Call a Tenant’s Bluff

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In this article, I will explain and apply commercial real estate concepts; using a real-world situation. Through this example, I will demonstrate the critical importance of working with an experienced, commercial real estate broker (especially) when negotiating the terms of a lease agreement. There are many considerations beyond basic economics that impact and govern the tenant/landlord relationship. If your lease is less than 20 pages, you’re doing it wrong (unless you like paying attorneys’ fees). There’s a saying that goes something like, “if it were not for attorneys, the world would not need attorneys.” A simple lease is a weak lease. An agreement that dictates the relationship between two unrelated parties for a period of multiple years benefits neither party if the terms are left ambiguous and open to interpretation. Ambiguity only benefits attorneys because they charge by the hour. By working with a commercial real estate broker (not agent) and particularly a CCIM, you will have access to market data and deal-structuring expertise that will allow you to negotiate effectively and “Call a Tenant’s Bluff.”

In this scenario, my client is the owner of a commercial property that is currently leased to a tenant with less than 6 months left on a 3-year lease. The tenant has a 5-year renewal option at the then market rate; however, it is capped at 106% of the rent in the final year of the lease term. The owner would like to sell the property and will likely realize a higher sales price if it were sold as an investment property (leased) versus vacant. My client sent me the following (paraphrased) message relating a conversation with the existing tenant:

I spoke with the tenant and they are on the fence and are weighing the decision to 1) stay in place and purchase the building, themselves; 2) renew the lease, but for 3 years not 5 years; or 3) move to another building in the same submarket at a far lower rate with 6 months of free rent and a moving & tenant improvement allowance. The tenant suggested I meet with their broker to discuss terms.

My response:

I would like to address the points we discussed over the phone and included in your email and will send a separate email with my recommendation moving forward.

Tenant weighing decision to stay in place and purchase the building

Most renewal options include a timeframe, expressed in months from the lease termination date, by which the tenant must notify the landlord of its intention to renew. Unfortunately, your lease with the existing tenant does not, which allows them to weigh their decision and keep you in limbo. If they are weighing their decision to stay, I would not put much “weight” in their claim that they are considering purchasing the building. If they truly wanted to stay then buying the building would make sense; however, it should be at the market price for the property as the cost of ownership would significantly decrease their costs of occupancy.

Renew for 3 years (not 5 years)

I would not recommend agreeing to anything less than a 5-year lease. When discounting cash flows, investors must apply a cap rate plus a risk premium to the income stream to ascertain its value. Sales data can be used to determine the market rate for a particular asset type, class, etc. but, at the end of the day, the cap rate is a reflection of what each individual investor is willing to pay for each dollar of net operating income. Because there are multiple years of income the investor must also apply a risk premium to the cap rate to account for the potential loss of that income. Discount rates consider a number of risk factors, including but not limited to: length of lease term, single tenant vs. multi-tenant, size of space, cost of reletting space, difficulty in reletting the space, etc. Based on the fact that our property is a 10,000 SF (actual square footage redacted for confidentiality), single-tenant space, most investors would place a significant risk premium on a 3-year lease from an existing tenant because it strongly indicates that they do not intend to stay long-term. Below is a (relatively) hypothetical example of how the risk associated with a 3-year lease could impact the sales price.

5-Year Lease

  • 10,000 SF x $12.00/NNN = $120,000/year net operating income
  • $120,000/year ÷ 6.5% (hypothetical market cap rate) = $1,846,153.85 Sales Price

3-Year Lease (with added risk premium)

  • 10,000 SF x $12.00/NNN = $120,000/year net operating income
  • $120,000/year ÷ 7% (discount rate) = $1,714,285.71 Sales Price

As you can see, a 3-year lease has the potential to lower the investment value of your property by over $131,868.14.

Tenant moving to another building in the same submarket at a far lower rate with 6 months of free rent and a moving & tenant improvement allowance

I would recommend asking for the address of this supposed location. There are so many contradictions within this assertion that I almost don’t know where to start.

Far lower rate

I ran a search for flex spaces in our submarket from 7,500-12,500 SF and have attached a report showing the available options. In addition, I’ve attached an analytics report on all flex properties within our submarket; showing the average market rent to be $13.46/SF ($12.74/SF for available space). The maximum rent we can charge the existing tenant based on our current lease is $12.50/NNN. If they are looking at another submarket then it’s not “nearby” and is not comparable. If they’re looking at straight warehouse/industrial space they can expect to pay a lower rent but not “far lower.” In addition, if the rent is “far lower” that would be because the space is not built out; meaning there is no (significant) showroom/office portion of the space. If there was the landlord would adjust their rental rate accordingly. I originally used a square footage range of 7,500-12,500 SF but after expanding it to 15,000 SF, identified one property to which they may be referring. The space is 14,419 SF (over 30% larger than our space) and they are asking $9.32/NNN. The space is 60% office and has 3 docks. I spoke with the listing broker and they have not seen demand for that much office and are thus pricing it closer to a straight industrial property. For a tenant with good credit that is willing to sign a 5 to 7-year deal they would be in the $7-$10/SF range in terms of a tenant improvement allowance. At their asking rate the annual rent would be $134,385.08 ($14,385.08 more per year than our property at $12.00/NNN).

6 months free

This amount of rental abatement is not market for industrial spaces. Because flex space is a combination of office and warehouse a tenant may expect a slight increase in the number of months of rental abatement but that would be based on the length of the lease term, proportion of office to warehouse, rental rate, etc. A landlord may be willing to provide 6 months free for a 10-year term but not likely for a 5-year and certainly not for a 3-year.

Moving & tenant improvement allowance

How much? Allowances are based on a number of factors; including but not limited to, length of lease term, rental rate, landlord’s pro forma, etc. If they’re paying a “far lower rate” there’s a high likelihood that there will be “far lower” money the landlord is willing to provide for either a moving or improvement allowance. As mentioned previously, if they are truly being offered a “far lower rate” this would likely be because the property is more warehouse than flex and would require a significant build out to make it comparable to your property.


In summation, based on these points along with the list of current, available options I do not believe this to be an accurate claim. They may be able to find a space that has two of the three, if they are willing to sign a longer-term lease, but not all three and not in this submarket.

Not explicitly addressed in my response but a telling an important point is that the tenant suggested that my client speak with their commercial broker; clearly so that they could receive unbiased advice. After all, this is the impartial party whose appraisal of the leasing market is founded on objective data and not on the fact that they only get paid a commission if the tenant moves or if they’re able to convince my client to pay them if they can convince their own client, the tenant, to renew. Just like landlords (can) take advantage of unrepresented tenants’ lack of experience, expertise, and market knowledge the reverse is also true. My client was unrepresented when they originally negotiated the lease with their tenant; resulting in a renewal option without a notice period and in which the rental rate was capped. They also agreed to a 3-year lease term, which is not long enough for it to be a viable investment sale and is too long for the property to be considered by an owner-user. Commercial real estate decisions should not be made in isolation, but rather should be part of a greater strategy based on the client’s goals and plans. Good commercial real estate brokers, particularly CCIMs, have the analytical tools to help clients formulate said plan and the expertise to structure deals in accordance with it.

Herndon Submarket Q4 2019

Herndon

  • RBA: 12,815,207 SF
  • Vacancy Rate: 15.7%
  • 12 Month Net Absorption: 307,000 SF
  • Average Asking Rent: $31.83
  • 12 Month Rent Growth: 2.8%

Herndon is one of the most exciting submarkets in the DC metro, quietly nestled in the shadow of neighboring juggernaut Reston; however, with the delivery of the 2nd phase of the Silver Line in 2020, Herndon is poised for explosive growth. Historically, Herndon has suffered from an “address stigma,” which is more relative (compared to Reston) than objective. Herndon has over 7,600,000 SF of 4 & 5-Star properties many with prominent visibility along the Dulles Toll Rd and Route-28. Rates for these properties increased by a whopping $1.00/SF (2.86%) from last quarter ($35.02/SF to $36.02/SF) and average rents increased by $0.63/SF (2.02%). Even 3-Star properties saw a $0.20/SF increased from last quarter ($25.73/SF to $25.93/SF). On top of that, Herndon’s metro accessible properties command rates higher than the average market rate for both Reston and Tysons Corner. That’s not all.

Herndon has been plagued by high vacancy since Q1 2016 when the submarket saw a 3.7% jump in the rate in one quarter from 12.5% to 16.2%. Vacancy peaked at 18.7% in Q2 2017 and then fell to 14.5% just 3 quarters later (Q1 2018). Just when things were looking up, vacancy again skyrocketed by 3.7% in 2018; ending the year at 18.2%. The submarket’s rollercoaster ride is the result of large-scale move-outs, the most recent being Time Warner Cable vacating 13820 Sunrise Valley Dr in 2018 when it was acquired by Charter Communications. Herndon has endured stormy weather for nearly 4 years; however, recent and significant leasing activity (including at 13820 Sunrise Valley Dr) has brought vacancy back down to 15.7% and should indicate an end to Herndon’s vacancy woes. Projections have rates dropping to 12.1% in the next 12 months likely due to the delivery of the 2nd phase of the Silver Line.

13820 Sunrise Valley Dr Video (1)

Amazon may have chosen National Landing as the site for its HQ2, but its subsidiary Amazon Web Services (also known as Vadata) is quietly making Herndon its unofficial headquarters in the DC metro. On October 4, 2019, AWS purchased 13600 EDS Dr for $54,000,000. The 400,000 SF office building sits on 57.05 acres along Route 28 (the property was assessed at $80,676,490). The company established One Dulles Tower (13200 Woodland Park Rd) as its east coast hub in 2017 when it leased the entire building (403,622 SF). Remember 13820 Sunrise Valley Dr that contributed to the spike in the submarket’s vacancy rate? AWS leased the entire building (268,240 SF) in May of this year.

The reason for all this is Herndon’s strategic location. The submarket provides access to two major north-south and east-west transportation nodes: Route 28 and the Dulles Toll Rd, respectively. Herndon is situated between two of the largest industrial submarkets in the area: Route 28 North and South. Tech giants like AWS are continually building and leasing more data center space and neighboring Loudoun County and the area known as Data Center Alley is home to the largest concentration of data centers in the world. In addition, Amazon’s disruption of the retail industry has directly benefited the industrial market by increasing the need for storage and distribution space as well as last-mile delivery. Herndon’s proximity to over 47,200,000 SF of industrial inventory and Dulles International Airport along with its inventory of 4 & 5-Star properties make it an ideal choice for Amazon and others.

One Dulles Tower Video1 (1)

With the opening of Herndon’s two metro stations (Herndon Station and Innovation Station) next year, the submarket will be immediately connected to Dulles International Airport and the greater DC region by public transit. Reston and Tysons Corner have already begun syphoning demand from closer-in submarkets (Rosslyn-Ballston Corridor) since phase-1 of the Silver Line delivered because of their relative affordability and new supply of trophy, 4 & 5-Star properties. Herndon has similar quality product and is even more affordable.

Considering these recent developments, it should come as no surprise that Herndon led all Virginia submarkets in sales over the last year with almost $1,000,000,000 deployed over the past 3 years. Despite this, Herndon’s average market cap rate (6.3%) is still above the metro and its average sales price per square foot is below that of Reston and Tysons Corner. As a result, Herndon presents a rare opportunity for investors to “buy low” in a submarket in the early stages of a complete transformation. There are more than two dozen projects proposed and in April 2019 the Town of Herndon approved Penzance Properties’ first mixed-use redevelopment at 555 Herndon Pkwy. This project, located right at the new Herndon Metro Station, will include a high-rise office building and two high-rise residential towers. This is just the beginning for Herndon. The combined forces of the Amazon effect, AWS’ growing office and data center needs, and a regional shift in employment growth into the cyber-security, IT, and high-tech fields could see Herndon join the ranks of Reston and Tysons Corner as one of Northern Virginia’s premier office submarkets.

13600 EDS Dr Video (1) (1) (1) (1)

Using the Income Approach to Value Non-Income-Producing Properties

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No one wants to pay more for something than it’s worth; however, determining what something is worth isn’t always straightforward. The difference between market value and investment value can sometimes blur the lines when appraising or assessing real estate, especially for owner-occupied properties. Market value is defined as a property’s likely sales price in an arm’s length transaction (in a competitive and open market) between a buyer and seller, both acting knowledgeably, prudently, and without compulsion. Investment value is unique to each buyer and, as a matter of perspective, it can include tangible and intangible considerations. As a result, when a buyer is purchasing real property for their own use a subjective element is introduced into an otherwise objective (valuation) process.

There are three main valuation methods used to appraise/assess a property’s value: 1) cost approach, 2) direct capitalization approach, and 3) sales comparison approach. The cost approach is primarily used for insurance purposes because only the value of the improvements are insurable. This method calculates the cost to build an equivalent property (minus depreciation) and then adds the value of the land. The direct capitalization approach is used for income-producing properties and calculates value by “capitalizing” (dividing) a property’s net operating income by the appropriate (cap) rate. Cap rates, expressed as a percent, reflect the return an investor is willing to accept for each dollar of NOI based on an all-cash purchase. For example, an investor that is willing to accept a 10% return would be willing to pay $1,000,000 for a property with a net operating income of $100,000 ($100,000 ÷ 10% = $1,000,000). Market cap rates vary based on property type, age, etc. and are calculated through analyses of recent market sales of income producing properties.

The sales comparison approach compares recently sold properties with similar characteristics to the property being valued, including location (within the same building, project, neighborhood, submarket, market, etc.). Price adjustments are made for differences between the sales comps and subject property to determine a value that is consistent with recent market activity (typically within 6 months). This method is most commonly used to value residential properties, both because of the large number of sales (sample size) and due to the fact that owners enjoy beneficial occupancy of the property (not income-producing). Because owner-occupied commercial real estate also provides beneficial occupancy rather than rental income, the sales comparison approach is also commonly used valuation analyses for such acquisitions.

The biggest problem in using the sales comparison approach to value commercial real estate is the issue of sample size. The number of residential properties exceeds that of all commercial properties (office, retail, flex, and industrial combined) by many orders of magnitude. Leasing makes up the overwhelming majority of commercial transactions and, as a result, there may be few, if any, sales to use as a basis of comparison. This is evident in assessed values that remain the same year after year. Assessors use the direct capitalization (income) approach to assess income-producing real estate, but generally use the sales comparison approach when valuing owner-occupied commercial properties. When there are no comparable sales in the year of assessment or other data to support an increase or decrease in a property’s assessed value remains the same. Because assessors often value properties at an assessment-to-sales ratio (ASR) below 100%, many (brokers and laymen, alike) believe that a property’s assessed value reflects the lowest end of the spectrum in terms of market value. As alluded to earlier, this is not necessarily the case and as certain properties, property types, etc. age and become functionally obsolete, the reverse may be true. A lack of comparable sales may indicate that there is no market for a particular property (type) and is likely evidence of a decline in value and in a property (type) being over-assessed.

As the title of this article suggests, there is a way to use the direct capitalization approach to value for owner-occupied properties. As mentioned previously, most residential transactions involve the purchase and sale of real estate, while leasing dominates commercial real estate. As a result, leasing comps are nearly as numerous, on a proportionate basis, in commercial real estate as sales comps are in residential. In order to use the direct capitalization method to calculate the market value of an owner-occupied commercial property, one must perform a hypothetical investment analysis of the subject property using actual market data, rates, etc.; treating it as if it were being purchased as an income-producing property.

Market Analysis

Prospective buyers and/or brokers must first conduct a search for comparable properties that are available for lease. Search parameters such as square footage (range), building age (range), location, etc. should be as narrow as possible. The resulting (short) list of properties should produce an accurate market rent (range) for the property. Rents quoted in triple net terms allow for a quick and easy calculation of net operating income (rental rate x square footage = NOI). Full-service gross leases present more of a challenge and require all costs of ownership (real estate taxes, operating expenses, utilities, cleaning, & insurance) be added together and subtracted from the rental rate on a per square foot basis. The resulting number is the triple net equivalent rent which can then be multiplied by the square footage to calculate the property’s net operating income.

After calculating the subject property’s potential net operating income, more market research and analysis is required to determine the appropriate market cap rate to apply to the income stream. There are a number of sources which provide cap rate information based on submarket, property type, etc.; however, as before, the narrower the focus the more accurate the resulting valuation. Assessors will add basis points to cap rates based on age, vacancy, etc. thereby lowering the value relative to NOI. For example, if the market cap rate for industrial properties in a particular submarket is 7% with average vacancy rate at the time of sale of 50%, a property that is 0% vacant may justify a 0.5% reduction in the cap rate while a property that is 100% vacant may require a 0.5% increase to account for risk. For a property with an NOI of $100,000 the resulting difference in value would be $205,128.21 = ($100,000 ÷ 6.5%) – ($100,000 ÷ 7.5%). Relevant/current data coupled with market knowledge and experience will produce the best, most accurate estimates of value.

Case Study

Ryan Rauner is interested in purchasing 123 Industrial Ave and plans to occupy and use the 25,000 SF property for his storage and distribution business. Due to a lack of comparable sales in the surrounding area, Ryan is having trouble determining how much he should pay for the property. After researching leasing rates for comparable properties within the same submarket, he determines that the market rent is about $10.00-$11.00/NNN; resulting in a potential net operating income of $250,000-$275,000. The current market cap rate for industrial properties in the subject submarket is 7%; however, the submarket’s vacancy rate is slightly about the market average. Ryan knows that investors would likely require a higher rate of return to account for the risk associated with the property’s vacancy and thus adds 1 basis point to the cap rate as a risk premium. He then capitalizes the potential NOI by 8% for a resulting valuation of $3,125,000-$3,437,500.

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Fairfax County Town & City Submarkets Q4 2019

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Fairfax City

  • RBA: 5,054,602 SF
  • Vacancy Rate: 10.9%
  • 12 Month Net Absorption: 24,000 SF
  • Average Asking Rent: $24.72
  • 12 Month Rent Growth: (0.2%)

At slightly over 5,000,000 SF, Fairfax City is 1.78, 2.55, and 2.96 times larger than the McLean, Vienna, and Falls Church submarkets respectively. The vast majority of the submarket is comprised of 3-Star and 1 & 2-Star properties (98%) and the average market rate of $24.72/SF reflects as much. The submarket’s vacancy rate of 10.9% is well below the metro average but this is the result of zero supply side pressure. There have been no significant deliveries since 2007, before the Great Recession, and there are no projects under construction and none proposed in the next 12 months. Low demand is the biggest threat to Fairfax City’s fundamentals. The office inventory is old with an average and median age of 1978 and 1982 respectively and small with an average and median size of 22,872 SF and 13,096 SF respectively). Combined with a lack of metro access the submarket will continue to struggle to attract large tenants. This risk is reflected in the recent sales of WillowWood Plaza I & II (10300 & 10306 Eaton Pl) and WillowWood Plaza III & IV (10302-10304 Eaton Pl), arguably the submarket’s nicest and best located buildings. Buildings I & II sold in June 2018 for $22,300,000 ($91/SF) and were about 50% vacant at the time of sale. Buildings III & IV sold in December 2018 for $32,000,000 ($115/SF) and were 0% and 50.1% vacant at the time of sale respectively. The submarket’s largest tenant, Zeta Associates, occupies the entire building at 10302 Eaton Pl (Building III). Despite having an occupancy level approximately 25% higher, this portfolio sale was only able to achieve a $24/SF higher sales price.

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City of Falls Church

  • RBA: 2,831,871 SF
  • Vacancy Rate: 12.4%
  • 12 Month Net Absorption: (25,400 SF)
  • Average Asking Rent: $25.46
  • 12 Month Rent Growth: 1.4%

Negative net absorption of 25,400 SF led to a 0.9% increase in the submarket’s vacancy rate over the past 12 months. Oddly, this was accompanied by a 1.4% increase in market rents. Even more strange was that this increase came largely from 4 & 5-Star properties ($30.10/SF average rent), which have a vacancy rate of 21.5%. Despite only comprising 17.5% of total office inventory, 4 & 5-Star metrics are heavily influencing the submarket’s fundamentals. Combined, 3-Star and 1 & 2-Star properties have an average market rent of $24.48/SF and vacancy rate of 10.5% versus the submarket’s $25.46/SF and 12.4%. Vacancy rates should remain low due to zero supply side pressure. There are no properties under construction or proposed in the next 12 months. The average & median age of the office inventory is 1962 & 1965 and the average & median size is 14,749 SF & 5,560 SF respectively. As a result of demand trends, Falls Church would benefit from new product, particularly in proximity to the submarket’s lone metro station (East Falls Church). The most significant recent sale was of 6400 & 6402 Arlington Blvd in February 2019. The 410,197 SF project was 26.76% vacant at the time of sale and sold for $38,119,000 ($92.93/SF); reflecting the value-add nature of the sale.

mclean

McLean

  • RBA: 1,708,579 SF
  • Vacancy Rate: 11.2%
  • 12 Month Net Absorption: (40,800 SF)
  • Average Asking Rent: $31.18
  • 12 Month Rent Growth: (0.5%)

McLean was once the central business district of Fairfax County; however, this title was usurped by neighboring Tysons Corner. The submarket’s fundamentals provide a telling picture of the state of office demand in McLean and the greater DC metro, as a whole. Negative net absorption of 40,800 SF led to a 2.4% increase in the submarket’s vacancy rate and a 0.5% drop in market rents, which despite having no 4 & 5-Star properties average $31.18/SF. At $32.82/SF and $28.93/SF, McLean has the highest 3-Star and 1 & 2-Star rents in Fairfax County. With an aging inventory (average/median age of 1977/1980) and no access to metro, McLean’s fundamentals should continue to suffer. The submarket’s one saving grace, zero supply-side pressure, is also the main contributing factor to its lack of demand.  There are no properties under construction or proposed in the next 12 months and with high rents relative to asset quality and demand trends favoring newer product with proximity to metro, tenants will likely look to Tysons Corner for their office needs. Despite this Fairfax County’s Department of Tax Administration considers McLean to be one of the County’s premier submarkets, along with Tysons Corner and Reston. As a result, commercial properties received a 0.5% reduction in their market cap rate; leading to an increase in assessed values even if a property’s net operating income remained the same. The recent sale of 1420 Beverly Rd may cause assessors to reevaluate the submarket’s status. The 46,000 SF building, built in 1985, sold in November 2018 for $12,700,000 ($276/SF) at a 7% cap rate and was fully leased at the time of sale. Another significant sale occurred in December of 2018 when 1313 Dolley Madison Blvd (53,051 SF) sold for $13,000,000 ($245/SF). The property was 13.8% vacant at the time of sale with the most recent lease signed in September 2018 at $32.00/SF full-service.

town of vienna

Town of Vienna

  • RBA: 1,984,657 SF
  • Vacancy Rate: 7.3%
  • 12 Month Net Absorption: (8,200 SF)
  • Average Asking Rent: $28.86
  • 12 Month Rent Growth: 2.0%

Vienna’s total office inventory is fairly, evenly divided between 4 & 5-Star, 3-Star, and 1 & 2-Star properties (634,390 SF, 595,033 SF, and 755,234 SF respectively) as are the rents for each property class with an average of $4.46/SF between them. Despite a 7.3% vacancy rate which decreased by 0.5% over the past 12 months and is nearly half the metro average along with 2% rent growth over the same period, Vienna’s fundamentals are misleading. The true Vienna submarket is located within 2 blocks of Maple Ave (Rt-123) and is comprised solely of 3-Star and 1 & 2-Star properties with an average rent and vacancy rate of $26.64/SF and 10.4% versus the submarket’s $28.86/SF and 7.3%. Vienna’s inventory is old and small, with an average and median age of 43 years (built in 1976) and average and median size of 18,901 SF and 7,200 SF respectively. A total of 3 buildings comprise the submarket’s 634,390 SF of 4 & 5-Star office inventory. One of the three is 1007 Electric Ave, a build-to-suit, headquarters expansion for Navy Federal Credit Union that delivered in 2017 and increased the submarket’s 4 & 5-Star inventory by 37%. This property borders Tysons Corner. The other two, 9300 & 9302 Lee Hwy, are located by the Dunn Loring Metro and I-66’s Nutley St exit and border the Fairfax City submarket. Full building leases for both properties expire in 2022, which could have a tremendous impact on the submarket’s vacancy rate if they remain unleased. That being said, the properties’ proximity to metro coupled with the submarket’s most significant, recent sale may alleviate such concerns. In December 2018, the 41,224 SF 2-Star office building located at 9401 Lee Hwy sold for $9,300,000 ($226/SF) despite its age (built in 1973). This property is even closer to the Fairfax City submarket, notably the new mixed-use development, Scout on the Circle, which will have 83,200 SF of retail space and 400 apartments and was likely purchased as a redevelopment play.

Regular Business Hours

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“Regular Business Hours” is a term used in full-service gross (primarily office) leases and refer to the days and times that a property is open/accessible to the public and during which building services are provided at maximum levels. They are based on and consistent with how and when most office users/businesses operate. In most commercial leases, regular business hours are 8:00am-6:00pm, Monday through Friday, and 9:00am-1:00pm on Saturdays with federally recognized holidays exempted. Office tenants still have access to the property 24 hours a day, 7 days a week, 365 days out of the year; however, some building services may be unavailable or reduced to minimum levels outside regular business hours in order to reduce expenses. Examples of services that may be unavailable at such times can include but are not limited to property management, mail service, access to fitness or conferencing facilities, etc. Elevator service will always be available but may be reduced to one lift during off-hours.

Regular business hours are generally not subject to negotiation, particularly in multi-tenant office buildings where provisions that govern management of the entire property require consistency. For tenants that consistently operate outside regular business hours, there may be the option to have the leased premises separately submetered; however, this may be inefficient, ineffective, or prohibitive from a cost standpoint. Full-building tenants might request changes/extensions to the building’s regular business hours based on their hours of operation; however, this must be done during the proposal/letter of intent stage of negotiations because of the potential impact on operating expenses. Any resulting increase or decrease would need to be factored into the other economic terms of the deal. For the landlord this means increasing the base rent, lowering the amount of rental abatement (if any), and/or lowering the improvement allowance (if any). For tenants it means extracting additional economic concessions equivalent to the landlord’s savings.

The primary purpose of regular business hours is to provide the landlord with a framework to accurately estimate operating expenses and thus their projected rate of return. The primary building service affected by regular business hours is HVAC (heating, ventilation, and air conditioning). Lease language may vary, but landlords are required to maintain comfortable temperature levels during regular business hours (comparable to other office buildings) as part of a tenant’s right to quiet enjoyment. Utilities such as electricity and water are always fully available, but heating and cooling levels are modified during off-hours to lower energy consumption. Landlords do not turn off the heat in the winter or air conditioning in the summer outside regular business hours, but rather lower the minimum temperature and increase the maximum temperature respectively. For example, the HVAC system in an office building may have the temperature/heat set at 70° during regular business hours and at 65° after hours.  Tenants may request the landlord to extend HVAC service beyond regular business hours by providing advance notice and paying the landlord’s hourly rate for such service, which is subject to change. Depending on the tenant’s square footage, this may not be a viable or cost-effective long-term solution.

Most office leases are full-service gross and include all costs of ownership within the base rental rate. Real estate taxes are based on the assessed value of the property and determined by the applicable municipality’s tax rate and are thus outside the landlord’s control. Operating expenses, on the other hand, which include utilities and HVAC present the opportunity for cost savings through efficient management and/or investment in capital improvements such as energy efficient systems. Because the difference between the base rental rate and the costs of ownership equals the landlord’s net profit and landlords are constrained by market rents, they have an interest in minimizing their controllable expenses in order to maximize their profit. Landlords are able to charge tenants for increases in expenses after the first lease year (base year), but acquisitions are based on a property’s projected net operating income and without a consistent, set schedule acting as a control against which to measure expenses (energy consumption), landlord proformas would be unreliable and their rates of returns unpredictable. Furthermore, the predictability of energy consumption and the associated costs provide landlords with a benchmark against which to measure and identify usage that exceeds normal office use on a per square foot basis. Most leases contain provisions that allow landlords to submeter a tenant’s space, at the tenant’s expense, and require them to make payments directly to the utility provider in cases of excessive use.

Finally, regular business hours also provide the landlord with means to predict and limit wear and tear on a building’s common areas. Tenants may have 24/7, 365-access to their building and space, but visitors and guests do not. Regular business hours restrict access for non-tenants and discourage excessive usage by building tenants by limiting building services and decreasing energy consumption, particularly with regards to HVAC levels; thereby prolonging the life of building systems and finishes and reducing the frequency of and need for repairs, replacements, and capital improvements.

not even supposed to be here