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.