Keeping a Commercial Space From Going to Waste

David Bogoslaw in Legal/Financial on December 11, 2017

Upper East Side, Manhattan

Commercial Space 1

Some boards are allowing once-banned businesses into their commercial space (illustration by Marcellus Hall)

Dec. 11, 2017

Brick-and-mortar retail stores are feeling the heat from the boom in online shopping, and that’s reflected in mounting store vacancies in New York City. Asking rents for ground-floor retail space have fallen in 14 of Manhattan’s 17 most desirable shopping corridors, according to the Real Estate Board of New York. As a result, co-op and condo boards that rely on income from their commercial space are scrambling. 

Afraid that a prime asset will become a liability if commercial spaces sit empty, some boards are reducing rents or accepting once-undesirable businesses, such as bars or gyms. Other boards are trying to minimize risk by locking in guarantees. But what is a fair price for peace of mind

Taking the long view, one Upper East Side co-op signed a 99-year lease with an investor group for a large ground-floor commercial space with multiple shops whose existing lease runs until 2030. The deal provides an upfront payment of several million dollars to the co-op, followed by annual payments of close to $1 million for the next 13 years, until the 99-year lease kicks in. 

Once the new master lease takes effect in January 2030, income from the retail space will be split 60/40 between the operator and the co-op. The new lease also guarantees the co-op a base annual income. If there are vacancies, the risk 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.”

Ira Meister, president of the management firm Matthew Adam Properties, says he’s recently seen some investor groups offering co-ops unrealistically high upfront payments to get them to sign a long-term commercial lease. “They’re offering a lot of money, like stupid money,” Meister says. “I’ve seen offers in excess of $10 million in upfront payments.” 

One reason he’s wary of generous offers is the current slump in New York’s retail market. “If you look at the Golden Mile on Third Avenue between 57th and 79th Streets, it’s like Death Valley,” Meister says. “There are so many vacant stores. And on that line there are a lot of co-ops and condos.” 

Meister recognizes that retail rents are cyclical, but he worries that rich deals may lead to defaults if investors cannot attract tenants willing to pay the rents required to make the leases profitable. If there is a default or a bankruptcy, the co-op would become just another creditor with which the investor would try to re-negotiate its deals.

A co-op in downtown Manhattan managed by Choice New York Property Management is weighing a much more modest offer for a 99-year lease from a Connecticut-based private equity fund. The proposed upfront payment is under $1 million, and the revenue-sharing component is less alluring than a 60/40 split, says Michael Feldman, co-owner of Choice New York, who is advising the co-op on the deal. But it’s for a smaller space than the one in Reich’s building, Feldman says, adding that he doesn’t share Meister’s “stupid money” concerns. “When you look at it on a per-square-foot basis, it seems like a golden ticket,” Feldman says. “But if you actually do the math, it’s not crazy.” 

Reich knows of a few other co-ops that have entered into long-term agreements similar to his building’s, and he expects other deals to emerge as existing leases on commercial spaces expire. Such boards are, in effect, willing to trade a potential future bonanza for long-term peace of mind.

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