Real Estate - Restoration Clauses

Published on Thursday, 11 July 2013 09:27:11    Written by Marc

Don’t forget the restoration clauses. Read them c-a-r-e-f-u-l-l-y.

Leasing 101. Question: what is a restoration clause?

Answer: - it’s a clause in a lease that tells you what you will need to restore at the end of the lease. Fair enough, a restoration clause is normally a clause in a lease that will inform the tenant what are his obligations at the end of the lease. Technically this would be a simple but sound definition.

So, if it’s so simple, we can assume that all tenants read the clause and take appropriate action for when the time comes, any cost associated with the clause is already known and provisioned as part of their lease management. Yes?

Restoration Clauses

Well, in all fairness, it’s not always that simple. First, that restoration clause could have been put in the original lease 20 years ago, and the lease could have been renewed many times without any reference to the original clause. Or even worse, the renewals could have included new clauses that blur the idea of the original clause. Then there is the essence of the clause, what the landlord really meant at the time. If the restoration clause indicated that the landlord can force a tenant to remove an improvement installed by the tenant, but at the time or the original lease there was a gentlemen’s agreement of what the landlord was ok to accept to leave in place at the end of the lease, then good luck finding that gentlemen’s agreement 20 years later, especially if the landlord has changed and the tenant was a company acquired by another one.

Think this is not real life? In mid-2005 I came onboard to work for a large manufacturing corporation and we had just acquired two companies at the same time on the east coast. The acquisitions came with about a dozen sites. Considering the real estate was a small part of the deal (the main part was the manufacturing business), during the due diligence process each lease was read the corporation also got in some consultants to read them as well, in order to see what the obligations of each of the leases were. Of course, like in every due diligence process, time is limited and there are often too many documents to read. Consultants and lawyers, haven read all document, cleared the way for the acquisitions and the companies were acquired a few weeks afterwards. Following the acquisitions, some of the people in management decided that to reduce costs, we should centralise customer service and data centers, so one of the site (out of the dozen that were acquired) that looked the best for this was chosen and the new offices for the customer services were built. It was during the last weeks of the construction of the offices that I joined the corporation and had a chance to visit the site as people were slowly moving in to their new office spaces. The project it seemed had went well, although taking a little more time than planned and requiring a little more money than planned also, but we were going to be here for the next 10 years, so there was no real problem.

Fast forward to the end of 2008 and the corporation had decided to close some of the sites since we were in the middle of the financial crisis. In preparation for closing down one lease that had a few months remaining to the term, the landlord came to us and informed us that he wanted us to restore the site to its original state.

The 1977 original state. There was a restoration clause in that original lease that mentioned that the landlord could ask the tenant to remove anything the tenant was adding to the site, regardless of what it was.

- Holly cow, I asked the landlord, are you guys serious? In early 2005 we added over 1.5 million dollars to your site to create offices, add data rooms and make the site worth much more that it was worth even before 2005, let alone in 1977. (we were occupying 100% of the building and had made it our data center as well as our customer service center for the east coast, office were still virtually new, since they only had been used a little less than 3 years).

- I don’t really care about the improvements the landlord told me, we specialize in simple industrial sites and we don’t really need any of the offices you built there, they are reducing the value of the building according to our needs.

It was a dead end conversation. Weeks of trying to negotiate fell on deaf ears. Reviews of the restoration clauses by our lawyers clearly gave the landlord the upper hand. The clause of the original 1977 lease was there and during all renewals no mention of any restoration was ever made. Price tag for us: over 600K. It turned out, the company we had acquired had done work back in 1977, the in the early 1980’s, then in the early 1990’s and then again at the end of the 90’s. By the time we built our offices in 2005, the site already looked like an office to the management group of the company, so it simply decided on taking that site. No review of the lease was made, apart from looking at the rate and the renewal date. Had management simply take a very close look at the restoration clause, the company would probably have chosen another site which had no restoration clause in the first place.

So, if you are a landlord, restoration clauses can be a powerful ally for you, since you could require a tenant to bring back a building to an original state or decide that the tenant improvements made over the years are a good thing and leave them in place. In either case, you could win.

For tenants, remember that before you actually sign a lease, or even better, before you agree to a lease proposal, negotiate the restoration clauses in a way that you will be comfortable with. Before the signature you have power to negotiate this and some landlords will bend backwards to accommodate you. In 2009 I negotiated with a large pension fund to lease a portion of one of their industrial buildings with no restoration clause. I even added in the lease proposal that if we were to sign a lease, we needed to have the right to cut holes in the roof to increase the height of it. These were to be large 40 feet by 40 feet (roughly 12 meters by 12 meters) cuts in order to raise these sections of the room by about 15 feet (close to 5 meters). Our rationale is that we had equipment that needed the extra height in some localised area, but raising an entire roof would have been useless and cost prohibitive. The landlord agreed to this and we proceeded in cutting the roof and raising it in a few places. Obviously this did not add any value to the building (most possibly just the opposite since roof repair just became more tricky), but we negotiated in good faith and informed the landlord on our first visit while we still have many options to go elsewhere. For the landlord it was a small price to pay to have us. Had we asked to modify the roof after the lease was signed we would have either received a no or the landlord would have forced us to restore the site afterwards. Remember, these small clauses can make a huge difference in the end.

So Here We Are