What, then, motivates IDRC to produce another document on the subject? Veteran corporate facility planners and real estate managers can quickly supply the answer: almost all of the wealth of existing data has been prepared and presented from the viewpoint of the landlord, owner, or broker. IDRC members report a dearth of material written with the interests of the corporate tenant in mind.

This problem has been discussed at IDRC seminars over a period of years. Several aspects of the leasing problem have been covered in IDRC papers and research studies. These earlier presentations provide clues to the issues and problems which have attracted the interest of council members.

In 1969, IDRC issued a "Leasing Policy Guide" (see footnote 1) which was authored by John (Hank) Rutledge, IDRC president, and, at that time, real estate manager of Consolidated Foods. Rutledge, an attorney by training, summarized findings at the time as follows:

          
          Real estate commitments will often outlive the person who made 
     them.  Certainly, time will judge the wisdom of each decision and 
     its prudence in a changing environment.  Our company's name and 
     credit rating carries great weight at the negotiating table and will 
     permit us to enjoy many of the following rights "if only we ask for 
     them!"
          1--A free right to assign or sublet in exchange for an 
     unconditioned obligation to pay the rent.
          2--An option to renew at a specified rent.
          3--An option to purchase at a specified price (subject to 
     Internal Revenue Service standards) or current market appraisal.
          4--A right to cancel upon payment of agreed penalty.
          5--A right to cancel in the event of economic abandonment.
     This simply means that should the property cease to be feasible due 
     to a loss of business from any cause, we may upon payment of penalty 
     and after a specified period of time elect to cancel the lease.
          6--A tenant's share of any comdemnation award.  The measure of 
     damages should include:  (a) the difference between the contract 
     rent and current rental value; (b) the unamortized amount of 
     leasehold improvements; (c) the cost of taking down and setting up 
     fixtures in place; (d) moving expense; and (e) any other compensation 
     permitted by law.
          7--Eliminate restoration requirements at termination of lease.
          8--Eliminate security deposits, bonds for performance and rent 
     insurance requirements.
          9--New buildings should be guaranteed by owner for minimum of 
     one year and all maintenance requirements by tenant waived for a 
     like period.
          10--Buildings and offices occupied in common with others should 
     have lease provision for mutual exchange by landlord and the company 
     for waivers of rights of subrogation (a technical term preventing 
     landlord's insurer from suing us after payment for loss).
          11--Arbitrating clause for settlement of disputes by third 
     party and/or eliminate trial by jury.
          12--Eliminate "evergreen" clauses which accelerate rent at 
     landlord's option during holdover period.
          13--Net leases are preferred.  Taxes and insurance payments are 
     made directly at the best rates available.

          It is a fact that most standard leases today are oppressive and 
     to the disadvantage of the tenant.  Many in our business have come 
     to accept "landlord leases" or "New York leases," as some call them, 
     as a necessary part of our existence.  There is no point here in 
     speculating more than a brief moment on the reasons for this 
     situation.
          Some people--quite often the owner-developer--blame the lending 
     institutions for a trend that began when money became tight a few 
     years ago.  The lender's insistence on having "kickers"--sometimes 
     politely referred to as "participation"--as a condition of the 
     permament loan no doubt has had an effect.  Certainly, building 
     owners have had all kinds of tenants for which they seek protection.
     Also for a few years, the office building market was tight, and 
     owners could be more selective.  At any rate, today we find 
     ourselves confronted with a standard form, for which the landlord is 
     almost apologetic, written by someone else in another part of the 
     country, and given approval by the owner's attorney.
          Let us review the reasons for the formal lease document.  I 
     would generalize by suggesting two main functions of the document:
          1--To set forth intent of the negotiators and to capture 
     specific points of agreement and,
          2--For protection of both primary parties.
          If we would accept this, then it follows the lease form should 
     receive careful scrutiny at the very beginning of negotiations.
     First of all, you are going to avoid some surprises which often hit 
     home after a letter of intent has been signed or a handshake 
     agreement has been made.  Maybe the services provided do not include 
     electricity.  Perhaps it was not mentioned that actual space is 
     increased by a factor, such as 15 percent, to cover building common areas.
     Another surprise may mean that the tenant must be responsible for 
     all repairs within the leased premises, regardless of type of 
     circumstances.  These are just a few, but enough to make that "good 
     deal" you just made suddenly look rather expensive.  This should be 
     the point, early in negotiations, when you put the prospective 
     landlord on notice that there are certain things which must be 
     included in the lease and certain matters already in the form with 
     which your firm cannot live.
          Determine whether or not the prospective landlord has full 
     control of his enterprise.  If he repeatedly says the lender will 
     not permit him to do this or that and it turns out his objections to 
     your suggestions are genuine in this regard, then you have 
     discovered something important.  You now have a decision on whether or 
     not there is a reason to continue negotiations.  Obviously, the 
     decision is based on the alternatives available to you.

The renewal option, for a succeeding term or terms, at the same terms and conditions, is an important one to the corporation and can be provided without undue sacrifice, by the lessor. Our problem here deals with that awesome word--"inflation". There are few responsibilities we have as facility planners and managers more important to our respective companies than to protect them from the ravages of inflationary real estate. As painful as it may be, we accept the necessity of the cost increase generally imposed with a new lease. With the economic benefits derived by the owner, he is in a position to provide the cost stability required for corporate planning and budgeting.

Granted, the lessor must be protected by an appropriate escalation clause to cover his operating cost increases. He has established his rental rate to cover his loan commitment, management of the facility and a fair margin of profit. This income along with proper escalation makes it possible for the corporate tenant to achieve this stability for a reasonable period. We have been and are currently negotiating five-year leases for offices, with a renewal option, at the same terms and conditions, for a second five years. Permit me to summarize this point by suggesting we accept the realities of inflation but we don't have to become the victims of inflation.

The expansion option depends on how you fit into the overall building program of the owner. If you are renting a fair amount of space, he should be able to provide options to you for adjacent spaces at two or three year intervals during your lease. It is a necessary flexibility and is again, economic in nature. To be back on the street looking for new space within a few years because you have no place to grow can be a very expensive proposition.

Cancellation Options

Cancellation options have not been widely used but are becoming more popular. This is another flexibility feature but to be fair to the owner, it cannot be exercised until after several years of a new lease. Most of us are willing to pay a reasonable cancellation penalty if the lessor cannot obtain a quality replacement tenant within a certain period of time with appropriate adjustments for leasehold costs.

Purchase options are almost another ball game and quite involved. In certain net leases where we are the single building occupant, it can be another protection from inflation. We must understand potential tax problems the lessor has while we are negotiating. If the option is not exercised far enough "down the road" from the beginning and the purchase price is not a realistic one, the IRS can claim subterfuge and require him to pay tax on the basis of ordinary income, as a dealer in real estate. At the same time, we as tenants can be denied opportunity to deduct rental payments up to the period of purchase as expense. Again, the lessor has the favorable economic benefits which allow him to provide a future purchase price under the probable market level at that time. In negotiating this price level, we cannot accept the common request to tie into an increase based on the Consumer Price Index or any other standard index.

'Fair' Escalation Provisions

Previously, we referred to "fair" escalation provisions. We all realize this is difficult to determine precisely and to administer in a practical manner. The worse approach and most unfair to the tenant is tying the entire rental rate to an annual increase based on the same percentage increase as the Consumer Price Index or another general index. I have been told by building owners that a considerable number of corporate tenants sign leases without questioning this provision and I believe them.

The main fallacy here is that approximately 70% of the rental rate is structured to cover the owner's debt retirement (for land and building construction) and his margin of profit, fixed amounts that do not change. The tenant should be only confronted with the 30% of the rate, the portion that is subject to escalation--in other words, operating costs. The suggestion here is to reach agreement, regardless of what the standard form calls for, on what are legitimate items of escalation. Some of these are taxes, insurance, utilities, janitorial maintenance and landscaping.

It would be good to spell out terms not to be included such as administrative salaries, personal property taxes and capital expenditures for equipment. Remember, in a gross rental transaction, the owner does have a margin, or should have, beyond his debt retirement costs, to cover general administration for his entire enterprise which serves other facilities besides your own. Many owners or management firms understandably do not like the actual cost escalation formula because of the time consuming documentation of the increases and the necessity for the tenant to audit the owner's books. This formula includes an additional hazard for the tenant. Once the owner has his cost escalation passed on to his tenants, as written in his leases, he no longer has an incentive to fight increases such as higher tax assessments and higher janitorial labor contracts.

A simplified and fair proposal can, in some cases, be the use of the BOMA Index, published annually, as the Building Experience Exchange Report, by the Building Owners and Managers Assn. This is a survey of approximately 600 buildings from 21 different geograhic areas, by age and size. For the type of office space we rent at Armstrong, we would generally resist the use of this formula. In the cost breakdown by geographic areas, all types of buildings are lumped together. Our offices generally are in suburban locations, as opposed to downtown, in newer buildings and of smaller size.

The Preferred 'Formula'

All of these factors result in generally lower costs and lower cost increases. The escalation formula we prefer involves reaching agreement initially on that portion of the rental rate which is subject to change due to future operation. As an example, in a midwestern office lease, $1.87 a sq. ft. of the total $5.85 a sq. ft. rental rate is subject to automatic increase, in proportion to the increase reflected by the annual increase in the Consumer Price Index.

Although this index might vary somewhat from actual costs, it still is close enough and does eliminate substantial accounting by the owner. In addition, this method provides an incentive to the owner to hold his costs down since it provides a top limit, whereas the actual cost method does not provide any incentive to the owner to fight cost increases.

Finally, no matter what method of cost escalation you accept, there are two protective measures you should have included in your lease document:

1. Always add a provision for tax reduction as well as for tax escalation. In past years, we have paid no attention to tax reduction because it has been an empty myth but it is very possible that current legislation regarding property taxes might change this by shifting to other sources of tax revenue. Since we will help make up the difference, through other means, we should participate in this credit rather than have it become a bonanza for the building owners.
2. It is important to provide in the lease that the base year cost for operating cost escalation is the year that the building is fully or almost fully occupied. Otherwise, the owner may proceed from an abnormally low base if you use the first year, when the building is only partially occupied, which is the standard stipulation in some leases.

No discussion of lease escalation clauses is complete, or current, without reference to the "penny formula." If you haven't heard of it--beware. Like many "creative" proposals, this one got its start from our friends in New York. It seems to be spreading and is now showing up in some of the newer standard forms. Under this formula, a tenant's rent is automatically increased by 1 cent per rentable square foot of floor area for every 1 cent increase in the hourly wage rate paid to porters. This sounds like a very minor sort of increase and is therefor, readily accepted by those tenants who do not want to quibble over pennies.

If as is scheduled, 1973 brings an additional 30 cents an hour labor increase and 1974 adds the projected 25 cents an hour, New York office rents could rise as high as 50 cents a sq. ft. in the case of tenants who signed penny formula leases last year. "Real Estate Forum" magazine cites an example of a corporation occupying three floors, or 100,000 sq. ft. in a major office building under the penny formula. Fifty cents a sq. ft. would represent $50,000 a year. The owner's increased cost, in this case, will probably be somewhere around $12,000 a year. So, this is not only an obvious and unwarranted drain on the poor tenants, it also puts the porters and the building owners in bed together. And where and how will restraint be exercised on the matter of future porter wage rates?

Guard Rights To Sublease

Some modern office leases also place severe restrictions on one of the basic rights a tenant should have for his space under lease-- that is, the right to sublease or assign to a quality subtenant. While the landlord must be protected for the income initially contracted for and standards for the premises must be maintained, this can be readily done without such harsh provisions as "Lessor will not consent to any assignment or subletting to any person or entity whose use, occupancy or possession of the demised premises would, in Lessor's sole judgment, conflict with that of any tenant of the building in which the demised premises is located."

In other words, you are subjected to the whims of another tenant, who may be a competitor to your prospective subtenant or who may object for any other reason. Another restriction, not uncommon, deals with the restriction that subletting or assigning be done only through the building manager. Of course, when he has other vacancies within the building or office park, you know what kind of priority your space has. Another less common intrusion upon this basic right are restrictions, placed by the owner in the prime lease, on what rent you may charge a sub-tenant.

Perhaps the most serious provisions of many lease forms are those which make it possible for an easy cancellation of the lease-- at the sole discretion of the lessor or a successor to the rights of the lessor. These permit cancellation, with specified periods of notice, for any default, including the rules and regulations of the building, a partial taking of the premises under comdemnation (this could include a minor section of the parking lot), by reason of fire or other damage or due to foreclosure proceedings against the lessor. First, we should have a right to expect to have proper notice and a suitable time period such as 30 days, to remedy a situation that places us in default. You have all seen notice periods as low as 5 days. A clerical oversight, a vacation schedule, or misdirected internal communication can all result in a lease cancellation if enforced.

One protective provision for the tenant should always be included, particularly when a lease is subordinate to a mortgage.

Consider this: "So long as Lessee shall perform and observe all of the covenants and agreements and undertakings of this lease on Lessee's part to be performed and observed, Lessee shall have quiet, peaceful and uninterrupted possession of the demised premises." Another section of the lease should include that, under any circumstances, the violation must be of a material nature before cancellation can be made.

On the matter of cancellation, we might ask ourselves, "Why should a landlord want to throw nice people like us out?" How many of you have had the experience, toward the end of a lease, of paying $4.50 a sq. ft. for rent when the market was $7.00 a sq. ft.--and you had a five-year renewal option at the same rate, due under the lease? Maybe you were lucky and the initial landlord was still around and wanted to perform.

Remember, the years fly by, building managers change and buildings are sold. We had identical experiences in a southern city and a large eastern city under these circumstances. We received very poor services, repairs weren't made and parking problems became worse. Both owners felt things would improve if we would only agree to a higher rent. Neither lease gave us rights to deduct rent for any reason, and in doing so, we would have been in default and could have had the lease terminated by the owner. In both cases we chose not to exercise our renewal options at the end of the initial term.

Protection from Non-Performance

This brings us to the matter of how we might protect ourselves from non-performance on the part of the lessor. Granted, this isn't easy but nightmarish circumstances can result without some recourse available on the part of the lessee. Our most recent office lease has included this exact language:

"It is mutually agreed that in the event Lessor shall not provide adequate and reasonable services including but not limited to janitorial services and security services and fails to cure said inadequate and/or unreasonable building services within 30 days after written notice thereof from Lessee, Lessee shall have the right of a reasonable deduction or set-off until such services are made adequate and reasonable by Lessor; no deduction or set-off shall be permitted Lessee due to circumstances beyond the control of Lessor."

It is our intention to continue insisting upon this or a similar provision in future leases. We will be reminded that the lender won't permit such a clause which affects income to the enterprise--a statement we never know whether to believe or not. At any rate, do developers and brokers who are competing hard for a transaction with us really want to say the landlord won't agree to adequate performance? Will a responsible lender tell us that he insists on protecting a landlord who will not perform? Or that his loan agreement with the building owner cannot cover this situation?

You may recall my suggestion that you seek to exclude certain items from the lease form during early stages of negotiations. The automatic rent increase, tied to a standard index, has been properly discussed. The waivers of recourses against the landlord, for any circumstances, should be eliminated. These deal with nonperformance, structural failures of the building, failures of mechanical equipment and the like. We would certainly accept a phrase that relieves the landlord in situations beyond his control but for no other reason. A problem directly related to this is all of the one-sided provisions included in so many lease forms.

I have always been amazed that the lessor can be relieved of all liability and can default without recourse by the tenant, while the tenant, for similar failures or negligence can be dealt with by lease cancellation or several other harsh methods. Furthermore, under the latter circumstances, the tenant even agrees to pay all legal fees for the lessor in taking action against the lessee. Certain telltale phrases are commonplace in this type lease such as "at sole option of lessor," "in the judgement of the lessor," or "discretionary with the lessor."

Repairs, Capital Equipment

Two other items which we should resist seem to be trends in recent lease forms I have examined. They are quite a departure from traditional gross leases and are hard to justify. They are:

Responsibility of the lessee to pay for all repairs to the premises, fixtures and equipment therein, and,

A proportionate charge to all tenants, to pay for capital equipment which provides a cost-saving operation.

The defense of asking the tenants to collectively pay for capital equipment goes something like this: it only applies when operation cost savings are realized. Since the tenants are paying for cost escalation, they benefit and should be charged. However, what is a cost saving is a judgment made by the landlord. When he buys a tractor to replace his power mower, he is free to use it at any of his facilities. You have paid for it although he takes the depreciation and has ownership. What equipment cannot be represented as a cost saving device?

You may be tempted to suggest, with all the problems mentioned, that Armstrong Cork Co. begin to deal with different kinds of people. Actually, we like to think we are, in fact, dealing with trustworthy and quality owners and managers who are leasing from attractive facilities in good locations. As I observed before, ownership and management changes are not uncommon in our business. We are talking here about a formal document which can be assigned and enforced by those who have legal rights to do so.

As corporate facility and real estate managers, we, like other managers in our companies, have another very sober responsibility. That is to eliminate or at least minimize risks for the corporation. More than legal review is required of a lease form. Real estate knowledge and good judgment must be applied by the man who negotiated the transaction. Also, a lawyer can only review what is already in the lease draft. We have no assurance he can grasp those important points which are left out. Remember, even the lease which includes the lowest price can be the most expensive obligation your company has ever accepted.

Interest in leasing techniques and strategies continued to grow during the mid-Seventies. Seminar panels were involved in probing various aspects, including the critical lease-vs-buy decision. Evidence of this interest appears in the IDRC research study, "Buy or Lease: Motorola's Approach To Financial Decision Making" (see footnote 3), contributed by IDRC member Daniel Przybylski.

But, for most members, there remained the everyday problem of going from general advice to specific drafts. There emerged the idea of collecting from members a fund of available lease data and setting up a "bank" of tested and tried clauses.

At this point, IDRC former President Robert E. Baird generously offered to assist. In connection with his duties as Director of Real Estate and Natural Resources for Masonite, he was interested in developing a standard corporate lease form. He volunteered to assemble lease documents and help launch the IDRC data bank.

(Mr. Baird's professional background qualifies him admirably for his effort. Following receipt of his undergraduate degree from the University of Idaho and post-graduate degree in finance at Northwestern, he has worked for 15 years in commercial, industrial, residential, and resort property development. He currently handles Masonite properties, which include not only industrial real estate, but also oil, gas, mineral, and geothermal properties. He also has functioned as a mortgage banker and broker.)

This report constitutes the first edition of the IDRC lease data bank. It is presented in loose-leaf binder format to achieve two objectives: first, to enable the user to insert his own notes and, second, to permit additions to be made later.

It is hoped that members will contribute new material for future additions. Also, it is important that members report any difficulties encountered with drafts included.

Under some headings, only two or three lease clauses were received. Under most subjects, however, a number of versions were received and were included. Hence, the user may pick and choose among the clauses for the one he believes will best serve his need.

It will be apparent that some forms best fit industrial leases and others relate to offices. It is hoped that the variety of drafts contained in the data base will permit the user to customize each new lease without having to reinvent the wheel on each project.

While no effort has been made here to propose an ideal or model lease, it was felt, nevertheless, that it would be helpful to include several complete leases being used currently by members. Representative samples are given in Section III.

It should be evident that the lease data bank lends itself well to EDP system applications. The alphanumeric organization plan suggested herein should make it easy for members to set up storage in word processing or computer systems.

IDRC comtemplates the development of a substantial data base in the HQ center, and work has been underway for some time to lay the groundwork. A subject definition and hierarchy for a major bibliographic data base has been prepared, and the lease data base has been coordinated with it. The ultimate development of the system will provide an on-line service which members can access via remote terminal.

Finally, it should be stressed that, in the publication of this study, IDRC is not seeking to give legal advice. After all research is done, it is assumed that users will consult their attorneys when legal opinions are needed.

In summarizing his findings, author Baird reminds that:

          "The real estate lease is one of the oldest forms of contractural 
     agreements and one offering many opportunities for conflict between 
     parties.  Those differences surface during the negotiation and 
     drafting stage of the agreement when each party wishes to insure the 
     future security of his interests.  They also occur during the life 
     of the agreement when an event, such as fire damage, condemnation by 
     a public agency or the unforeseen ability of either party to continue
     its responsibilities under the contract, disrupts the agreement.
          "In the first case each party wants the language within the 
     contract to properly define the contingencies and then to state 
     clearly those actions required to equitably resolve the situation.
     The second area of conflict may be in the interpretation of the 
     agreement as it affects each party after the occurrence of a contingency
     or, worse yet, of an occurence not covered in the agreement.
          "One system used in preparing for negotiations and drafting an 
     agreement is to select those clauses which do not require special 
     negotiation or discussion between parties, such as premises, use, 
     etc.; then select those clauses which require discussion and agreement,
     such as signs, repairs, maintenance, etc.; and lastly, select 
     those clauses of potential conflict such as rental, options for 
     extension or sale, condemnation, damage, etc.  This process offers 
     the opportunity to formulate your requirements and latitudes prior 
     to formal negotiations, giving you a clear picture of your objective.
     With your objectives clearly defined, you may proceed with 
     negotiations and the drafting or redrafting of the contract in a 
     clear and equitable manner.  A good agreement is fair to each party 
     with no major advantage or disadvantage to either party."
                                                                        H.M.C.
                                                                        L.L.L.

1. John M. Rutledge, "A Leasing Policy Guide," IDRC Research Series, no. 3 (Atlanta: Industrial Development Research Council, June, 1969).
2. J. Kenneth Rankin, "Leases: Let Them Serve Both Parties," "Industrial Development," CXXXXII (May/June 1973), pp. 5-8.
3. Daniel C. Przybylski, "Buy or Lease Decision: Motorola's Approach to Financial Decision Making," IDRC Research Series, no. 18 (Atlanta: Industrial Development Research Council, August, 1977).

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