Parking Leases 101
June 21, 2021
Parking Lease Overview
A parking lease is an agreement structure that allows a parking operator (lessee) to manage a parking facility for a defined period of time in exchange for paying rent. Rent is typically divided into two types:
Fixed or Base Rent:
Fixed rent is a dollar amount that is defined by the lease agreement and typically paid on the first day of each calendar month.
Percentage or Incentive Rent:
Percentage rent is typically a percentage of revenue, adjusted for parking tax, sales tax and credit card fees. This rent exceeds one or more thresholds on an annual basis. For example, percentage rent paid to the owner could be structured as 75% of the gross revenues less taxes and credit card fees that exceed $1,200,000 during the lease year. An estimated amount is typically paid each month and a true up occurs after each lease year.
The operator collects all of the parking revenues, pays taxes & operating expenses and then pays rent to the owner. The amount left over is the operator’s profit. In addition, a lease agreement should define the operator’s responsibilities, operating expenses, termination options (if any) and default provisions.
Why Parking Leases Exist
There are three main reasons why parking leases exist:
REIT Qualifying Income Requirements
To shield investors from taxes, investment managers place real estate investments in REITs. There are a number of rules that a REIT must follow to maintain its status as a REIT. Income generated must be “qualifying” or all of the income generated by a REIT may become taxable. Tax attorneys typically advise that no more than 5% of the revenue a REIT generates may be non-qualifying. Parking revenue is considered non-qualifying income unless it is structured in a lease agreement. Therefore, many REITs that have a lot of parking or non-qualifying income will use parking leases. This helps them meet the qualifying income requirements.
Unrelated Business Taxable Income (UBTI)
UBTI income is income regularly generated by a tax-exempt entity by means of taxable activities. For tax-exempt entities, parking income is considered a taxable activity and the entity must pay tax on that income. Many tax-exempt entities structure their parking as lease agreements to avoid paying taxes.
Some real estate investors do not want the headache of actively asset managing their parking investment. Therefore, the investor will lease a parking garage or lot to an operator and collect rent. The lessee is often responsible for almost all of the operating expenses associated with the parking facility. This includes utilities, maintenance and real estate taxes.
Parking Leases vs Parking Management Agreements
Management agreements are the most common parking agreement and comprise approximately 90% of the agreements in the United States. An operator managing a parking garage under a management agreement will collect the revenue, pay the operating expenses, pay itself a fixed management fee and remit the remaining income to the owner. Sometimes, the operator’s fee also includes an incentive component. In this arrangement, the operator’s fee is not at risk and the owner is responsible for covering any shortfalls that occur if expenses exceed the revenue collected.
Since an operator is required to pay fixed rent regardless of the underlying economics of the parking facility and could lose money, an operator typically targets higher profits for leases compared to management agreements. The targeted profit will vary based on the perceived riskiness of the lease. In addition, an operator entering into a lease agreement will typically heavily negotiate its termination options, force majeure language and the definition of operating expenses to try to minimize the lease risk.
New York and Washington DC have historically had a higher percentage of lease agreements than other markets in the United States. This trend is changing; however, as operators are less willing to enter into lease agreements. In general, parking operators are not structured to manage and monitor lease risk. Therefore, most operators have shifted to being fee-for-service vendors.
Our extensive experience working on parking projects with lease agreements have uncovered the following common issues:
Owners that have leases that don’t need them
Since lease profits are typically higher than management agreement fees, owners typically generate more parking income from a management agreement structure. Therefore, it is important to evaluate if a lease is required for REIT or UBIT purposes. Parking Advisors works with owners and their tax attorneys to determine the appropriate agreement structure.
Operator profit levels are too high relative to the lease risk
When a lease agreement is required, Parking Advisors often finds that the operator’s profit is too higher relative to market benchmarks and the riskiness of the lease. Parking Advisors works with owners to terminate leases with above market operator profit levels.
The lease agreement does not required detailed revenue and expense reporting
Historically, lease agreements require less financial reports and back-up than management agreements. Parking Advisors recommends requiring full revenue and expense reporting in lease agreements so the owner always has an understanding of a parking facility’s underlying economics.
Rent is incorrectly calculated
It is not uncommon to find that the fixed rent being paid does not match the lease agreement or that the percentage rent is incorrectly calculated. Parking Advisors recommends that all lease agreement reporting include the calculation of percentage rent.
Service standards are missing or not enforced
A lease agreement should always clearly allocate maintenance responsibilities and other service standards to the parking operator. The owner or the property management company should enforce those standards to ensure the operator is properly maintaining the garage. This will ensure that the operator is not cutting corners to lower the operating expenses.
Checking the credit of the lessee
It is important that all leases have a guarantor that has a significant net worth relative to a lease’s fixed rent obligations. When a downturn or other event occurs that decreases revenue, it is common for operators to attempt to identify loopholes in the contract to avoid paying rent.
Parking Advisors’ team works on parking assets in every major U.S. market, producing valuable knowledge about industry trends, challenges and opportunities. The parking research below was developed by our team’s experiences, studies and analyses. Learn more about Parking Advisors and what our team can do for you.