Updated: Jul 9
One of my guiding principles has always been: Do not guess, do the math. I had the great fortune of presiding over the billing of over 30,000 leases. In those leases were approximately 800 different clauses just for real estate taxes.
Landlords and management companies across the country struggle with a seemingly simple process: Quote rates. What psf figure should we quote for tax? What about CAM (if not fixed)? For renewals, the process is simple: what are they paying now? But for new leases, leasing agents usually want one figure. That is not reality. Why? Simple: what will the lease say? Not all “pro rata” clauses are created equal.
As noted above, there is leakage all throughout the process. Quote rate ===> Final Lease. Final Lease ===> Settlement Billing. Educated guess, for the entirety of the CRE industry I would estimate that the amount of leakage that comes from quote rate to final lease combined with incorrect billing of leases may well be in the order of magnitude of the largest NOI centers in the country. The leakage due to quote rate loss I would gather no landlord in the country knows that definitively.
The problem? We do this to ourselves and the problem is - no offense ladies and gentlemen – well intentioned leasing agents and lawyers.
Optimization: If CRE truly wants to maximize efficiency enabled by technology, then this effort muststart with the lease itself. It does not mean you cannot work with tenants. However, that process of legal negotiation leaves money on the table. It costs time and legal costs ($$), and it costs real $$ in the lease itself. The right solution that no one wants to tackle is standardizing the lease.
Note to tech: I am sorry but NO OCR technology nor even AI in the foreseeable future will ever be able to interpret and properly set up a commercial lease. If you think so, then you have never billed a commercial lease. Let alone the variabilities in rental commencement dates. However, there IS a way to do this. Standardized language and at the same time still giving options.
Creating Options: For example, say you have 3 different clauses with billing impacts. 5 sets of standard lease language for each clause = 5 x 5 x 5 or 125 different lease combinations. 2 clauses? 5 x 5 = 25. That seems like you can “work with your tenants.” Furthermore, by having only 5 options, it is far easier to ask accounting & finance to provide updated quote rates for those with far greater accuracy. Change the lease language in negotiation? Tell the tenant you need more rent – they have changed the deal from what was quoted.
How to solve the problem:
Review the Data: Take a hand full of properties and review the final settlement billings. Organize the data in terms of psf and review the frequency of the rates psf. Each psf will likely correspond to a different lease language. You will likely have 2-3 rates that are most common with a smattering of one-offs.
Review the Leases: Take the leases and review the clauses for comparability for those that have the same rate psf.
Quantify the impacts: Go back to the data. Now ask yourself, is modifying the lease language for the one-off’s really worth it to impede optimization of the overall process? How much wasted time is there on both sides of the table as well-intentioned lawyers went back and forth for weeks over…$0.05 psf? Also, look for language to the positive as well - are there any opportunities?
Pick your language: Once you review these rates and language – pick the lease language you want to use for your standard language.
Other Considerations: Please keep in mind that any numerical figure such as a cap growth percentage or an occupancy floor percentage is far easier to program and to even provide a calculation to allow leasing/legal to adjust on the fly. This also gives you infinite flexibility. For non-rate psf language – such as termination options – this becomes a more manual process but still the same idea - pick language and stick to it.
Once you have the lease language options and the standard rates, you can tell your tenants with certainty what those rates mean in the lease drafting process. Successful CRE companies having great cohesion between leasing, legal and lease abstriction & billing. With the outcomes for each clause type minimized, you can optimize the tech and the process as a result.
Tech companies – if you want a challenge on your OCR technology applied to commercial real estate leases, then I will happily grab some friends and come audit your abstracted leases. One condition: I get to keep the findings (including cap rates applied) but promise that I am open to stand corrected.
pssst! Tenants – negotiate hard after the LOI.
Contact Thurston Advisory & Consulting - firstname.lastname@example.org
Optimizing real estate process for better improved operations