222 Week 2 A /For WIZARD KIM

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AND REWARD

RISK >>

BY KRISTIN GUNDERSON HUNT

THE FIGHT TO FILL VACANT COMMERCIAL REAL ESTATE SPACE IN RECENT YEARS HAS FORCED REAL ESTATE OWNERS AND MANAGERS TO CONSIDER NEW USES FOR THEIR PROPERTIES—EVEN IF THEY REQUIRE TAKING ADDITIONAL RISKS.

especially vacancies,” said Janice Ochenkowski, managing director for Jones Lang LaSalle and the com- mercial real estate firm’s director of global risk management in Chicago. “But property owners and manag- ers have been very creative in how to use their existing facilities.”

Traditional retail stores have been transformed into everything from medical office space and churches to fitness centers and breweries. In addition, special events and pop- up stores are more commonplace; traditional office spaces have been converted to daycare centers; in- dustrial warehouses are being used as practice facilities for youth base- ball teams; and the list goes on.

“From a risk management per- spective, these new uses can bring new challenges,” Ochenkowski said. “However, it is the primary goal of the risk manager to support the business, which means we need to be more creative in the way we deal with these risks.”

DOESN’T MEAN YOU HAVE TO WALK AWAY.”–JANICE OCHENKOWSKI, JONES

LANG LASAL LE

DO THE ASSESSMENT HONESTLY. JUST BECAUSE THERE IS A HI

GHER RISK

“DON’T BE AFRAID TO THINK ABOUT WHAT THE RISKS ARE.

the tough economy has resulted in a lot of challenges—“ DUE DILIGENCE

The risks associated with new-use tenants are as varied as the tenants them- selves.

First and foremost, certain tenants could present additional life safety risks, said Jeffrey Shearman, a Pittsburgh-based senior risk engineering con- sultant and real estate industry practice leader for commercial insurance provider, Zurich.

For example, restaurant tenants create increased exposure to fire; church and/or educational institutions might spur egress concerns because they en- courage large gatherings in spaces formerly used for different occupancy; and hazardous waste can be a risk with some medical tenants.

“You have to recognize that certain types of work are going to create cer- tain types of hazards,” Shearman said.

Beyond life safety risks, certain tenants might be more susceptible than previous tenants to codes and regulations imposed by state or federal laws, such as licensing regulations for daycares or American Disabilities Act re- quirements for medical tenants, said Pat Pollan, CPM, principal at Pollan Hausman Real Estate Services in Houston.

New-use tenant risks don’t stop there: financial risks also exist. Replac- ing a unique tenant with a similar occupant after the lease expires can be difficult—a particular concern if a lot of money was spent customizing the space for an alternative use.

“It’s not just the risk of liability, it’s the risk of the tenant going out of busi- ness and losing any money you put into the tenant, or its space, and not be- ing able to recoup that,” Pollan said.

Flight of other tenants from the property—disgruntled either by the type

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DOESN’T MEAN YOU HAVE TO WALK AWAY.”–JANICE OCHENKOWSKI, JONES

LANG LASAL LE

DO THE ASSESSMENT HONESTLY. JUST BECAUSE THERE IS A HI

GHER RISK

“DON’T BE AFRAID TO THINK ABOUT WHAT THE RISKS ARE.

of new-use tenant or the adverse effects on their business because of the new tenant—can also cause financial strain if landlords struggle to renew leases, said Beau Beery, CPM, CFO of Coldwell Banker M.M. Parrish and president of its commercial division in Gainesville, Fla.

“If you bring in one tenant that doesn’t play nice or isn’t what [the tenant] promised to be, you could lose other tenants,” Beery said.

To realize a potential tenant’s risks, owners and managers must firmly grasp the tenant’s business, its operations and its customer base, said Bob Smith, global property risk consulting practice leader for Marsh Risk Con- sulting, a unit of Marsh Inc.

“As the owner [or manager] of a building, it is prudent to understand the business you’re moving in and whether it increases or reduces the risk to your assets and other tenants already in the space,” Smith said. “If owners don’t do their due diligence, they could be held accountable in the event something goes wrong.”

Due diligence involves acquiring information about the equipment and materials tenants use, understanding operations needs, like water usage or ventilation requirements, noting storage needs, obtaining references from

THE MOST IMPORTANT

ASPECT IS TO ENSURE THE TENANT HAS A VALID CERTIFICATE OF INSURANCE WITH A PROPER ENDORSEMENT TO THE POLICY, DEFINING THE LANDLORD AS AN

ADDITIONAL INSURED PARTY.

PHOTOGRAPH © I LOVE IMAGES/CULTURA/GETTY IMAGES

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other landlords and observing ten- ants’ operations at other locations— even if it’s just to find the simplest snafus that could disrupt a property.

“Don’t be afraid to think about what the risks are,” Ochenkowski said. “Do the assessment honestly. Just because there is a higher risk doesn’t mean you have to walk away.”

LEASE LANGUAGE

To adequately address risk when leasing to an untraditional tenant, property owners and managers might consider enlisting the help of their insurance company’s risk management department or even local authorities like the fire department, all of which can help ensure compliance with codes and regulations, Shearman said.

“Don’t look at the various authorities as enemies, but as partners,” he said. “Getting them involved early in the game can be helpful.”

PHOTOGRAPH © THOMAS BARWICK/STONE+/GETTY IMAGES

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When Houston Community College filled two floors of a traditional downtown office building with a massage therapy school and continuing education classrooms, the space had to be modified. In particu- lar, a substantial number of restrooms were added be- cause of code requirements, according to Pollan, who represented the tenant in the lease deal.

Similarly, when Beery slated a church to fill 10,000 square feet of a property traditionally used for retail, the space’s use had to be changed for the purpose of “assembly,” which meant stricter fire code standards. Beery added additional fire alarms, another means of egress, and other safety mechanisms.

While owners and managers should be aware of such regulations and enforce them, they should also transfer the risks relating to such regulations to the tenant, Pollan said.

“Put the onus back on tenants to provide you with the information to make sure they are meeting regula- tions,” he said.

Transferring such risk, as well as mitigating the ad-

ditional risks that come with a new- use tenant, can often be achieved with a solid lease.

“Find out what the tenant’s oper- ation is all about and any additional hazards it may present, and address them in the lease language,” said Alex Glickman, area vice chairman, managing director and practice leader for Gallagher Real Estate and Hospitality Services in Glendale, Calif.

Shearman said lease language should be explicit. The responsibil- ity of each party—on issues rang- ing from financial obligations and waste removal, to building access and security, to insurance require- ments and “use” clauses—should be identified.

When Beery moved a dentist into a multi-tenant retail center several years ago, he had the foresight to negotiate that the tenant improve- ment costs be amortized over the initial lease term—not the initial term plus renewal options.

This helped ensure that when the dentist moved out, Beery wasn’t stuck with a customized medical office in a retail center along with hefty tenant improvement costs and no other potential dental tenants in sight.

“The best way to protect yourself is to have a clear-cut delineation of what tenants can and can’t do in the lease,” Shearman said.

COVER YOUR ASSETS

Although risks and leases may change substantially with a new-use tenant, a property owner’s actual insurance coverage may not change at all, both real estate and insurance experts said.

Regarding insurance, they said

TRADITIONAL OFFICE SPACES HAVE BEEN CONVERTED TO DAYCARE CENTERS; INDUSTRIAL WAREHOUSES ARE BEING USED AS PRACTICE FACILITIES FOR YOUTH BASEBALL TEAMS...

AND THE LIST GOES ON.

SPECIAL EVENTS A ND POP-UP STORE

S

ARE MORE COMMO NPLACE;

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the most important aspect is to ensure the tenant has a valid certificate of insurance with a proper endorsement to the policy, defining the landlord as an additional insured party.

Beyond verifying certificates of insurance, property owners and manag- ers must decide on a case-by-case basis whether they should tweak their insurance programs or require tenants to buy additional coverage on top of standard general liability policies.

“It’s up to the landlord to understand what the exposures are,” Glickman said. “They need to make sure insurance is adequate and appropriate.”

Environmental, professional liability and special event insurance are the main categories owners and managers might explore depending on the new- use tenant’s risks, said Kevin Madden, national real estate practice leader for Aon Risk Solutions in New York.

Environmental insurance can offer protection for tenants who might gen- erate pollution, like nail salons and dry cleaners creating odors, or medical tenants generating hazardous waste.

Professional liability insurance should come into play if the tenant is pro- viding a special service whereby the landlord could be vicariously liable. Daycare centers, fitness centers and medical tenants are ideal candidates for professional liability insurance.

Special events insurance elicits short-term policies, written specifically for high-hazard exposures, like a fireworks display or a temporary amusement park in the parking lot.

For temporary stores or kiosks that might be run by small or family- owned entities not typically carrying insurance, a landlord can invest in a group program for a nominal fee and the tenants can pay into it cheaply.

“Make sure that for the risk being taken, the proper insurance, coverage and deductibles are being secured,” Madden said.

IN THE LOOP

Making such assurances about risk and insurance, though, can be dif- ficult—especially for smaller com- mercial real estate firms lacking a formal risk manager. In such in- stances, Madden said brokers or insurance agents can be outsourced risk managers.

“Don’t use insurance brokers or agents just to place insurance, but rely on them as risk managers—to identify, manage and transfer risks,” he said. “Risks continue to change and it can be difficult to keep up. Brokers and agents are aware of what is current, what their [clients’] peers are getting and what industry standards are.”

Ochenkowski said it’s always wise to keep insurance companies and brokers informed of changes in use because they will likely be able to provide insight into the standard risks and responsibilities of such a tenant, which can then be used to develop solid leases and risk man- agement practices.

Beery said keeping the insurance team in the loop is another way to mitigate risk.

“It’s in our best interest to be open with all of our vendors, espe- cially our insurance guys, on any change of use,” Beery said. “In the event of something happening, we want our stream of income to con- tinue, and if the insurance is there, we’re protected.”

KRISTIN GUNDERSON HUNT IS A CONTRIBUTING WRITER FOR JPM®. IF YOU HAVE QUESTIONS REGARDING THIS ARTICLE OR YOU ARE AN IREM MEMBER INTERESTED IN WRITING FOR JPM®, PLEASE E-MAIL MARIANA TOSCAS AT [email protected].

“DON’T LOOK AT THE VARIOUS AUTHORITIES AS ENEMIES, BUT AS PARTNERS. GETTING THEM INVOLVED EARLY IN THE GAME CAN BE HELPFUL.”

-JEFFREY SHEARMAN, SENIOR RISK ENGINEERING CONSULTANT, ZURICH

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