regardless of location and structure acquisitions in a way as to maximize the investment’s return. They should also manage the asset efficiently; minimizing operating expenses while adequately maintaining the common areas and building systems so that the property maintains its value and provides the highest return to investors.


Delaware Statutory Trusts provide accredited investors with the ability to defer capital gains and invest in institutional quality investments without the responsibility of managing the properties, themselves. Depending on the skill, experience, etc. of the trustee, beneficiaries may have the opportunity to invest in markets outside their area of expertise where returns are higher or where there is a greater likelihood of appreciation either through effective management or capital investments. Finally, DSTs provide a “fallback plan” if sellers are unable to identify a suitable or desirable replacement property within 1031 exchange timeframes.