Chapter 6 — Exercises

Thirty-five problems, graduated from recall through applied judgment. Items marked with a dagger (†) have worked solutions in the Answers to Selected Exercises appendix — try them before you look.

Do the arithmetic by hand or in a spreadsheet. A lease is a document you will read four times in ten years and pay every month for a hundred and twenty of them; the arithmetic is worth doing slowly once.

Every scenario in this set is a constructed teaching example. Lease law and construction practice vary enormously by jurisdiction — nothing here is legal advice, and a real lease requires a real attorney.

A. Recall and definitions (1–9)

1. Define second-generation space. Name three systems you typically inherit in one, and state the specific hazard attached to each.

2. What are the three "nets" in a triple-net lease? Which of the three is most likely to move from year to year, and why is that the one you negotiate protections around?

3. † Explain the difference between a natural breakpoint and an artificial breakpoint in a percentage-rent clause. Which one generally favors the tenant, and under what circumstance would the other be preferable?

4. What is a good-guy clause? State precisely what it limits and two things it does not forgive.

5. Define change order and name the five categories described in §6.6. Which is the only category fully under the operator's control?

6. † Explain why the rent commencement date can be worth more than a dollar a foot of base rent. Give the three common formulations in order of tenant-friendliness.

7. What is a punch list, and how is it connected to retainage? Why does releasing retainage early cost you leverage?

8. Distinguish the construction contingency from the working-capital reserve (Chapter 1). What goes wrong when an operator treats them as one pot?

9. What is a co-tenancy clause, in what kind of property is it most standard, and what is the usual remedy when the condition fails?

B. Occupancy, rent, and escalation arithmetic (10–18)

10. † A space is 3,400 square feet at \$24.00 per square foot base plus \$8.25 per square foot NNN. Compute the all-in annual and monthly occupancy cost. If the restaurant forecasts \$1,380,000 in first-year sales, what is occupancy as a percentage of sales?

11. Using the space in problem 10: what annual revenue would be required to hold occupancy at 6.5%? At 9.0%? State in one sentence what the second figure tells an operator about the risk in this lease.

12. † A landlord proposes \$30.00 per square foot on 2,600 square feet with 3% annual escalation. Build the ten-year base-rent schedule and total it. Then build the schedule for a **\$1.25 per square foot step every two years**, starting at \$30.00, and total that. Which is cheaper, and by how much?

13. A lease carries percentage rent of 7% over a natural breakpoint. Annual base rent is \$96,000. Compute the breakpoint. If the restaurant does \$1,640,000 in sales, compute the percentage rent owed and the total rent for the year (ignore NNN).

14. † A tenant occupies 2,900 square feet and pays a CAM estimate of \$4.75 per square foot. The year-end reconciliation comes in at \$5.90 per square foot. Compute the true-up invoice and the new monthly estimate. Then answer: does this event hit the P&L or the bank account first, and in which month?

15. Bellwether's three months of free rent is worth \$23,800 because it abates base rent and NNN. What would it be worth if the lease abated base rent only? Show where the difference comes from.

16. † A 2,800-square-foot space is re-measured after four years and found to be 2,660 square feet — 5% less than the lease states. At \$34.00 per square foot all-in, how much has the tenant been overpaying per year? Over a ten-year term at a flat \$34.00? What should have prevented this?

17. A restaurant carries \$118,000 of annual occupancy cost and serves 240 covers a week for 50 weeks. Compute rent per cover. Now recompute if covers come in 15% below plan. State what an operator can and cannot do about the difference.

18. For Bellwether's \$95,200 of annual occupancy cost, build the required-revenue table: what revenue is needed to hold occupancy at 6%, 7%, 8%, 9%, and 10%? Which row would you put in a business plan as the honest planning floor, and why?

C. Build-out, contingency, and change orders (19–25)

19. † A general contractor's stipulated sum is \$318,000. Soft costs (architect, engineering, permits, utility fees) are \$41,000. The operator wants a 12% contingency computed on hard cost. Compute the total construction budget and express the contingency as a percentage of that total. Explain why those two percentages differ.

20. Same project. The operator can only fund \$375,000. Two options: reduce the contingency to \$16,000, or value-engineer \$22,160 out of scope and keep the full contingency. Show that both reach \$375,000, argue for one, and name three specific things you would and would not cut.

21. † Cost this change-order log against a \$28,000 contingency. Compute the running total after each entry, identify the week in which the contingency is exhausted, and state the final overrun.

22. Categorize each of the eight change orders in problem 21 as concealed condition, authority-required, design error, allowance reconciliation, or owner-requested. Which were controllable, and what is their total?

23. † A build-out is budgeted at \$142 per square foot on 3,100 square feet. Compute the budget. The lease provides a \$60,000 tenant-improvement allowance paid on completion against paid invoices and lien waivers. How much cash must the operator have available during construction — and explain why that is a different question from whether the project is funded.

24. Bellwether's construction line is \$310,000, of which \$264,000 is the contract sum and \$9,000 is contingency. If net change orders run 12% of the contract sum, compute the overrun against the contingency. Given that the \$310,000 line is fixed by the project budget, name three places the money could come from and state the cost of each.

25. † A what-if on Figure 6.5, not a prediction: suppose the mechanical scope that carried an \$18,000 allowance re-bids at \$52,000, and the plumbing scope that carried an \$8,000 allowance re-bids at \$19,000. Compute the total increase. Against the \$9,000 contingency, how much must be found elsewhere inside the \$310,000 line?

D. Reading documents and finding the leak (26–30)

26. † Read this lease abstract. Compute the year-one all-in occupancy cost, then identify the five clauses that will cost this tenant the most, and say what each one costs or risks.

LEASE ABSTRACT — 2,400 sq ft in-line space, suburban center   [constructed teaching example]
  TERM              10 years. No renewal options.
  BASE RENT         $31.00/sq ft
  ESCALATION        4% per annum, compounding
  NNN (est.)        $9.00/sq ft. No cap. No audit right. No exclusions stated.
  PERCENTAGE RENT   6% of gross sales over an artificial breakpoint of $900,000
  FREE RENT         2 months, base rent only
  RENT COMMENCES    45 days after delivery of possession
  TI ALLOWANCE      none
  PERMITTED USE     "operation of a full-service Italian restaurant"
  EXCLUSIVE         none
  ASSIGNMENT        landlord consent in landlord's sole and absolute discretion
  GUARANTY          full personal guaranty, unlimited, entire term
  RELOCATION        landlord may relocate tenant to comparable space on 90 days' notice
  CONTINUOUS OP     tenant shall operate 7 days, 11:00 a.m. to 10:00 p.m.
  HOLDOVER          200% of last month's rent, month to month

27. Using the abstract in problem 26, compute the total base rent over the ten-year term at 4% annual escalation on 2,400 square feet starting at \$31.00. Compare it to what a flat \$36.00 per square foot would have cost over the same ten years, and say which you would have preferred.

28. A tenant's lease says rent commences on "the earlier of (i) opening for business or (ii) 120 days after delivery of possession." Construction takes 190 days. All-in rent is \$8,600 a month. Assuming no abatement, how much rent is paid before a single guest is served? What would the figure have been if rent commencement were tied to the certificate of occupancy?

29. † An operator tells you: "My occupancy is 5.9%, so rent isn't my problem." You then notice that the 5.9% was computed against next year's forecast, which assumes 14% sales growth over the year just completed. Diagnose the statement precisely, compute what occupancy actually was last year, and state the one question you would ask next. (Use \$106,000 of annual occupancy cost and \$1,796,610 of forecast revenue.)

30. A restaurant has an excellent rent and a continuous-operation covenant requiring seven-day service from 11:00 a.m. Their Monday and Tuesday lunch services each lose \$340 a day. Over 50 weeks, what does the covenant cost? Name three things the operator could try, and state the one that requires the landlord's signature.

E. Judgment, writing, and the Business Plan (31–35)

31. Write the policy. Draft a one-page change-order control policy for your project, to be signed by you and the general contractor at the pre-construction meeting. It must cover: written authorization, pricing before performance, the running log, who may approve what dollar amount, the owner-change freeze date, and how the contingency position is reported.

32. † Write the memo. Draft the counter-proposal section of a letter of intent covering three terms: escalation, CAM protections, and rent commencement. Three short paragraphs, business language, no legalese, and a stated rationale for each ask that a landlord could actually agree with.

33. Judgment and ethics. Two situations, one paragraph each.

(a) Your general contractor suggests starting demolition "under a maintenance permit" while the building permit is still in plan review, to save three weeks. He says everybody does it and the inspector is reasonable. What do you do, and what do you say to him?

(b) The broker who found you the space — the listing broker, paid by the landlord — advises you not to "nickel and dime" the landlord over the good-guy clause because it will sour the relationship. Evaluate the advice, the incentive behind it, and what you say.

34. † Business Plan extension. For Bellwether — or for your own concept, if you are working Appendix C — build the Site & Lease summary table: premises, term, base rent, NNN, escalation schedule, all-in Year-1 occupancy, occupancy as a percentage of the forecast, and the required-revenue inversion at 6%, 7%, 8%, 9%, and 10%. Then write the two-sentence honest caption that belongs underneath it.

35. Business Plan extension. Write two paragraphs for the plan's risk section. The first states the personal-guarantee exposure in dollars, explains how the figure was computed, and names what would have to be true for it to be called. The second states the contingency weakness — \$9,000 against a \$264,000 contract sum — and says what the partners will do about it. Neither paragraph may be reassuring; both must be accurate.