Real Estate
A landlord’s dictionary
Knowing lease definitions is essential to proprietors.
Smart Business Miami | May 2006
If you are the proprietor of a property that could be used as a retail outlet, or if you aspire to be one, you need a broad understanding of the basic business terms of a retail lease. You need a working knowledge of “escalators,” “pass-through expenses” and much more.
You’ll also need as much information about the condition of the property as is available — especially if a compromise might be needed to get everyone to ink on the dotted line.
When Smart Business recently spoke to Liran Friedman of the retail/investment sales group at Colliers Abood Wood-Fay in Coral Gables, he defined many of the terms that perspective proprietors of business properties should know before making the big leap into the rental/lease market. Here’s what he told us.
What major factors can cause rent to fluctuate so much from property to property?
Prior to making an offer, tenants need to make a short assessment of whether they have bargaining leverage, and if so, how much. Is the center well located, well tenanted, and well maintained? Is the space highly visible from the surrounding thoroughfares? Are the dimensions of the space adequate? Is the space raw, a shell, or does it contain improvements? The answers will determine which side has more leverage in negotiating rent.
For example, imagine a 100,000-square-foot center built five years ago at the corner of ‘Main and Main’ with a large grocery anchor and a strong mix of tenants, and the center doesn’t experience frequent tenant turnover. Now, suddenly, this center has one 2,000-square-foot vacant bay whose asking rent is $30 per square foot triple net and available ‘as is.’ However, this space is located in the not-very-visible elbow of the center where consumer traffic isn’t quite as busy as the other parts of the center — plus, the space is a raw shell in need of new flooring, drywall, ceilings, plumbing and other improvements. In this example, both sides can claim some leverage in negotiating rent. Both will need to consider if, when and how much to compromise.
What are some of the issues that tenants and landlords might need to compromise on?
Things like escalators, pass-through expenses, term and extension options and guaranty, which may benefit one side or the other. Let me explain.
Escalators are most commonly quoted as a flat annual percentage increase (usually 3 percent to 4 percent) or tied to an index such as the Consumer Price Index. Well known retail chains with established credit ratings will typically require escalators to kick in every five years (or longer) rather than annually. Mom-and-pops will almost certainly see annual increases.
Pass-through expenses include cam, insurance and taxes. They are typically not negotiable in the base amount, but a savvy tenant can minimize exposure to rising costs by insisting on capping annual increases.
Term and extension options will help maintain a going concern, which is always paramount to a retailer. From the viewpoint of a tenant who has a solid business plan, the longer and the more option periods, the better. Shorter terms can expose the retailer to inflationary pressures. Further, landlords of A- and B-class properties will not look kindly upon startups requesting 1- to 2-year leases.
Guaranties by the principals of a retail concern are more commonly being requested by landlords. If the space is in high demand, there is simply no way to completely avoid a guaranty, but it can be mitigated. For example, options might be a guaranty for the first year, for five years or a ‘floating’ guaranty, which guarantees a certain amount of the lease at any point in its term.
Do any other terms come into play?
Although they’re beyond the scope of this article, retailers will negotiate security deposits; build-out expenses (for example, vanilla shell or turnkey); tenant improvement allowances (the landlord will pay for improvements up to an agreed upon amount); rent abatement periods and rent commencement dates (time from execution date of lease to actual rent commencement); product exclusivity; right-of-first-refusal to expand if additional space becomes available; percentage rent (landlord receives percentage of sales above a breakpoint); and assignment and subletting rights.
What’s at stake? For a retailer, the three biggest cost components are typically cost of goods, payroll and, of course, rent. For the landlord, rent is the primary source of revenue. But, as I’ve summarized, there’s far more at stake for the people sitting at the opposite sides of the bargaining table.
LIRAN FRIEDMAN is part of the retail/investment sales group at Colliers Abood Wood-Fay in Coral Gables. Reach him at (305) 446-0011.
