Understanding a Lease
For the past few months, we've looked at how to determine the types of locations that are best for your business and how to find that perfect location. This month, we'll look at some of the economic terms commonly found in a commercial lease.
Many franchisors provide new franchisees with hands-on assistance in understanding or negotiating leases. Others may provide training programs on site selection and lease negotiations, or addenda of terms that should or must be included in leases their franchisees sign. Find out about any of this assitance before you enter into negotiations with your landlord. Franchisors have done this before, and their experience can not only save you time and money, but also help you avoid losing that perfect space.
Once you've found a good location, most franchisors will ask you to complete a site review package, which could include demographic information, photographs of the exterior and interior of the space, and photographs of the surrounding area. There will be questions concerning traffic counts, other tenants in the center, the size of the space available as well as the condition of the space and the work required to bring it up to your franchisor's standards. In most instances, you will need the approval of the franchisor before you're able to sign anything. You should also hire a good real estate attorney to help you evaluate the lease and assist you in negotiations.
Your focus should be on the total cost of the location. While you'll often find that larger locations have a smaller cost per square foot, if you don't need the extra space, there's really no reason to incur the extra expense. Here are some terms to keep in mind:
Base rent: This is typically stated as a square-foot cost. For example, an annual gross rent of $36,000 for a 2,000-square-foot location will usually be stated as a base rent of $18 per square foot.
Percentage rent: Many centers will charge you an additional amount based on a percentage of your gross sales. Typically, the percentage rent can be calculated as a fee over and above a projected minimum sales volume. Try to avoid a percentage rent altogether or negotiate a high sales point above which the percentage rent would be calculated.
Cost-of-living escalator: In times of inflation, many landlords will try to limit their risks associated with rising costs by increasing your rent. This increase is based on a formula, such as the Consumer Price Index. For many years now, with inflation low, this hasn't been a major problem for most tenants. But you shouldn't ignore the possibility of higher inflation, and you should limit the amount of any cost-of-living escalator your landlord may require.
Common-area maintenance fees: The composition of these costs will vary from location to location, but they typically include the costs of items shared by all the tenants, including parking lot maintenance, snow removal, common signage, security, exterior lighting, general maintenance and repairs. Landlords typically allocate these expenses based on the size of your location as a percentage of the total center size, but you should be careful about how this is calculated. We'll discuss leased vs. leaseable later.
Merchants association fees: While usually only found in mall locations, merchant association fees pay for the mall's general advertising and promotion. As with common area maintenance fees, your charges are usually based on the size of your location.
Real estate taxes: As with common area maintenance and merchants association fees, you will typically be charged with your percentage of the total real estate bill of the center.
We've covered most of the common additional costs. However, how those costs are calculated can have a dramatic impact on your overall occupancy expense.
Leaseable vs. leased: Landlords prefer to charge you additional expenses based on the amount of space they currently have leased in your center. In this way, they don't incur the additional expense for locations that are vacant. For example, assume you're in a center that has 500,000 available feet of retail space but only 400,000 square feet of it are leased. The size of your location is 2,000 square feet. If your lease provides for you to share common expenses based on leaseable square feet in the center, you would pay .004 percent of the common expense (2,000/500,000). However, if your lease provides for you to pay based on the total space currently leased, then your share would be .005 percent (2,000/400,000), or 25% percent higher than under the leaseable calculation. It's always in your best interest to negotiate your additional lease contributions based on a leased formula, as a leaseable formula typically benefits the landlord.
Remember, having a low square-foot rent does not necessarily mean your overall rent will be low. You should be concerned with your total occupancy, and that means having an understanding of the additional costs and how those costs are calculated. An experienced franchisor or real estate attorney can help you make the right decision.
Michael H. Seid, founder and managing director of franchise advisory firm Michael H. Seid & Associates, has more than 20 years' experience as a senior operations and financial executive and a consultant for franchise, retail, restaurant and service companies. He is co-author of the bookFranchising for Dummiesand a former member of the International Franchise Association's Board of Directors and Executive Committee.
Kay Marie Ainsley, managing director of Michael H. Seid & Associates, consults with companies on the appropriateness of franchising; assists franchisors with systems, manuals and training programs; and is a frequent speaker and author of numerous articles on franchising.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.