Once you have gone through the site selection process you will need to commence discussions (or retail lease negotiation) regarding the overall structure of the deal and some of the key terms.
Retail lease negotiation is both an art and a science. The desired outcomes and where you can create leverage is unique to each deal and to each business. For those Tenants that haven’t acquired lease negotiation services, this article provides guidance on how to identify the outcomes that you want before entering into a retail lease negotiation. For example: Is a 2-year lease term or a 10-year lease term better? Should you negotiate for fixed rent increases or a market increase? What kind of control do you need over your branding?
Invest the time and work through these items to develop your ideal position prior to commencing negotiations.
Do your research in respect of the market rent payable for your location. In retail leasing, the rent is generally either structured as a net rent or a gross rent. A gross rent means that the outgoing costs are built into the base rental rate. It doesn’t usually mean, as often thought, that you aren’t contributing to outgoings / operating expenses. Before attempting to negotiate a gross rent make sure that you know the statistics. If you don’t know the numbers, then you may end up with a gross rent that is higher than a net rent plus outgoings / operating expenses – but still think you are coming away with a good deal.
The cost analysis does not stop with the base rent. You need to consider the overall occupancy costs, which includes other costs such as turnover rent (if any) and electricity. The measure of success for your retail business will ultimately be determined by an occupancy cost ratio. Namely, what percentage of your gross sales was spent on leasing the business?
There are additional ways to structure the rent payable under a lease – it’s not limited to net or gross. For example: A gross occupancy cost based on a gross sales threshold. However, these are complicated concepts and we leave them for another piece of leasing literature in the future. If you are interested in learning more about turnover rent though, you can head over to our article titled ‘5 Things Tenants Should Know About Turnover Rent’.
Rent Review Structure
There are 3 types of rent review structures available to retail tenants, which generally occur annually. Rent increases are either by:
- the consumer price index;
- a fixed percentage (e.g. 5%); or
- the current market.
An independent lease negotiator will consider the length of the lease when determining which structure should be adopted. If your lease is particularly long, then you will want to consider a market review to ensure that the rent is corrected by the market at a particular point in time. A market review is carried out by the specialist valuer and the process is regulated by the retail legislation. The ultimate result is that the rent payable will be reverted to the current market rate.
Why is this correction important? Imagine that you have a 10-year lease with annual increases by a fixed percentage of 5%. Over the term of the lease, the rent would increase by 50%. If we look at the historical data we can see that over a decade the market (for retail / commercial rentals, not Sydney housing prices!) didn’t double. To avoid paying an overinflated rental, you can build in a market review to correct the rate.
Length of the Lease
Determine your ideal lease term. Whether that is a longer or shorter-term will ultimately be decided by your individual business circumstances. For example: If you have a brand-new business, in an untried location, then perhaps a shorter term is preferable from a risk perspective. However, this approach is subject to having an option to renew.
There are various benefits to a longer-term lease. For example: It’s a saleable asset. Additionally, if you rely on foot traffic or customers knowing your location, then a guarantee that you will remain in the same location is a good risk management practice. In keeping with good risk management practices, if you opt for a longer-term lease then make sure that you develop a leasing strategy to accommodate any future growth or downsizing of your business. These types of property strategies for Tenants are critical, yet often overlooked.
Fitout of the Premises
You will be required to fitout the premises to some extent, whether that be a full fitout from a bare shell or relatively minor refurbishments with signage and branding installations.
Regardless of the level of work required, ensure that you conduct a cost analysis. In conjunction with the cost analysis, you need to investigate whether a Landlord incentive or rent reduction can be negotiated to help offset those start-up costs.
When carryout works in a shopping centre, the Landlord will usually have a document called a fitout guide. This guide sets out the Landlord’s requirements on materials or building work standards. It is imperative to factor in the costs of compliance.
The permitted use dictates how you will be allowed to use the premises. Normally the lease will prevent all other uses. For that reason, it is vital that you ensure the permitted use captures all parts of your business. For example: If you are a café, but also selling retail products such as branded t-shirts, you don’t want a permitted use that simply reads ‘café’. You want to ensure that the retail apparel part of your business is also incorporated.
If you are a food based retailer, then sometimes it can be a good idea to leave your permitted use broad (such as ‘Japanese cuisine‘). Try to avoid linking the permitted use to a specific menu.
Finally, it is wise to incorporate some broad wording at the end of the permitted use to provide some flexibility as your business or industry evolves during the lease term.
Finding the perfect balance between specificity and broadness can be difficult. The negotiations in this area can also be laborious as the Landlord is interested in maintaining a high-level control over its centre. If you run into difficulties consult with an independent lease negotiator.
Assignment and Sublease rights
Assignment: At a minimum, the assignment provisions in the lease should be consistent with the retail legislation in your jurisdiction. Going a step further, it would be preferable to negotiate some more specific release provisions. This is because in some jurisdiction the retail legislation makes the release dependent on compliance with certain disclosure obligations.
Sublease: Retail leases can sometimes be restrictive on your on the ability to sublease. However, in reality the risk to the Landlord is greater in an assignment of lease than a sublease. Hence you want to ensure that the requirements for subleasing are a little laxer in comparison to the assignment provisions.
If you are a franchisor, make sure that you negotiate the occupation licence for your franchisee at this stage.
- Outgoings / Operating Expenses If you, or your independent lease negotiator, have negotiated a net lease then you will be required to contribute to outgoings. Outgoings effectively represent the Landlord’s cost of operating the shopping centre. Your portion of these costs are calculated based on the floor area of your premises. Before entering into the lease, you will be provided with an annual outgoings estimate. However, it can be worthwhile asking a few more questions about how much the outgoings have increased historically. Based on that information you need to determine whether it’s necessary to try and negotiate a cap on outgoing increases each year.
During the term of the lease you may want to make alterations to the premises. Ensure that the alteration clause in the draft lease is not unnecessarily restrictive. For example: You want to ensure that you can make overall branding changes to the premises without prior Landlord approval.
9. Make Good
You will be required to make-good the premises at the end of the lease term. However, you must carefully review the make-good clause to determine the specific condition you need to return the premises to.
For example: When you took possession, the fitout from the prior Tenant remained in the premises. You use this fitout during the lease term. If the make-good clause requires you to return the premises to a bare shell, then you will incur the cost to remove and dispose of that prior Tenant’s fitout. Here you would want to draft the make-good clause to exclude this removal.
Similarly, if you are required to return the premises to the condition as the commencement date, but you carried out the fitout works during a fitout period, then you may be required to leave your fitout to the Landlord at the end of the lease.
10. Relocation and Demolition
Retail leases often contain provisions which allow the Landlord to relocate your business to another comparable premises in the shopping centre if required as a result of centre development works. If the Landlord is considering centre development works, you can usually get an indication from the Lessor Disclosure Statement (if you know what you are looking for).
If there are potential development works it would be preferable to have the relocation / demolition clause removed from the lease. This would help avoid any business interruption disputes. However, Landlords are quite reluctant to remove these provisions. If you can’t negotiate the clauses out of the lease, then ensure they are reviewed carefully and amended as appropriate.
Overwhelmed? We can help.
There are a lot of moving parts to a retail lease negotiation. One of the most difficult tasks for Tenants is defining their position in a negotiation. Our Tenant Representation & Advisory Services can offer you a top-tier independent lease negotiator. Alternatively, we can offer you a full suite of Tenant Representation Services – from site acquisition / site selection through to lease negotiation and execution.
You can contact Liberty Leasing on (07) 3359 8273 or book an appointment online.