David Bogoslaw in Bricks & Bucks on September 20, 2017
Online shopping is putting a hurt on brick-and-mortar retail. Store vacancies are up in New York City, especially on tony Madison Avenue. Asking rents for ground-floor retail space have fallen in 14 of Manhattan’s 17 most desirable shopping corridors. As a result, co-op and condo boards who rely on income from their commercial space are scrambling. Some are cutting rents. Others are allowing once-banned businesses, such as restaurants, bars, or gyms. And a few are striking innovative long-term leases.
Take one Upper East Side co-op that has signed a 99-year lease with an investor group for a large ground-floor commercial space whose existing lease runs until 2030. The deal provides an upfront payment of more than $1 million to the co-op, in addition to the locked-in annual income of close to $1 million for the next 13 years.
Once the new master lease takes effect in January 2030, income from the retail space will be split 60/40 between the co-op and the operator. The new lease also guarantees the co-op a base annual income in the event of vacancies, the risk of which will fall solely on the investor group.
The agreement gives the board a clear idea of “the worst-case scenario for budgeting,” says attorney Jeff Reich, a partner at Schwartz Sladkus Reich Greenberg Atlas, who represents the co-op’s board. “They’ve protected their downside and will achieve some of the upside.” The board, he adds, was “willing to take a little less in terms of base rent and a little less upfront in order to be able to participate in the increased revenue streams that someone is able to derive from this asset.”
Reich knows of a few other co-ops that have entered into similar long-term agreements in the last year, and he expects other creative deals to emerge. Boards are, in effect, willing to trade a potential future bonanza for long-term peace of mind. Some, however, question the wisdom of the trade-off.
“The co-op may feel it doesn’t have the capacity to lease the space, to manage the tenants, to manage the whole process – and this [investor’s] going to take that off their plate,” says Adelaide Polsinelli, principal and senior managing director at Eastern Consolidated, a commercial brokerage. If a co-op wants relief from the daily headaches of managing commercial space, she adds, a managing agent could handle those, while a good broker would be able to lease the space, vet tenants to the co-op’s liking, and mitigate any risks regarding tenants and their financials.
“Usually, once you give up your right and assign a 99-year lease to a third party, that third party can put whoever he wants in there,” she warns. “It depends on what your agreement is with him. Before engaging in this relationship, a board should put the lease out for bid to make sure they are getting a competitive price for the lease and not leaving money on the table.”
Polsinelli cautions boards against signing long-term leases on their commercial space in exchange for a quick infusion of cash. Reich says that the money from the 99-year lease was “very timely” for the Upper East Side co-op.
Polsinelli recommends, at the very least, that co-ops protect themselves by negotiating Consumer Price Index increases and rent resets into long-term commercial leases – and by never agreeing to a flat rent for the term of the lease.
The lease agreement should also specify what would happen in the event of a default, Polsinelli says, because if the operator can’t get tenants and the space is vacant, it makes the building look bad. “When you give away control of the ‘face,’ so to speak, of the co-op to an entity that has no vested interest in any other part of the property,” she says, “you’re giving away more than just the value of the retail. It can have an impact on the value of the apartments above.”
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