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3 Baltimore 12,265,346 14.6 511,516 21.44 17.83
4 Boston 41,914,373 14.9 (1,713,211) 25.52 18.84

5 Charlotte 8,316,639 14.3 115,031 19.54 16.01
6 Chicago 60,274,643 17.5 (2,084,261) 27.92 21.09

7 Cincinnati 9,568,033 15.0 (422,197) 18.57 15.15
8 Cleveland 14,599,859 16.7 (1,206,311) 20.96 18.03
9 Columbus 10,675,469 15.3 (224,831) 18.29 15.91

10 Dallas/Fort Worth 54,393,363 21.2 (1,321,402) 20.35 16.12
11 Denver 26,627,391 17.5 (333170) 19.56 15.84

12 Detroit 23,022,862 16.5 252,904 24.09 19.75
13 Houston 36,379,858 16.8 (1,562,424) 20.57 16.09

14 Jacksonville (Florida) 4,656,598 12.8 214,714 19.16 17.07
15 Los Angeles 47,088,090 12.8 3,627,294 25.67 22.11

16 Minneapolis* 11,995,159 23.1 (698,268) 19.48 17.75

17 New York City 49,894,973 10.3 809,767 47.02 32.53

18 Northern New Jersey 41,461,052 14.8 1,540,882 26.71 20.82

19 Orange County (CA) 15,261,193 12.2 3,872,769 24.56 22.31
20 Orlando 8,589,690 13.8 336,810 20.33 17.79
21 Philadelphia 40,568,678 15.9 (3,559,273) 23.47 18.52

22 Phoenix 17,166,985 15.9 3,250,136 22.15 19.35

23 Raleigh/Durham 7,805,438 17.5 595,488 18.76 15.89
24 San Diego 9,581,579 11.7 1,456,488 29.57 25.27

25 San Francisco Bay Area 55,327,833 17.4 491,690 26.54 22.97

26 Seattle/Puget Sound 16,936,507 13.3 1,190,471 24.53 19.65
27 South Florida 20,395,707 12.7 2,537,962 26.71 21.13
28 Tama/St. Petersburg 10,102,167 12.6 471,460 20.68 16.98
29 Washington 43,624,113 12.0 6,426,232 30.01 26.87

Class A, B, C Class A Class B

Exhibit 18.1 Recent Square-Foot Lease Rates in Major
U.S. Metro Areas. Source: CoStar Group. Inc. *NAIOP


478
479
Real Estate and Facilities

general, operating expenses refer to the actual costs associated with operat-
ing an office building, including maintenance, repairs, management, utili-
ties, taxes, and insurance.
Operating expenses are dealt with by one of two different types of com-
mercial leases, the gross lease and the net lease. According to one author, the
difference between the gross lease and net lease can be explained as follows:

The primary difference between these fundamental lease types is the variation
in responsibility of the payment of operating expenses. At one end of the spec-
trum, the gross lease generally requires the landlord to pay all of the operating
expenses. At the other end of the spectrum, a net lease generally provides that
the tenant will pay a pro rata share, as defined in the lease, of all operating ex-
pense items.4


GROSS LEASES. Under a traditional gross lease, the tenant™s monthly rent
will be higher than under a net lease because the landlord has assumed re-
sponsibility for all of the operating expenses. However, under a traditional
gross lease, the landlord also assumes all of the risk that such operating ex-
penses will increase during the term of the lease. Thus, it should come as no
surprise that landlords today are rarely willing to enter into a traditional gross
lease. Rather, landlords most often attempt to limit their exposure under a
gross lease by inserting provisions in the lease that allow the landlord to off-
set the cost of any future increases in operating expenses. One way landlords
might try to limit their exposure under a gross lease is to insert a provision
that ties future increases in monthly rent to the Consumer Price Index (CPI).
However, because market indices such as the CPI are large scale in nature,
they rarely ref lect the operating expense changes felt by the landlord at a par-
ticular building. As a result, while tying rent increases to the CPI is, from the
landlord™s perspective, an improvement over the traditional gross lease, land-
lords prefer to make any escalation under the lease relate more directly to op-
erating expenses as opposed to the base rental rate.
One way that landlords can accomplish this is to insert an expense stop
into the lease. An expense stop puts a dollar limit on the total operating ex-
pense that the landlord is obligated to pay. Expense stops are usually calcu-
lated on a dollar per square foot basis, which serves as the benchmark
against which future increases in operating expenses will be measured. If,
for example, the landlord agrees to pay $1.00 per square foot in operating ex-
penses and such operating expenses increase to $1.10 per square foot in the
second year of the lease, the tenant would be responsible for its pro rata por-
tion of the additional 10 cents in operating expenses. The expense stop need
not ref lect the actual amount of operating expenses that the landlord is pay-
ing at the time the lease is negotiated. Rather, the expense stop is a nego-
tiable amount that depends in large part on the strength of the commercial
lease market. Thus, the higher expense stop that the tenant can negotiate,
480 The Back Office: Efficient Firm Operations

the better off the tenant will be if there are future increases in operating
expenses.
Another way landlords try to limit their exposure to future increases in
operating expenses is to insert a base year provision into the lease. Similar to
the expense stop, a base year clause provides that the landlord will be re-
sponsible for paying the operating expenses incurred during whatever “base”
year that the parties agree on, and the tenant will be responsible for paying
for any increases in operating expenses that occur after the base year. Again,
because operating expenses are almost always on the rise, it is in the tenant™s
best interest to try to negotiate a lease with a base year provision that is
either the year the lease is executed or the following year, whereas the land-
lord will try to incorporate a base year provision that relates to the year prior
to the lease commencement.

NET LEASES. As opposed to the modified gross lease that establishes a
f loor above which the tenant is responsible for paying operating expenses,
under a net lease, the tenant pays its pro rata portion of the operating ex-
penses. Net leases come in one of three different varieties: net leases, net-
net leases, and triple-net leases. According to the Urban Land Institute, the
difference between these versions of net leases can be explained as follows:

In the net lease, the tenant is usually required to pay its pro-rata share of all util-
ities, ad valorem taxes, and any other special assessments associated directly
with the leased premises. In the net-net lease, the tenant pays its pro-rata share
all of the above costs of a net lease plus its pro-rata share of the cost of the ordi-
nary repairs and maintenance of the common areas and building systems. The
triple net lease usually requires that the tenant pay its pro-rata share of all of the
above costs of the net-net lease plus the cost of certain capital improvements.5

Given the foregoing description of the various types of net leases, it should
come as no surprise that landlords favor the triple-net lease.

GROSS UP. Grossing up is a mechanism that is often employed in an effort
to account for increases in operating expenses when, in the base year, the
building occupancy rate is less than 100 percent. If, for example, in a build-
ing that is 50 percent occupied, a tenant negotiates a lease with an expense
stop or base year provision of $10 per square foot, then without a gross-up
provision, the tenant will be liable for not only the annual increases in oper-
ating expenses that are contemplated when negotiating the lease but also any
increases in operating expenses that are attributable to increased occupancy.
Thus, in the foregoing hypothetical, if the building goes from 50 percent oc-
cupancy in year one to 100 percent occupancy in year two, the operating ex-
penses for which the tenant is liable will increase dramatically, from the
negotiated amount of $10 per square foot to, for example, $13 per foot.
481
Real Estate and Facilities

Although occupancy rates have effectively doubled in this example, because
a significant portion of operating expenses are fixed regardless of occupancy
rates, operating expenses will increase by only a fraction of the increase in
occupancy. Examples of fixed expenses include security, garage expenses,
landscaping, and insurance, whereas variable expenses include items such as
repairs and maintenance. If, in calculating the expense stop or base year, the
landlord had grossed up expenses as if the building were fully occupied, the
tenant might have been able to negotiate a higher expense stop or base year.
Thus, in considering the rental rate and expenses that are within the pro-
fessional services firm™s budget, the firm should confirm that any expense stop
or base year provision is based on a grossed-up operating expense figure. Fur-
ther, regardless of the manner in which the gross-up calculation is performed,
the tenant should insist that the landlord be precluded from recovering more
than 100 percent of its actual operating expenses in any given year.

Property Inspection/Walk-Through
Once a list of potential office buildings has been narrowed down, the next
step is to arrange meetings with the appropriate leasing agents and landlords
to conduct building inspections. Many of the things that the firm considers
when conducting the physical property inspections are similar to the topics
that the firm should have reviewed on paper. Nevertheless, to confirm or
dispel any conclusions that the firm reached based on preliminary due dili-
gence, it is important that the firm take into account each of the following
considerations when touring potential office space.

FUNDAMENTAL ASPECTS OF THE BUILDING. Are the building and pro-
posed office space consistent with the image the firm is trying to project?
While the design, finish-out, and furnishings can have a dramatic impact on
the overall ambience and feel of the office, there are certain immutable
things that the potential tenant cannot modify or which can be changed only
at great cost. The fa§ade of the building, natural lighting, landscaping, and
access to parking (both tenant and visitor) are all factors that should be con-
sidered when conducting the physical inspection.

COMMON AREAS. Bear in mind that the first thing a client or potential
client is going to see when entering an office building is the foyer. Pay atten-
tion to the quality of the finish-out in the foyer and other common areas in
the building. Additionally, note whether there is a tenant directory in the
foyer, as well as an information/security desk.

PROPERTY MANAGEMENT/MAINTENANCE. During the property inspec-
tion, note the general appearance of the interior of the building and the level
of upkeep/maintenance. Although this should not be a problem in most Class A
482 The Back Office: Efficient Firm Operations

buildings, different property management companies have different styles
and provide different levels of service. If the other tenants in the building
have had problems with the building manager or it appears that management
is not maintaining the building sufficiently, this alone might be a reason to
rule out a particular building. On the other hand, if there have been prob-
lems with the building management, but the owner is committed to rectify-
ing the situation by, for example, switching management companies, it might
be a nonissue.

CURRENT OFFICE DESIGN. Although a cursory review of the office lay-
out can be undertaken on paper, pay attention to the location of the interior
walls, size of the offices, and whether significant improvements will need to
be made before taking possession.

ELEVATORS. When touring an office building, note where the available of-
fice space is located in relation to the elevator bank. If the firm is not going
to lease an entire f loor of an office building, it may be important for the firm
to be located close to the elevator bank so that it is one of the first offices
that clients and potential clients see. Although the f loor plan should depict
where the office space is located vis-à-vis the elevator bank, the tour should
give a sense of the exact location and whether the exposure is optimal.

TAKE NOTES. Whoever participates in the property tour on behalf of the
firm should bring along a notepad or a form to complete during the property
inspection because it is often difficult to remember details about each par-
ticular building as the tour proceeds. Notes will prove valuable when dis-
cussing the options with members of the firm who may not have participated
in the property inspection.

MAKING A DECISION. Once the property inspection has been completed,
the firm is ready to decide which building or buildings best suit the firm™s
needs. This decision is typically made by the management of the firm; how-
ever, management should consider getting the input of all, or at least a por-
tion of, the professionals and employees at the firm. While the firm cannot
please everyone with its selection of office space and location, conducting a
survey or poll of the firm™s employees will, at a minimum, make employees
feel as though they had a hand in the decision and are part of a firm that con-
siders their opinions when making a major decision such as office location.

Negotiating the Lease
Once the firm has decided which building meets its needs and requirements,
it is time to initiate lease negotiations with the landlord. The process of ne-
gotiating a lease typically begins with the potential tenant sending a request
for proposal (RFP) to the landlord, spelling out the firm™s business needs.
483
Real Estate and Facilities

The landlord will counter with a response to the RFP, and, assuming that the
parties can come to an agreement on the business terms of the deal, the par-
ties will enter more formal lease negotiations.

THE REQUEST FOR PROPOSAL PROCESS. The RFP is the first opportu-
nity for the professional services firm to more formally convey to the poten-
tial landlord its business needs and requirements. Many, if not all, of the
conditions contained in the RFP will be derived from the preliminary as-
sessment and building inspection that the firm undertook. Depending on the
level of sophistication and detail of the preliminary analysis, the firm should
try to include in the RFP as many of its key business requirements as possi-
ble. Thus, for example, the firm should include in the RFP, at a minimum, its
initial rental rate offer, the manner in which the firm is willing to pay for op-
erating expenses, the firm™s parking needs, the term or length of lease that
the firm is willing to enter, and the size of the office space required.
In many cases, the RFP will also include additional requirements or speci-
fications that the firm may not have considered preliminarily, but which will
most assuredly be picked up in the lease. Examples of such provisions include
options to extend or terminate the lease, assignment /subletting provisions, se-
curity deposit and prepaid rent provisions, and insurance requirements.
It is important to include in the RFP as many important lease provisions
that the firm can identify because the RFP forms the basis of all future lease
negotiations. Thus, for example, if the firm does not include in the RFP a
right of early termination, it will be very difficult to try to go back and add
such a provision to the proposed lease. In such a situation, the landlord
would almost certainly feel that the firm was trying to retrade the deal by in-
corporating provisions that the firm had not contemplated or deemed impor-
tant enough to include in the original RFP. As would be true with any other
type of contract, in this situation you would expect the landlord to be very
reluctant to add or delete important business terms in the 11th hour of the
lease negotiations.
Although the professional services firm may have never submitted an RFP
for commercial office space previously and is unfamiliar with all of the terms

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