Calculating commercial lease increase due to improvements

[Bradley]

We've been approached by our commercial tenants to add a walk-in refrigeration unit to the commercial kitchen. The capital cost of this is approximately $30K, and I'm wondering if there's a general formula that any of you routinely use to derive a general lase increase value per month, taking into account deprecation, R&M etc. Neither party wants to engage a valuer as it will introduce additional cost.

Obviously, there are other variables that can be used in the final negotiation such as extending out the lease term etc. but having a base figure to start with would be useful.

I've searched through the forums and haven't found an obviously answer, with most of the discussion centering around residential.

How have you other approached this calculation in a commercial setting?

[Anthonyacat]

We've been approached by our commercial tenants to add a walk-in refrigeration unit to the commercial kitchen. The capital cost of this is approximately $30K, and I'm wondering if there's a general formula that any of you routinely use to derive a general lase increase value per month, taking into account deprecation, R&M etc. Neither party wants to engage a valuer as it will introduce additional cost.

Obviously, there are other variables that can be used in the final negotiation such as extending out the lease term etc. but having a base figure to start with would be useful.

I've searched through the forums and haven't found an obviously answer, with most of the discussion centering around residential.

How have you other approached this calculation in a commercial setting?

Lots of commercial leases that I've seen have a specific term for "improvements percentage" that is added onto rent as a result of landlords spending further money on the property. This is usually set higher than the net lease percentage. I've seen 8%-12% recently, but imagine they vary a lot.

[Davo36]

Yes I agree with that. The figure in the first schedule is the most obvious figure to use.

But of course, if you both agree, anything can be agreed.

One thing to think about might be what happens to the chiller when the lease ends? Like who owns it then? Does it stay with the property? Can the lessee onsell it to an incoming tenant etc.

[Rosco]

How long is the lease term? if it is only for say 3 years, do you really want to do this? With a longer lease term, what would happen if the tenant moves out and the chiller has not been fully paid for?

How long will the chiller last? Obviously you want to get the cost back over the term at the very least. So say it would normally last 30 years(i have no idea and just made this number up, so you would need to research it a lot more!), you need at least a $1,000 rent increase just to cover it.

Then what kind of return do you want on your investment? You might want 6.0% to ........... At 6%, you would need $1,800 extra rent per year.

So based on the example years above, you would need at least $2,800 extra rent per year, to give you a return plus allow for the asset to be replaced at 30 years.

Ross

[Bradley]

Thanks for the responses everyone.

The lease agreement doesn't contain the improvements percentage clause, even though it's a standard ADLS lease. I suspect this must have been revised in later versions. The percentage is however an ideal place to begin negotiations.

With regards to your post Rosco, this is how I initially approached the problem. Cap Ex, depreciation, maintenance, and some sort of rate of return, but though maybe there's a simpler way. Looks like I have been on the right two track after all.

The intent is that we would own the chiller at the end of the term.

Our tenants have 3 years left on their current term with a RoR of a further 3 years, so you're right that this is probably something we shouldn't get involved with unless the term is extended considerably. We also run the risk that any subsequent tenant either doesn't want to use that facility or requires something different, which is why I have avoided getting involved in internal fit outs. We would also run the risk of being held liable, or at least our insurance, if the unit was to break down, and this adds another layer of complication to the situation.

So I think the best option is for us to pass on this option and leave it up to the tenants to arrange.