Franchisees, Negotiate the Rental Rate
It should come as no surprise that rent can be one of your three major business expenses, if not the largest. Your rent is not only important as a big part of your day-to-day expenses but also a major factor if and when you sell your business. Many franchisees have come to The Lease Coach over the years because prospective buyers think the rent is simply too high. The buyer is essentially scared off by the overhead.
As we explain in Negotiating Commercial Leases & Renewals FOR DUMMIES, smart landlords don’t just pull a rental figure from the air. Instead, a commercial developer sets their rental rates based on a simple formula, whereby the rental revenue from the tenants covers the mortgage and provides the landlord with 10 – 20 percent capitalization rate (or return on investment).
Mathematically, this is an easy calculation for the landlord that involves two numbers: face rate versus net effective rental rate.
The face rate is the dollar amount that you pay and the amount that appears on your lease agreement.
The net effective rental rate is the amount left after deductions for real estate commissions, inducements, tenant inducement packages, landlord’s work done on the space, and so on. With a $24.00 per square foot rental face rate, the net effective rental rate the landlord is left with can easily be reduced to $17.00 per square foot after these deductions.
You can’t negotiate your rent until you have some idea of what you can afford to pay. This would seem to be a basic business tenant, but it’s one that many franchisees fail to figure out. A general rent range figure – encompassing all industries – is that tenants should budget to pay between 5 and 12 percent of their gross sales in rent (provided that their sales volume is high enough).
The landlord doesn’t generally set the rental rate based on what they think tenants can afford to pay. This is your job to figure out. If you’re a start-up tenant, you should have a business plan or sales volume figure in mind that you expect to achieve in any particular location (your franchisor may have some expectations as well). The amount of sales can vary depending on the location; even franchisors have different anticipated sales volumes for smaller or larger stores that are part of the same brand. So, part of being realistic about your rental budget begins with being realistic about your area and how much space you lease.
We often see franchise tenants who get into trouble by agreeing to pay a rental rate within a property where their location is inferior to other units. End cap units with a high visibility to the street and parking lot often pay the highest rental rates. If you are being offered a unit at the elbow or on the quiet side of a plaza, you will need to examine this closely and determine how this might affect your sales. Understand that a bigger commercial space doesn’t always equate into higher sales on an equal scale basis.
Different units within the same property have a different value based on exposure, visibility, frontage, and many other factors that will draw traffic to your door. Be prepared to challenge landlords and their agents who make blanket statements that all tenants pay the same rent and all commercial retail units (CRUs) are equal. Even the width and depth of the CRU can make a difference in rental rates and desirability to the tenant.
While you are comparing commercial spaces and related rental rates, compare what other tenants in the same building are paying in rent as well. The Lease Coach frequently uses this approach and the results may surprise you! Knowing this information can work in your favor when it comes to negotiating; however, expecting their rent to be the same as yours isn’t always realistic. There are legitimate reasons why various tenants pay differing rents in the same property:
- Size of space required
- Length of lease term
- Covenant and history of the tenant
- Offered landlord inducements
- Timing when a business becomes a property tenant (the first and last tenants in a newly developed property may pay different rates)
- Physical location within the location relevant to other tenants
In closing, considering the average franchise tenant stays in the same location for at least ten years, it’s easy to calculate the total rent that you may pay to the landlord over that time. This is often more than you have ever paid for a house or anything else that you have purchased. For this reason, franchise tenants need to develop a grave respect for their rent. On a monthly basis, the rent may not seem like a big purchase, but most franchise tenants aren’t leasing on a monthly basis but rather for a 5-, 7-, or 10-year term. The economy can crash and rebound in one entire lease term … what you need is a long-term vision.