Let’s take a quick look at the four most common types of commercial leases: gross, modified gross, triple net, and bond lease. Which one is right for the deal you’re trying to complete?
Brokers and landlord reps use of the escalation clause in a commercial space lease is a common one. These clauses provide for increases in rent over a specified period of time. Often, these increases are determined not by actual increases in the landlord’s operating costs, but are instead keyed to an index, such as the consumer price index (CPI) or the London Interbank Offered Rate (LIBOR).
Longer-term office leases so often involve the landlord’s lender that negotiations over lease provisions can seem to be between a tenant and lender rather than tenant and landlord. When a lender is in a position of underwriting the cash flow of a building, it’s that lender’s job to scrutinize closely the creditworthiness of a prospective tenant.
And therein lies the rub these days. The capacity of lenders to scrutinize creditworthiness has been called into very stark question thanks to a continuing series of scandals and financial meltdowns, the latest of which probably directly affects the lease on your table today. The LIBOR number — an interest rate that drives the rent escalation clause math in untold numbers of commercial space leases — looks like it is, was, and continues to be, in a word, rigged by banks. Banks, under investigation for engaging in book-cooking to cover their derivatives traders and to pretend to the wider market that the cost of money is lower than they actually pay, have distorted the LIBOR number to the point that holders of financial transactions that are keyed to it are hurriedly reviewing their portfolios in a hunt for lost money. And there’s plenty to find — LIBOR lives in the beating hearts of $350 trillion worth of contracts according to the Financial Times.
Going Up? No, actually
One argument about LIBOR in commercial space leases is that the bank scandals benefited tenants at the direct expense of landlords using escalation clauses tied to LIBOR. If, as allegations claim, starting in 2007, large banks began underreporting their costs of borrowing in order to stave off a rising sense of panic in the credit markets, that means that during those quarters, commercial landlords using LIBOR indexing in their escalation clauses were left holding the bag on rent — charging tenants less than they would have been due under the lease terms had LIBOR not been corrupted for the purposes of the banks’ charade.
One of the truisms in this business for both prospective tenants and landlords is to protect yourself — to secure your own representation at the deal table or otherwise run the risk of having your interests overlooked. But when our pinstriped friends the bankers are at the same table, offering both sides index numbers that amount to broken instruments designed to cover some derivative trader’s rear end instead of either the tenant or the landlord’s — how do you protect from that?
(Photo credit: Jeremy Brooks)