Weighted Average Occupancy and the Gross Up Clause

All of the office leases that I have been involved with through the years include a gross up clause (usually 95%).  The gross up clause applies to the operating expense reimbursements tenants pay as a part of their triple net or base year lease.  The distinction in the type of lease is important.  Certain leases, single net, double net and full service (also known as a gross lease) do not contain an operating expense reimbursement clause.  42floors has a good overview of the different types of commercial leases.

The operating expense reimbursement is a payment that occurs in addition to the base rent the tenant pays. At the beginning of each year, an operating expense estimate is provided to each tenant with their annual rent letter detailing the monthly payment based on the current years budget.  Each tenant pays an amount based on the percentage of the building they occupy. An example might help explain this better:

Rent Letter Sample

The sample rent letter above outlines the annual payments for the tenant on a monthly basis.  In this example, the tenant’s lease is a base year lease, meaning the tenant pays for the increase in costs above the base year as established in the lease (which is typically the year the tenant moves into the building unless they negotiated a new base year during a renewal).  This $250,000 increase is multiplied by the tenants proportionate share of the building, 2.00% (3,000 RSF / 150,000 RSF = 2%).  Divide that number by 12 and you have the monthly operating expense payment the tenant pays.

Where the Gross Up Comes In…

The gross up clause (let’s use 95%) affects the $250,000 escalation number. In instances where the Weighted Average Occupancy of a building is less than 95% (in some leases this number is 100%), then variable operating expenses (those expenses change as a result of more people being in the building) are grossed up as if the building were 95% occupied. Variable operating expenses would include expenses such as utilities (electricity, water, gas), cleaning costs and supplies, and trash removal. Expenses that do not change as a result of occupancy are taxes, insurance, landscaping and some repair accounts.

The variability of operating expenses can be challenging to figure out. In a suburban campus setting, using the operating expenses from a vacant building is the ideal scenario. In a high-rise office tower, it gets more complicated. One approach to determining the variability is by measuring the operating expenses of a vacant floor. With some adjustments, the cost to operate the building when vacant can be reasonably determined. The same method can be done in reverse for a full building and once you have the respective expenses you can determine the variability.

Putting the expense variability aside for the time being, a high level example may help explain the impact of grossing up the costs a bit better[1]:

Occupancy

Actual Costs

Tenant’s Share

Other Tenants

Landlord’s Portion

 100% $10.00  10% = $1.00 90% = $9.00 $0.00
 50% (no gross up clause) $5.00  10% = $0.50 40% = $2.00 $2.50
 50% (with 95% gross up) $5.00  10% = $0.95 40% = $8.55 $0.50

When the property is 50% occupied, the $2.50 that would be the Landlord’s costs shrink to $0.50 with the gross up provision.

Is This Just Good for the Landlord?

While the gross up clause seems to favor the landlord, it does protect the tenant from receiving significant bumps in the operating expenses charges each year.  In the instance of a base year lease, the tenant pays only for their percentage share of the escalation above the base year costs.  As long as the base year costs are also grossed up, the tenant shouldn’t experience a huge increase in their operating expense charges. This method also makes it easier for the tenant to budget for rent related expenses.

How the Weighted Average Occupancy Fits Into This

How do you know if the building is 95% occupied? It’s not simply a matter of comparing the total occupied square feet to the total rentable square feet at the end of the year.  The percentage of time occupied also needs to be considered. This is where the Weighted Average Occupancy calculation comes into play.  With each tenant, the percentage of the year occupied is calculated and then multiplied by the tenants proportionate share of the building. Thus if the 3,000 RSF tenant we saw at the beginning occupied the building from January 1 – September 30 we would take that into account for the total occupancy calculation.

The math looks like this: (3,000 RSF / 150,000 RSF) * 75% (occupied Jan – Sep) =  1.5%.

Tenant’s proportionate share of the building * Percentage of time occupied = Percentage contribution to the overall building occupancy for the year

The sample tenant would contribute 1.5 percentage points towards building occupancy for the entire year.  Adding together that same calculation for the remaining tenants in the building will result in the Weighted Average Occupancy. And, if it’s less than the gross up percentage in the lease, then there’s further gross up work that needs to be done. If occupancy exceeds the gross up percentage, then the actuals are used for the operating expense estimates and eventually reconciliations.

 

References:

[1] Holland & Hart has a good post on Gross Up Provisions. I borrowed the table above from their write up (with a few modifications).

Do The Work (Book Review)

A few years ago I set a goal to read a book a week for the year, 52 books total. I loved it. I read so many books on business, leadership, self improvement I surely became a better person/leader/husband by the time the year wrapped. While I haven’t kept up the 52 books a year goal, my passion for reading continues. I’m more strategic about reading now. It’s no longer a matter of getting a large quantity of books read. It’s about reading quality books and taking appropriate notes that can be referenced and reviewed in the future to remind myself of the primary principles in the book.

The other night, I finished reading Do the Work by Steven Pressfield. It’s a super quick read – less than 100 pages with some sentences in 20+ point font. Despite the lack of words (and probably the worst book cover I’ve seen), the content is exceptional.

Over the years, I’ve had a lot of various side projects or good ideas that I’d like to execute. Sometimes – to the detriment of my personal growth and development – those good ideas don’t get out of the idea stage. It could be for a number of reasons, but one key reason is resistance. And resistance, what it is, how it works and how to overcome it, is the heart of Steven’s book.

Do The Work is written with the context of helping you work through a project. The primary focus is with writers, but really the concepts could be applied to any project. The book starts with an orientation on our enemies and allies. The list of each is really quite ironic. Enemies include: resistance, rational thought and friends and family. Allies include stupidity, stubbornness, blind faith, passion, assistance (the opposite of resistance) and friends and family. To start, we must understand how resistance instills negative thoughts, questions, and discomfort when we are pursuing that new idea or being vulnerable.

Resistance comes from “any act that rejects immediate gratification in favor of long-term growth, health or integrity.”

With the orientation of the good and bad complete, the remainder of the book is broken down into three distinct sections (Beginning, Middle and End – no joke) with motivational and inspirational quotes scattered throughout.

The Beginning

The beginning is about starting. Putting words to paper. Not over analyzing. Not researching. Just letting the thoughts flow. And while you’re at it, swing for the seats. Think big, plan quickly and get going. Don’t let the resistance creep up. If it does, recognize it and shut it down. Doing everything you can to ignore any sign of resistance is key in creating momentum.

The Middle

Now that the momentum is going and progress is being made, gradually start to think about the work you are doing. Start to fill in the gaps. Continue the progress, don’t stop the work from happening, but fill in the gaps as they come up. All the while, be ready for the resistance to creep back up. Finally, be ready for what Pressfield terms as “The Big Crash.” You start to second guess your work. You share your product with others and they hate it. Recognize this will happen, identify the problem, fix it and move on.

The End

Finally, the end. Now it’s time to ship (Seth Godin is all about shipping). Overcome the fear of rejection. Set aside thoughts of being judged. Not shipping is resistance last final effort. Finish it and ship it.

Again, great book, full of inspirational quotes will motivate you to work on that project. Probably something that is worth revisiting multiple times throughout the duration, just as a reminder of how resistance can affect those goals that could make a significant impact in your life.

Prospecting with ProspectNow

One of the sponsors of CRE // Tech Intersect in SF this year was ProspectNow.  The site, most likely developed with commercial brokers in mind, culls together a ton of public information on commercial assets that ultimate leads to the key contacts for those assets.  [As an aside, the conversion of CRE and technology seems to be targeted mainly towards the brokers - both making their jobs easier and cutting them out of the loop.]

You can see why this information might be valuable… knowing who the decision makers opens the door to potentially earning their business.  Before sites like ProspectNow, this information was gathered via business relationships.  Now, there’s the potential to expand the potential business prospects without calling in a ton of favors.

As I mentioned last week, new business is a key factor in growing a real estate career.  The post covered the management side of the business, but frankly it’s true regardless of what you’re doing.

ProspectNow pitches itself as an “online commercial real estate database of six million building owners, including phone numbers, mailing addresses ,building details and 30 million tenants.” To get a better handle of what exactly this means, I took it for a spin.

My primary interest is in building ownership… specifically those that own buildings and hire firms to manage the asset.  I firmly believe the work we are doing in Pleasanton can be replicated at other assets to improve their performance, occupancy and value. To prove this, I need to find the right people to talk to.

I setup a trial account with access to data in the local county.  The first county is included in the monthly $89 fee, each additional county is an additional $10/month. There are other nuances with the pricing structure that I didn’t see spelled out on their website. Credits are distributed each month to be used for obtaining phone numbers and email addresses.  More credits can be purchased.  Likewise, exporting data is limited to credits on hand.

ProspectNow - Searching

Using the comprehensive search, I looked for commercial office projects over 100,000SF in size.  The search returned a list of the assets in the county in a map and table.  As I clicked through each property, I’m able to identify the ownership entity and in some cases the individuals associated with that entity.  For the larger assets, it’s hard to know for sure if the person and contact information listed is accurate. In many cases, the ownership entity may include registered agent information and not the asset manager that manages the day to day decisions. This was the case for the properties I’m currently involved in.

ProspectNow - Search ResultsProspectNow - Buidling Owner

The four properties that make up Pleasanton Corporate Commons are listed individually, all with the same ownership entity (an LLC not directly associated with the REIT that owns the project).  The address of the LLC in ProspectNow brought up the registered agent in Carlsbad, CA. I wasn’t able to tie the project back to the company or people who I deal with directly.  But that’s not always the case, the office project next to PCC has the contact information listed and the appropriate people to contact. So, some assets will likely be duds, while others will put you directly in contact with the people you want to talk to.

I’m encouraged by the data ProspectNow put together and plan to test several of the leads I pulled from the site to see how well it does work.  Having the opportunity to tell our story to other office owners would be well worth the monthly investment.