Lease Negotiating Like a Pro

Knowing how to effectively negotiate with landlords could save you a significant amount of time, effort and money.

Lease Negotiating Like a Pro

Fine print

In the excitement of starting a business, be sure there’s no fine print that will cause snags later down the line.

Landlords may be anxious to fill empty spaces, but they’re also eager to make up for the money they’ve lost during the recession, and, unless you’re careful, that bargain lease you sign today can be filled with hidden charges, escalating fees and clauses that kick in when you least expect it. But knowing what to negotiate is surprisingly complicated.

A case in point:

Nick Rizzi, a former banker, thought he knew a lot about leases when he rented space for his tax preparation business five years ago.

“It was February of my first tax season,” Rizzi says, “and the roof started leaking. I called the landlord and he said, ‘Didn’t you read the lease? I’m not responsible for the roof.’”

Related: Time to Lawyer Up

Commercial leases often run to hundreds of pages, and it’s easy to miss something crucial – such as who’s responsible for roof repairs or who foots the bill when the trees in the car park need to be cut down. And in the excitement of starting a business, it’s easy to forget what can go wrong.

What if the fast food outlet or anchor grocery store you were counting on to bring customers your way suddenly closes down? Or the shopping centre loses half its tenants? A properly negotiated lease contains contingency plans for those scenarios and many others.

As for Rizzi, he managed to land on his feet, opening several more outlets after his first location. Each time, he took much more care before signing a lease:

“If I find a vacant space I like, I spend a couple of days in the neighbourhood, talking to proprietors of nearby businesses. I’ll go into a deli, buy something to eat or drink, and before long the owner is telling me how business is and what he’s paying for rent. I watch the foot traffic going past and ask myself ‘Do they look like my customers?’”

Here are the fundamentals you need to get right, early on:

Find a locationbusy-street_franchising-a-business

Basically, you want to be near complementary businesses that are making money. A tax preparation business, for example, does best when it’s near a bank, an insurance office or even SARS; a children’s clothing store draws customers from a nearby toy store or activity centre. Or just get in your car and drive around looking for restaurant concentrations and the location of competitors.

This way you can identify a ground zero anchor point; once this is achieved, look for sites within that point.

“Look at the traffic patterns of local shopping centres,” says Stephen Walters, COO and founder of research consulting firm, Fernridge Consulting.

“Most retailers are directly dependent on the number of browsers (shoppers) that walk past a store. Destination shoppers only account for a small percentage of shoppers for smaller retailers (also known as line stores). Centres with a high number of fashion stores outperform centres with a smaller variety for example,” says Walters.

“I have to add that the quality of the shopper also plays an important role as it’s not helping much if you’re misaligned with your target market. Therefore, when I refer to volume I also mean that it must be of a good quality, consisting of a large number of people that can and want to buy what you put on offer,” he advises.

“Don’t make the mistake of going for the cheapest rent rather than the right location. Just ask yourself why this space is so cheap – and then count the vacancies near the site on offer or the number of independent shops without proper or professional branding,” adds Walters.

Hire a broker

You’ll need a commercial real estate broker to show you viable vacancies, but finding the right agent is tricky. Ask owners of recently opened businesses who they used, then interview several candidates and ask them the hard questions: Do they understand your business? How many similar deals have they done? What landlords have they worked with?

Don’t use anyone who represents a competitor or someone looking for the same type of space. And never use a broker who is also representing your potential landlord, because it’s the landlord who pays broker commissions.

What can you afford?

Work your numbers carefully. A landlord might be advertising a 350m2 store for R960 per square metre per year (or R80 per square meter per month), but that means the location rents for R336 000 a year or around R28 000 per month just for the space – not including water, electricity and so on. Business owners calculate how much rent they can afford as a percentage of annual sales.

Related: Understanding the Numbers with Ethel Nyembe

Generally this is less than 10% of projected gross revenues. So you need revenues of R28 000 per month to afford a R14 500 per month rent. Your broker will assist with these calculations, providing information on what similar tenants are paying in the area.

The heart of the dealfranchising-a-business_signing-a-contract

When you’ve found the right space, your broker will send the landlord a letter of intent, a non-binding document that spells out what space you want and what rent you’re willing to pay.

“A letter of intent unfortunately is not a binding agreement. It merely states someone’s interest in a specific shopping centre,” says Lizelle Cloete, director retail, Broll Property Group.

The letter also includes the business terms for the lease – and these are open to negotiation. The letter of intent may go back and forth for weeks before you and the landlord reach agreement, so be careful not to become emotionally attached to a property.

Here are the crucial points:

Term of the lease:

Typically commercial leases in South Africa endure for anything from five years (with or without renewal options) to 15 years. However, leases for shorter periods like three years, or longer periods like 20 years are not uncommon.

That said, if you’re spending a lot to improve the property, you’ll probably want a longer lease; if you’re worried about changes in the neighbourhood, you may want a shorter span. And because you’re planning on opening a franchise, your lease should last as long as your franchise agreement. Renewal terms should be clearly stated.

Rental can be anything – depending on the size of the store (smaller stores pay much more), established brands with a proven track record often pay less than a new brand or independent retailers – furthermore, anchor tenants (stores that draw feet for other mostly smaller retailers) also pay much lower rentals.

Lastly, if you sign a lease with a turnover clause, the basic rental is lower and you pay an agreed percentage of your turnover as additional rental if you achieve a turnover exceeding an agreed amount.

It will be difficult to get a rental for a non-anchor of less than R150/m2 in a centre greater than 20 000m2 unless the centre is struggling and the owners are getting desperate. Do not be surprised if the asking rental is closer to R1 000/m2 per month in high performing malls.

In such a situation, rather work out the total rental cost as a percentage of the expected turnover before rejecting such a rental just because it seems so high. In South Africa, some franchisors will insist on a clause affirming their right to take over the lease of the premises should the franchise agreement be terminated.

Beginning date of the lease:

If the space requires major revamps or is in the process of being constructed, you don’t want to start paying rent until it’s completed. Gigitte Phiri, Placecol franchisee at Forest Hill City Mall in Centurion thought she’d be in business by the end of May 2014, but when she opened her doors a month later, the mall was only 50% complete which severely impacted on foot traffic.

“Everything takes longer than you expect,” she says “Luckily, we negotiated lower rent, lower annual escalation and lower centre marketing fees.”

Kickout clauses:

What if you make less money than projected? A kickout clause lets you out of the lease after a certain time period – usually three or four years – if your revenues don’t reach expectations. Landlords of new shopping centres are more likely to agree to a kickout clause than ones with established malls.

Co-tenancy agreements:

Say you’re leasing space in a shopping centre because of another tenant, perhaps a supermarket or a clothing store. What if that tenant closes or moves away? You can negotiate that if an important tenant leaves, you can pay lower rent or follow suit and find new premises yourself.

Related: 6 Steps to Franchising: Closing the Deal

Tenant improvements:

In some areas, desperate landlords are offering huge concessions to attract new tenants, even building out their spaces for free.

It’s not unheard of if you’re proposing to bring a major franchise brand to a shopping centre, that the landlord will fork out big time for improvements that include upgrading the exterior, repaving the parking lot and improving the bathrooms and air-conditioning. If this is the case, be sure to negotiate a ten-year fixed-rate lease so you’re not hit further down the line with the costs of the improvements.

An experienced broker will know what incentives landlords are giving in your area – they’re often calculated in rands/m2 metre of leased space – and will ask for them in your letter of intent. If you don’t need major improvements, you may want to ask for several months of ‘free’ rent instead.

“A tenant can negotiate not to pay rent until the construction is complete at a building or shopping mall,” says Cloete.

Common Area Maintenance (CAM) fees: In addition to rent, a commercial tenant pays a share of a shopping centre’s maintenance – landscaping, cleaning, painting and so on.

It’s calculated according to how much space is leased. In South Africa this is included in the operating costs, says Cloete. You can prevent CAM charges from soaring by negotiating:

  • A fixed CAM rate. Without this, your landlord can increase your share should other tenants leave the centre.
  • A cap on CAM increases, set at somewhere between 3% and 7% a year.
  • A refusal to pay CAM administrative charges. These fees can be highly profitable for landlords.

Exclusivity clause:

This protects you by asking the landlord to agree to not place a competing business in his centre, or, if it’s

a large mall, within so many metres of your business.

Hire an Attorney

When you and your landlord reach an agreement, the terms will be drafted into a formal lease and you’ll need an attorney to review it and negotiate with the landlord’s attorney.

“Choose that attorney carefully,” says restaurateur Josh Fröm. “When I was negotiating a lease for a restaurant space, I used an attorney who was referred by another restaurant operator, but he did not have the experience I needed and the negotiations fell through.”

To vet a new attorney, Fröm asked for references and talked to people who had signed leases that the attorney had negotiated. 

Understanding lease agreements

It’s vital that you get a commercial property lawyer to look over your documents and explain them to you. Here are some of the main characteristics of a lease agreement:

  • The agreement should cover all of the important issues in clear, concise language that you can understand.
  • It should contain the names of all parties involved in the lease agreement, the address and description of the property, the rental lease period, and rental amount.
  • Check on the conditions that must be met before the offer takes effect: Deposit amount, surety, inspection of the property and your obligations.
  • The lease should state the exact size of the space you’re renting, the position within the broader premises (if applicable) and anything else included in the rental.
  • Any other facilities you or your clients may use within the broader premises (like restrooms) should be mentioned.
  • Stipulate any changes or improvements that need to be made by the landlord before you move in or pay your first month’s rent.
  • Make sure you know how your rental will be calculated. (Rentals for industrial and commercial property are usually quoted in rands per square metre per month, excluding Vat).
  • What costs are included in the renal amount and what other costs will you incur monthly, like electricity, security, maintenance, insurance and so on. The lease should state exactly what and how much these costs are.
  • How much parking space is there? Do you pay extra for parking and car security?
  • When does the rental appreciate, by how much and how much notice does the property’s management have to give you in this regard?
  • The lease should state exactly what kind of changes you’re allowed to make to the premises, either structurally or to the general look and feel.
  • Who is liable for costs related to damage to your business’s property or the premises in the event of a crime or natural disaster?
  • What are the general rules governing a tenant, like keeping your premises clean, noise levels low, hours of operation and
    so on.
  • Under what circumstances can the lease be voided, either by you or the landlord?
  • How does a notice period work should you or the landlord want to end the contract?
  • The lease should state what the procedure is should the landlord become insolvent or intend to sell the property.
  • What is the procedure and who is liable for costs in the case of legal proceedings between you and the landlord?

Get approval from your landlord

If you’re buying a franchise, make sure your franchisor is happy with the location – having conducted area analysis and demographic studies, perhaps even been involved in lease negotiations. Send your franchisor a copy of the lease and get their approval in writing.

Related: 18 Steps to Franchising: Vetting Existing Franchises

Get a ‘rent free use period’

Most landlords will give you 30 to 60 days rent free to instal your trade fixtures and spruce up the space before you have your grand opening and start paying rent. They won’t give it to you out of the goodness of their heart though, you’ll need to ask for it.

Carefully review previous tax and utility bills

Shopping centre leases require that you pay your percentage of the landlord’s property taxes and electricity in addition to the monthly rent. Ask to see the previous tenant’s tax and utility bills and be sure to check with the local municipality and ask if any major tax increases will be coming in the next few months.

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