Great article in the February 2016 edition of Parking from JNL's own John Roy:
In the summer of 1993, Donald Trump landed in Tokyo and was chauffeured to Tokyo Imperial Hotel to have dinner with wealthy Japanese hotelier Hideki Yokoi. The purpose of the visit was to enlist Trump to help Yokoi in dealing with a common business enemy–Leona Helmsley.
Two years earlier, Prudential Insurance Company secretly sold the Empire State Building to Yokoi for $41 million. At the time, most people believed that the building could command a price of more than a billion dollars, but Leona Helmsley inherited a 114-year lease that her late husband had negotiated with Prudential in 1961, and she refused to break the lease at any price.
Since Yokoi’s building could be worth 25 to 30 times more without Helmsley’s lease, he enlisted the help of Trump to find a way to terminate the lease. In exchange, Trump negotiated a 50 percent ownership of the building for nothing more than $100,000 in legal fees.
As parking investors and owners, the value of our parking assets are perfectly correlated to the leases that encumber real estate.
Your reaction may be to question how Prudential could possibly make such a foolish business decision as to enter into a 114-year lease.
When you dig into the details, you see Prudential’s mistakes, and learn what owners of parking assets can do to protect themselves from entering into similar bad leases.
Everything Starts With the Lease
Parking brokers throughout the country review and negotiate leases for clients. Before negotiating a deal, good parking brokers will always begin with the lease, as owners are not always aware of all of the points and nuances in them.
In some cases, brokers can uncover value of which the seller was not aware, allowing brokers to value assets at higher prices than the current asking or market rate.
In other cases, time is wasted throughout numerous hours of negotiation to find out that the deal was not what the owner had represented. The following outline gives investors an idea of some of the most important aspects of a lease.
Take a Close Look at Lease Terms
What is the term of the parking lease? I have seen brokers market a parking asset as a secure 15-year passive parking investment.
The real truth of the security lies in the termination clauses. What “outs,” or ability to cancel the parking lease does the lease document contain? Most operators have “demand generator” clauses that allow the operator, as a lessee, to terminate the lease if revenues fall below a certain percentage. In some cases, what the owner thought was a long term lease can actually be a very short lease that destroys the overall value of the property.
Avoid Opting for Automatic Extensions
In the case of Prudential, they originally signed a 30-year lease at 100 basis points above the prime interest rate in 1961. At the time, as a risk-averse insurance company, it was considered a decent lease. The problem was that the lease contained four, 21-year extensions at the termination of the original 30 years without the lessor having any ability to terminate the lease over the next 114 years.
I recently advised a large parking company to change the terms of their operator leases to include “mutual” extensions to their leases instead of automatic extensions. Under mutual extensions, both the lessee and lessor must agree on an extension past the original term.
Most operators include language that give them an “option,” which is the right but not the obligation to extend the lease past the original termination date. Since parking rates and revenues historically continue to increase, owners want the flexibility of shorter term leases with mutual extensions beyond the initial term.
Allow Termination of Leases Upon Facility Sales
Owners must include language in leases that allows the seller to terminate the lease upon sale or for development. I recently negotiated a lease in Northern California where the owner gave an operator an option for a 10-year extension without any “outs” in the lease. The property’s value based upon a multiple of the current lease is approximately $4 million.
I submitted the seller a cash offer on behalf of my client for $11 million contingent upon the operator not extending the lease. This operator controls the future sale of the property and has all of the power.
Another client purchased a portfolio of surface lots and signed 15-year leases with a national operator. He sold the portfolio two years later for more than $13 million, nearly doubling his original investment because he had termination clauses upon sale that allowed the new owner to sign significantly higher leases on the portfolio.
Negotiate Annual Increases
Parking rates and revenues tend to increase yearly. It is important to negotiate annual consumer price index increases and/or participation. Participation is a lease clause that allows owners to collect a certain percentage of every dollar generated on their lot beyond a certain threshold or benchmark.
As the site’s revenues increase, owners should be able to participate in the increased revenue along with the operator. This allows the owners’ parking asset to continue to appreciate in value during the term of the lease instead of essentially turning their parking asset into a fixed income bond or coupon clipper.
By increasing revenue on an annual basis, a buyer will pay the owner a set multiple for every dollar of additional revenue. In Houston, a client is on pace to collect approximately $120,000 in additional rent in the form of participation on a garage. Assuming he sold his garage at a 15-times multiple, the extra revenue stream makes his garage worth an extra $1.8 million.
Whether it’s the Empire State Building, a large parking garage or a small surface lot, there is power in a good lease with the right business clauses negotiated. In parking, shorter-term leases with revenue participation are best, with the ability to terminate leases upon sale or development.
John Roy is co-founder of JNL Parking. Email him at email@example.com
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