The developer also gets to deal with the fact that virtually all commercial real estate loans have call provisions. Meaning that even though the loan may be amortized over 25 years, and everything is going well, at the five- or seven- year mark they get to take a peek and see if they still like you and everything that’s going on. The bank basically calls the loan due. The bank will underwrite the loan all over again. This may result in a change in terms, or a requirement to buy down the principal amount of the loan if the ratios are out of line.
Land rent, percentage rent, and escalations
When there is a developer between the tenant and the airport, it is a virtual certainty that the tenant will have to pay more to be in business than if the airport did the project itself (assuming costs are the same). The developer needs to be reasonably confident that it can make a profit over the holding period by leasing up the project, and either keeping it or selling it to a long-term investor.
The developer will most likely include land rent in its CAM (common area maintenance) charges to the tenants in multi-tenant buildings. A typical retail layout may have a floor area ratio (FAR) of .25, meaning the rentable building square footage covers one-fourth of the land area. Therefore if land rent is one dollar, the tenant is paying four dollars per square foot plus all other common charges.
It’s always interesting to know how an airport sets the land rent per square foot. Is it a result of some formula that generates an amount to recover costs; is it arbitrary; or is it market value? If its market value, how is that determined? A range might be six to eight of the value of the land per year. But then the trick is to determine what that value is. One could obtain an appraisal or a broker’s opinion to determine the value. Whatever the rate the airport charges the developer, the developer will most likely want to increase that rate to the end-user to recover improvement costs and to make a profit.
Percentage rent could be applied to gross revenue received by the developer (which they really hate), or more typically require each end-user to pay the percentage rent directly to the airport, since different uses may result in different rates.
Escalation provisions in a short-term tenant’s lease can generally be dealt with by the end-user agreeing to pay a fixed stair step of increases, or base it on increases in the consumer price index (CPI) or a fixed percentage. This leaves the risk of undefined rent escalations imposed by the airport with the developer. Fixed increases on a long-term lease can sometimes get out of hand, and it may make sense to negotiate a “market rate” reset periodically during the lease.
Some airports want somewhat open-ended language regarding escalations due to their own requirements. This requires some real explaining to the bank and the developer as to why this won’t be a problem. And that is always the position taken. No problem. The bank, developer, and long-term tenants do have a problem with this. The developer wants to pass it straight through to the tenant, but the bank wants to be sure the tenants are strong enough to handle undefined future rent increases.
In a nutshell the bank needs default language that allows it to step in and take over the project if the developer fails. And do it without taking any kind of title to anything, and be able to then transfer everything to a new developer without a whole lot of interference from anybody. It needs to be able to step in and cure any money defaults, but perhaps not be required to perform all non-monetary obligations the developer was required to do under the lease. This is a major over-simplification of the issue, as there are many elements that go into the default provisions, but if there is a default the lender needs to be able to act in a timely manner to preserve the asset.
We developers know the airport needs a relocation provision whereby they can terminate the lease, as unlikely as it is that it should be required. Developer and lender will need some formula for this. Does the airport agree to pay an amount equal to the remaining balance after straight-line depreciating the project over the term of the lease? It may or may not even be enough to pay off the loan. Is there any compensation at all?