WeirTalking Leasing / Season 1 / Episode 4

Unattractive Properties

Lawyers Karsten Lee and Robert Eisenberg talk “unattractive properties.” What exactly do we mean when we’re taking about unattractive properties? Tune in to find out!

Transcript

Narrator: You’re listening to WeirTalking Leasing, an eight-episode podcast series from WeirFoulds LLP’s Commercial Leasing Group. Educating landlords, tenants, and property managers on today’s commercial leasing landscape in Ontario. Our legal specialists will be discussing everything new and interesting from lease terminations, office sharing, unattractive properties, cannabis and so much more.

Karsten: Thanks everyone for joining us today. I’m Karsten Lee. I’m a commercial leasing lawyer here at WeirFoulds. And joining me today again is my colleague, my trusted sidekick, Robert Eisenberg.

Robert: Hi Karsten. Nice to be here.

Karsten: So Robert practices commercial leasing as well. One of the issues that we’ve been chatting about recently are unattractive properties. I know each time on my way home, I always pass by this building with a beautiful neon pink hue on it. And whenever I think of unattractive properties, this particular building always pops to mind.

Robert: Sadly, that’s not normally what we mean in the leasing context when we’re talking about unattractive properties.

Karsten: Okay, so when we’re talking about unattractive properties, what exactly do we mean? What exactly do we classify as quote, unquote “unattractive”? Are we talking about location? Like is it a bad location?

Robert: I think the best way to think about it is it’s just these are properties that would normally not be your first choice or your second choice. But due to a variety of market factors, have now become more appealing. So there’s actually two categories of so-called unattractive properties that I’d like to talk about today. And these are generally older properties and properties that have some environmental issues.

Karsten: So why is talking about unattractive property something we should be doing?

Robert: Well that’s a good question and I think that especially in Toronto, in the GTA, this is something that’s going to become more topical as we go forward. As development continues at a growing rate, we’re
running out of new spaces to build property in urban and near urban areas. There’s no new land and this is leading landlords and tenants to start looking at existing older assets that may not have been their first choice or their second choice or third choice or even their fourth choice, for where to set up shop. But because of the vacancy crunch right now, especially for office and industrial properties, especially in the Golden Horseshoe, tenants are being driven into looking at properties that they would not normally consider attractive properties. The rents might be at bit cheaper or even just there’s space available in these buildings.

Karsten: Fantastic. So at least now we know we’re focusing on older properties and properties that have environmental issues. So let’s get started with older properties then. What are some of the major issues that landlords and tenants should be thinking about when they are negotiating the lease for this type of property?

Robert: Well, let’s start with what I think is the big ticket item for older properties and that’s, it’s an old building. There may be big capital costs coming down the line that you don’t always know about. For landlords, obviously they’re going to want the tenants to cover the costs of these capital repairs. Either in doing the work themselves or the landlord’s going to do the work and make the tenant or the tenants foot the bill through operating costs. For tenants this is a huge risk and it really should be one of the first things tenants look into when going into an older building.

Robert: See whether there are any big costs anticipated. Look at building reports, look at the age of the building, ask about the age of the roof, the age of the HVAC, look at the parking lot. Is it all cracked up? Does it need repaving? This is all stuff that you can look and see. Depending on the length of your term, might not be so much of an issue if it’s a short term. But if you’re going to be there for a few years and you look at the roof and you know it’s 20 years old, there’s a likelihood that it’s going to need to be replaced when you’re there and you’re going to be bearing some of the costs of that.

Karsten: Yeah. So it certainly merits the tenant having to do a little bit of a deeper dive in terms of their due diligence, like when you have to visit the site more than once.

Robert: Get somebody out there who… A building consultant or an engineer or an environmental expert, someone who knows the telltale signs of what to look for and where the red flags are.

Karsten: And at the end of the day, if you’re going to be looking and doing a walk through the property, if you’re noticing these issues, if you know that this building is a few years, a few decades old, and you’re seeing the issues. You’re seeing cracked windows, you’re seeing leaking water damage here and there, you can bet yourself that you’re going to be…there’s going to be issues down the road and it’s not just from a cost point of view that you have to think about it. You also have to think about some disruption to your business, because if the landlord ends up having to take a lot of time fixing these issues, that may well be a big disruption to your business.

Robert: In terms of what tenants should look for, I think the first thing obviously is you want to try to get the information from the landlord and if they’re not providing you with reports or anything to your satisfaction at a minimum, you want to try to get some reps and warranties about “these are all in good working order. We don’t anticipate that there’s any major capital costs coming down the line.” If there is something that you notice or something that you’re specifically concerned about, from a tenant’s perspective, the ideal would be to get the landlord to fix it before you get in there. And fix it at the landlord’s cost, not your cost, of course. You know that’s not always likely to happen so you can try to mitigate your risk in the lease itself. Your first position might be you want to exclude all capital costs as a tenant and say, “Well, you know, this is to your account landlord, I’m not paying any of this.”

Robert: And depending on the market you’re in, and the building, and who the landlord is, you might have some success with that, but you might not. So there’s other less strong positions that you could take. Some of those might be capping liability to a set dollar amount. If you know that you’re in an office building, let’s say that requires a lot of painting or is going to require it, you can say, “Well, I’ll pay it, but up to a certain number of dollars per square foot, that’s what my exposure will be.” Some reasonable amount. Or if the landlord is saying, “no-go, it’s a net lease, I’m going to charge through all my costs to you,” well then you can try to say, “What a minimum, then amortize your costs. So I’m not going to get hit with a giant bill in year one, but at least then it’ll… I’ll pay for it but I’ll pay for it on an amortized basis over my term.”

Karsten: And one of the things that I think deserves to be highlighted is when you are negotiating some sort of cap on the cost that you’re paying, or if you’re trying to negotiate an allocation of costs that is more heavily favoured towards you and having the landlord pickup a lot of the tab. These are issues that you really need to negotiate as a tenant during the negotiation of the offer to lease as opposed to signing the offer first and then thinking about it while you’re negotiating the actual lease.

Robert: Absolutely. Especially if you’re on a landlord’s form of offer, because you know, it’s just going to say net lease, tenant’s going to pay for these costs. When you think that there’s going to be a big capital cost or you know there’s a big expense coming down the pipeline. Bring it up at the beginning. I mean, get it on the table. At worst you’re going to press the landlord and they’re going to say, “No, you’re going to pay it” and then you might have a better sense. Well, there’s a ticking time bomb here, maybe I want to reconsider this. Or you get it into the deal. And you get some sort of limit on your liability here, whether it’s a cap or an exclusion or whatever it is.

Karsten: One of the key things I always tell my tenant clients is bring it up. Bring it up early and make sure that the landlord knows exactly your concerns right at the beginning. So aside from the cost issue, one of the other biggest things in my point of view, that tenants have to think about are what kind of alterations that they need to do to an older building. A lot of the older properties were built in decades past where the needs of a tenant are vastly different than what the needs of the modern tenant are now.

Robert: Well you hit the nail right on the head there. Often these older properties have unique design layouts. There’s weird structural columns and walls in places you wouldn’t normally expect or want them to be. There’s other penetrations in the space that you can’t move and before you decide you want this space as a tenant, you need to understand, can my business operate in this space? How are these things, these structures being in these locations going to impact my ability to run my business, and can my business even function there? Some of these additional concerns from a specific leasing, in terms of drafting the lease are, “If I have structural penetrations, I got columns in the middle of my store, I’ve got structural walls.” It’s how do we divide up responsibility for them?

Robert: If I’m the tenant, these things are in my space. How do I define my premises if they’re within the boundaries of my four walls, am I responsible for these things? Even though they’re structural. If you’re a landlord, are you going to want the tenant to be responsible for these things if they’re structural or are you going to want the ability to get access to the space, go in and be able to do any necessary work on the structure. Because it’s your building. You want to make sure structurally sound or that’s going to cause you problems.

Karsten: That underscore is again, another big issue that tenants really need to think about is their design layout. One of the things that I always recommend tenants to do before signing the offer or the lease is to get their designer or architect right into the space. Just to make sure that they are able to build out the space in an efficient manner, in a manner that they can capitalize on the space rather than having the lease done and then getting your architect or designer in after the fact and realizing that you can’t use a mezzanine and it’s a structural mezzanine. They’ll cost $100,000 to take down, which is one of the issues that I’m actually dealing with right now with one of my clients.

Karsten: So definitely think about, the space issue, the layout issue. And exactly how it is that you can work with the landlord to make sure that the space is going to be as sufficient as you’re hoping it would be. So this goes to my next question to you. What do you think tenants should think about with respect to setting out exactly what the landlord’s work is going to be in the lease as opposed to taking a building as is?

Robert: If you’re a tenant looking at a building and you want to decide, well, you know, can I do my standard fit up here? Or how can I alter the space? I guess there’s kind of three major categories I would think about. The first is alterations to the physical layout. What’s going to need to be done to it to make it work for me. So if it’s something structural or moving walls, if you’re the tenant you might want to push that onto the landlord and say as part of your landlord’s or before you give me possession, I want you to put up a wall here. I want a receiving door over there, whatever it is, in order to… Once you take possession you can hit the ground running and start actually fixturing the interior rather than having to worry about dealing with any structural issues or moving doors.

Robert: But, you really need to look at the space carefully because there really just might be physical limitations and things that can’t be changed, despite what you’re looking for. A lot of the older retail units, they’re often narrow storefronts and they’re very deep. There’s sometimes pillars in the middle of the space and that might not work for you. These are things you need to think about and how they’re going to impact your building.

Karsten: And don’t forget a lot of those old structural pillars and the utilities, you’re actually paying rent on that.

Robert: Absolutely. And sometimes they look ugly. It’s old discoloured brick and you’ve either got to clean it or try to cover it up or put some drywall around it or something. That’s added cost that maybe you weren’t budgeting for in your fit-up costs.
Narrator: You’re listening to WeirTalking Leasing, brought to you by WeirFoulds Commercial Leasing Lawyers. Whether you’re an established national landlord, an up and coming developer, the owner of a single building, a single store tenant, a national chain, or simply someone with retail, industrial or office leasing questions, our team can help you manage your leasing issues effectively and efficiently. Visit weirfoulds.com after this episode to learn more.

Robert: Another big issue actually, and I think people don’t think about it too much, is how are you going to interface with the building systems? These older buildings might not have the power or water capacity that you’re looking for, especially if they haven’t been retrofitted. You want to get modern telecommunications equipment in there. I don’t know. Is there going to be capacity in the building for them to run new cabling? That’s probably going to be at your cost. What about signals through walls? Is your Wifi going to go through these old walls? Especially with any kind of insulation or anything like that. What about reception? Are these old buildings and dead zones? Are signals going to be able to be transmitted? These are all things that can absolutely skyrocket your fit up costs and just the cost of operating your business if you don’t plan ahead for them.

Karsten: Yeah. So you definitely need to really think about exactly what your business needs and what the layout is and what technology are coming in and make sure that if you’re not willing or not able to put these costs upfront that you need to make, to discuss these with a landlord, whether or not it’s getting the landlord to make these changes at their cost or if they’re forcing you to take it as is. Maybe think about getting a bigger allowance from the landlord.

Robert: For sure. And, and that’s the thing. People love these old buildings because I think they look pretty but often the person who goes out and does the site selection isn’t the one who has to deal with the operational issues. So I think, from a tenant’s perspective there really needs to be a wholesale approach to finding new spaces, especially when there’s some of these older buildings where there might be issues. Everybody needs to weigh in and make sure that this is a property that’s going to work for you. The last issue in terms of alterations that I wanted to mention is in Ontario, especially when we have heritage designation. So what is heritage designation? Well it’s provincial legislation that allows municipalities to designate certain properties that have a cultural value or interest in terms of the heritage of the neighbourhood or the building or anything like that.

Robert: And what that does is it really restricts the ability to make changes to that building. You can’t demolish it or make any really significant alterations without the consent of the municipality. So if you’re in a heritage building and you realize you need to make some changes, you better plan that this is going to take some extra time and extra costs. You got to go get all these consents, you’re going to have to maybe jump through some hoops they put you through to keep the character of the building. So, if you’re looking at a property and you think “well, this is a nice older building,” you might want to do some due diligence and take a look and see if it is a heritage designation.

Karsten: Now, turning back to one of the issues that we had spoken about earlier – and I think this is one of the bigger issues to think about when we’re talking about unattractive properties – is the issue about environmental contaminants in there and more specifically for, especially for older buildings.

Karsten: The big issue is asbestos.

Robert: As people know, asbestos, in and of itself isn’t necessarily a problem. Assuming it’s still in good condition. But the problem is, well, what if I want to go in and start doing alterations? Or what if the asbestos is starting to deteriorate, if it becomes fryable? So if there is asbestos in a property, you know in the walls, on the pipes, whatever it is, and you want to start making alterations, then you have to start thinking about complying with the Occupational Health and Safety Act in Ontario. So if there’s asbestos or if there’s another designated substance in the premises, then any alteration work you do has to be done in accordance with that act. So not only are you paying for the costs of doing your work, but now you’re paying for additional costs of doing it in compliance with these requirements.

Robert: So that might require special remediation work, special environmental reports. If you can normally set up your space in 30 days or 60 days. But you have these extra hoops to jump through. Maybe you’re going to want 90 days to deal with that extra time. So that’s something to really think about. But then the flipside of that also is, let’s say you’re already operating in this space. You don’t need to do any work, but you know that there’s asbestos or some other mould or some other hazardous substance in the premises is you’ve got to worry about employee health and safety. What happens if something gets into the ventilation or the air quality? And that’s where you get into what’s called “sick building syndrome” where you have, generally older buildings where there’s some deteriorating environmental condition.

Robert: I don’t want to say it’s causation, but there’s a correlation that a lot of employees often become ill with respiratory illnesses or something like that. So not only do you have liability questions there, but productivity for your business, you know, downtime. Keeping your employees happy. So it’s always something to think about. And in terms of trying to mitigate that risk, check the HVAC, make sure it’s working properly. If it’s an older system, it might need to be upgraded and may need to be replaced. You know, you need to do fairly regular checks for mould and for all these issues in terms of addressing and in the lease, whose responsibility is it going to be? Is the landlord going to have to replace this? Well, generally landlords – when it is their obligation to replace HVAC – only have to do it if it’s not working anymore.

Robert: What happens if it is working but it’s not working at the level that you need for a safe environment? So it’s worth addressing these risks in the lease document itself. You know, we keep going back to this point that it’s all about allocation of risk, but it really is. It’s about how you allocate the risk and what’s the agreement and that generally comes down to what’s the negotiating position of the parties here.

Karsten: And one of the other things that you’d really need to think about is how, if the landlord knows that there is, for example, asbestos in the building, how are they addressing it? A lot of the regulations in Canada require landlords to have, for example, an asbestos management plan. So as a tenant who’s entering into a lease, you really need to ask the the landlord “what is the asbestos management plan?” Or “where is it? Can we have a look at it? Are you abiding by it?”

Robert: To put a bow on on this topic and wrap it up. I think there are a few kind of best practices that tenants and some landlords should be thinking about when they’re entering into an offer or doing the lease for a building that has, or your concern may have environmental issues. And you know, this is the first thing, get reports for the property if they exist. If they don’t exist and you’re concerned, maybe you make it a condition of the deal that the landlord provides you with a phase one. And if there’s a problem they have to find a phase two. Baseline reports are also a really good way to make it clear what a tenant is and is not responsible for in terms of cleanup. If you can get a baseline report that’s done immediately or very close to before the start of the term, you know what’s already, what the contamination is.

Robert: And you know when you leave the landlord comes and says, “Wow, this place is a mess.” And you can point to that baseline report and say, “It was a mess when I got here. I’m not responsible for any of this.” Other things, think about making a deal conditional. Give yourself an opportunity to get an expert in there. Do investigate the property, review the reports. You can try to make clear environmental indemnities: who’s responsible for what. Carve out preexisting contamination for the tenant. You can try to carve out liability caused by third parties. Tenants as well. I’m only going to be responsible for something that I caused or my employees cause.

Karsten: So one of the last issues that I wanted to talk about before this podcast is over is what happens when the lease is silent. Now we obviously run into a lot of issues when that landlords and tenants have already had an ongoing lease for years and now they’re only starting to uncover these environmental issues. Then they go to the lease, crack it open and realize, oh, the lease is silent on anything that has to do with environmental remediation or environmental issues. What then? Who’s responsible to clean it up in those situations?

Robert: So unfortunately I don’t have a clear definitive answer for you. There is some case law that says that when a lease is silent, the cleanup obligations fall on the tenant and that’s an implied term of the lease. There was a case out west where a landlord had leased premises for a gas station and the court basically said, “Well, landlord, that’s on you, you knew you were leasing into a gas station.” And inherent with that comes the risk of environmental contamination. So they’re saying by doing this deal, you accepted that risk that you might get back a contaminated property as a risk of doing this deal. Some other things courts have looked at in terms of apportioning responsibility for who’s responsible for cleanup is who’s taking out the insurance. Is the landlord carrying environmental insurance onto the lease, even if responsibility for cleanup isn’t specifically addressed?

Robert: If that is the case, then there’s some basis in the case law to suggest that well the landlord’s taken on the risk. This has been looked at in other insurance contexts as well, you know, fire damage or anything like that, is that the party who’s taking out the insurance – barring anything to the contrary – there’s kind of this assumption that well
they’re responsible for it. That’s why they’re insuring they’re going to get the benefit of it. And the flipside though, often times tenants pay the landlord’s insurance premiums, but the courts have said, well that is not enough to put the obligation on the tenant because they’re paying for the landlord’s insurance doesn’t mean that they don’t get the benefit of that.

Robert: Overall though there’s really an ambiguity in the case law about whether there is an implied term in the lease that the tenant has to remediate the property. So, we’ll go back to what I think we’ve been harping on the whole time is that the best practice is to get it in the lease, get it in the offer, talk about this. A portion responsibility for environmental cleanup between the parties so you don’t have to fall back on 25-year-old case law from different provinces.

Karsten: Well, thanks for joining me today about talking about unattractive properties. I know we’ve touched upon a lot of things and we really set out a lot of the issues that tenants and landlords both need to think about when they’re entering into leases for older properties and properties that might have a little bit of contamination. So, thank you again Rob, for joining me today.

Robert: It’s a pleasure.

Narrator: Thanks for joining us for this episode of WeirTalking Leasing by WeirFoulds LLP. Please take a moment to rate, review and subscribe. And if you’d like to hear from our lawyers on another topic, send us an email at publications@weirfoulds.com.