Power centre leases: Cost sharing issues

January 2009

Power centre leases: Cost sharing issues

bouton-vers-francaisFredric L. Carsley
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514 878-3262

Major shortfalls, Caps, fixed charges

Generally speaking, satellite or commercial retail unit (CRU) tenants have, in their leases in major malls, reluctantly accepted to absorb major tenants' shortfalls through the "adjusted gross leasable area" formulae. As many of the main retailers in our power centres bring both covenant and store size that generate significant bargaining power, the chances of these retailers accepting to absorb major tenant shortfalls is unrealistic. In fact, there are several of these "medium box" retailers which do the opposite; namely, they impose caps on the common area maintenance provisions which the landlord has to absorb.
 
Sometimes, they insist upon so many exceptions, exclusions and/or deductions from normal commun areas maintenance (CAM) that when all is said and done, the landlord is often better off simply negotiating a fixed charge for CAM with a consumer price index type method of increase. When pushed, several of the box retailers have been known to accept this formulation. From the tenant's point of view, while it cannot work the CAM down, it does know exactly what it is going to cost on a month to month year to year basis from the landlord's point of view, the endless "pea splitting" arguments over whether or not this is properly justified under the overall CAM definition, the human energy really wasted over what are often insignificant amounts and the delays in making year end reconciliation adjustments are often not worth the effort.
 
Different developers have different feelings about the fixed charge, which certainly was used by some Quebec developers as early as the 1970's. The fixed charge is gaining increasing popularity among major developers, in the United States. General Growth Properties became the first major landlord to abandon variable CAM charges as a means to lock down and control the expenses. As of 2005, Taubman Centres is offering tenants a fixed common area charge option. Quoted in a year end 2004 earnings call, Lisa A. Paine, Executive Vice President and Chief Financial Administrative Officer of Taubman Centres stated:

"Will allow each retailer to choose fixed CAM or the traditional net CAM, whichever works best for them,"1  

If General Growth Properties and Taubman, owners and operators of major malls can do it, the power centres should find this an attractive option. A few tips on selling up a fixed charge program:

  • don't "fix charge" anything which you can't control, such as insurance, energy and taxes
  • provide increases based upon fixed percentages or CPI. Don't agree to a percentage increase in actual costs, as this loses the advantage of not having to explain or account, which is advantageous for both parties
  • the same thing applies to CAPs. In the Dominion Square Building Inc. and Hydro Québec2 , all taxes and operating expenses in the building were capped at $7 per square foot. A new tax was introduced with grandfathering legislation. The Court ruled contractual agreements to limit the taxes took precedence over the legislative grandfathering, and landlord could not recover a share of the new taxes

Cluster expenses

Most leases define proportionate share to be the ratio that the area of the premises bears to the gross leasable area of the shopping centre. This ratio generally works for expenses that are truly shared by all of the tenants of the shopping centre, but should not be used for expenses which are attributable to less than all of the leasable areas. For example, suppose the power centre consists of a series of clusters of buildings attached to one another and Hydro Québec decides to create a "chambre annexe" to source the power to the premises of each individual cluster. The "chambre annexe" becomes a common area which serves only a portion of the tenants. So if the expenses of one particular "chambre annexe" are charged on a traditional "proportionate share" basis, then since mathematically the larger the denominator the lower the percentage of each tenant's fraction, the landlord would end up collecting less than 100% of the costs. Furthermore, one cannot realistically expect a contribution from a tenant to the cost of a service being provided to other tenants but not being provided to the tenant from whom the contribution is sought. A good example is a free standing restaurant which pays 100% of the cost of utilities for its premises. While it should contribute to the cost of utilities consumed on the common areas in which it shares and benefits, it should not contribute to the cost of utilities consumed in other leasable areas.
 
Consequently, either the landlord should create a separate cost centre for each one of these and charge on the basis of the ratio that the area of the individual premises bears to the gross leasable area of those premises within the cluster, or aggregate all of the clusters and include the leasable areas of the various clusters into the denominator of the fraction. In the writer's experience, it is better to work on a cluster by cluster basis for at least the following reasons:

  • utilities are a function of consumption, which can vary by the nature of the operations. For example, a restaurant will consume considerably greater electricity than would a shoe store. Now if the shoe store was looking at the various cost sharing formulas and saw that there were higher consumers of electricity included in the formulation than its consumption level, it would then reason out that on a pro rata basis, it is really subsidizing the increased electrical consumption of the restaurant and will likely object
  • it is certainly easier to identify and explain the uses by cluster as they tend to be similar in nature
  • there is less room for clerical error when preparing the lease agreements that could lead to financial shortfalls. Suppose for example there is a free stranding restaurant outside of the cluster which is separately metered for electricity. The restaurant will justifiably not want to contribute to the cost of electricity in other premises or to any "chambre annexe" that does not service the restaurant in any manner, as it is paying 100% of the facility in its own right. However, if through inadvertence or whatever, the area of the restaurant is included in the denominator of the fraction, without the commensurable expenses to absorb and offset, then there will be a shortfall or hole in the cash flow to the extent of the proportionate share of the area of the restaurant's premises. The same could be said for roof repairs, particularly where buildings are constructed at different times. The roof, like anything else, has a useful life which will eventually run out. Obviously, the older the building, the earlier the useful life will expire, with the reverse being true for the subsequently built buildings. Now tenants of a future building will not want to contribute to the costs of replacing the roof on the earlier building, especially when the development is being done in phases

Separated centres

Finally, while for marketing purposes, a shopping centre may be seen as one integrated whole, where it is separated by a major thorough fare, the development on each side of the thorough fare should be treated independently of the other. A good example is Carrefour de la Rive Sud in Boucherville, Québec where the north side of De La Touraine is one shopping centre and the south side between De La Touraine and Highway 20 is an entirely independent shopping centre.

Real estate taxes

In Québec, La Loi sur la fiscalité municipale3 determines valuation roles on the basis of what is known as the "unit of assessment". Much to the chagrin of developers of power centres having to deal with tenants wishing to pay realty taxes based upon a separate valuation of the premises or what the taxes would be if the premises were separately valued, Section 34 of the Act describes the unit of assessment as follows:
 
"A unit of assessment consists of the greatest possible aggregate of immovables that meets the following requirements:

  1. the parcel of land or the group of parcels of land is owned by the same owner, or the same group of owners in undivided ownership
  2. the parcels of land are contiguous or would be contiguous if they were not separated by a watercourse, a thoroughfare or a public utility network
  3. if the immovables are in use, they are used for a single primary purpose
  4. the immovables can normally and in the short term be transferred only as one whole and not in parts, taking into account the most probable use that may be made of them

Where the parcel of land or group of parcels of land is not to be entered on the roll, the requirements prescribed in subparagraphs 1 and 2 of the first paragraph are met if the immovables other than the parcel of land or group of parcels of land are owned by the same owner or the same group of owners in undivided ownership and if the immovables are situated on parcels of land that are contiguous or that would be contiguous if they were not separated by a watercourse, a thoroughfare or a public utility network.

Some municipalities have even taken the approach that where the section of the power centre is clearly separated by a major thoroughfare which is or is intended to become municipalized and the practical likelihood of crossover truly minimal, they nonetheless consider this segregated portion as being part of the unit of assessment. So while there may be a temptation to draft a provision whereby taxes would be allocated to the segregated portion and then the tenant would pay a pro rata share of the taxes so allocated to that portion, the allocation process may be so difficult to achieve that the efforts simply may not be worthwhile. This then would necessitate including the taxes from the other areas into the definition of taxes for this segregated area and the denominator of the fraction to be the shopping centre generally.
 
What happens however if there is a lifestyle component in addition to the power centre? The astute retailer likely will not mind being part of the power centre taxes as generally speaking, the values will be reasonably uniform on a per square foot basis. However, in the same way as department stores in malls which have a lower economic value than the CRU tenants refuse to pay a proportionate share of the taxes, as they would in effect be subsidizing the taxes otherwise payable by the CRU tenants, the astute power centre retailer will not want to contribute on a pro rata basis to the taxes attributable to a lifestyle component which, based upon typical principles of assessment, would have a higher per square foot valuation.
 
One way to solve the dilemma is to create a separate unit of assessment for the lifestyle centre, by creating a new lot and transferring this lot into another entity which is controlled by the overall ownership group. Since Section 34(1) requires that the "parcel of land or the group of parcels of land is owned by the same owner, or the same group of owners in undivided ownership", by splitting the identity of ownership or, as emphyteusis is placed on the role on its own right, by creating emphyteusis or right of superficies, this could then carve out the lifestyle component from the rest of the centre.
 
Of course, income tax and mutation tax considerations cannot be ignored and will more often than not drive the decision. Furthermore, the leases will have to be adjusted to take into account the differing ownership structures, dependent again on how terms such as "Shopping Centre and Common Areas and Facilities" are defined. Clearly, the Lifestyle Centre tenants are going to need the common areas and facilities of the centre such as the parking facilities, means of access, egress and so forth as will the box power centre tenants.
 
Local by laws often require that buildings must front on a public street. Now a cluster of buildings such as a power centre which are all owned by the same owner would qualify, even if technically, not every store fronts on the public street. However, once ownership is fragmented, whether internally, or on an arm's length basis for a Shadow anchor, then the issue of fronting on a public street must be addressed in order to cause the development to continue to be compliant with local by laws.
 
Our next issues will be on the question of the use of the premises, exclusivity clauses, continuous operation and discontinuance of operations. Followed by transfer of commercial leases and change of destination which will be developed. A series not to be missed!

 

 

This bulletin provides general comments on recent developments in the law. It does not constitute and should not be viewed as legal advice. No legal action should be taken on the basis of the information contained herein.

 

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