Summer 2004 Movin’ Up, Movin’ In
Sooner or later, most specialty retail entrepreneurs operating temporary carts, kiosks or even in-line stores want to be successful enough to be a permanent tenant in the mall. It’s a big step. Many retailers find that negotiating their first lease for a permanent in-line is one of the most mysterious and aggravating parts of the going-permanent process.
As a result, it’s imperative to find a qualified real estate attorney to negotiate the legal points of the lease. But this doesn’t mean you can just sit back and sign it—mistakes can be costly. As the one whose signature is on the dotted line, you’re responsible for everything in it. So you need to understand and negotiate all of the important business points that may be vital to insuring your future success, like these.
The Use Clause
As the tenant, you need to clearly define the use clause at the time the lease is negotiated. Include every item you intend to stock. Management won’t agree to a use clause that’s too broad, so negotiate a clause that’s best suited to your business. While it’s not possible to predict every item you might sell at some point in the future, be as thorough as possible. If you do have to approach management for a major use-clause revision later, they may see this as an opportunity to get something in return—like a rent increase.
Rent and Ancillary Charges
Many first-time tenants sign a lease without really understanding all of the charges. It’s important to clearly define them before signing the lease so you know what your financial responsibilities are. The lease will require you to pay a base minimum rent plus:
- a percent of sales over a predetermined break point
- common area maintenance (CAM) charges
- real estate taxes
- services including security, insurance, pest control, sprinkler fees and trash removal
Base rent and some of these ancillary charges may be negotiable.
Limit on Ancillary Charges
The lease will contain provisions for mall management to recoup operating expenses for common-area maintenance, real estate taxes, insurance and marketing. While it’s certainly important that the center is maintained the same way throughout the term of your lease, you should negotiate to limit any increase in items that are within management’s control, such as common-area maintenance, and marketing expenses. So negotiate a cap on the CAM charges, and a cap on the annual increase in your contribution to the marketing fund at 5 percent a year.
Landlord and Tenant Work
It’s equally important to understand and clearly define the extent of the work that mall management will complete on the space before you take possession, and the work you’ll complete before you open the store. In a mall, it’s customary for management to “deliver” a basic shell: metal stud walls; electrical and telephone conduits; plumbing stub-in; sprinkler service without heads; a smooth, level concrete floor; and a rear door. The space may or may not include heating, ventilation and air conditioning (HVAC).
After that, it’s your responsibility to complete all of the additional remodeling and finishing work before you open. Your costs may run between $75-$200/sf, depending on the finishes you use and the local construction market. Many first-time permanent tenants underestimate the costs of building out a retail store, so before you sign the lease, do some homework. That way you’ll have a good understanding of how much the build-out might cost you—and then you can try to negotiate with management to help offset your remodeling cost. You can ask them either to make a cash contribution, called a tenant allowance; or do some of the remodeling work themselves.
Radius Restriction Clause
This protects management by preventing you, the tenant, from opening another store so close to the mall you’re in that it would impact your sales in that space. And reduced sales would reduce or eliminate the percentage rent the mall can collect from you. The radius restriction is expressed in miles, usually five. It’s in your best interest to negotiate reducing or eliminating the radius restriction so that your ability to expand isn’t hampered.
This provision helps ensure that the mall stays busy while you’re a permanent tenant. It’s typical for a tenant to make a five- to ten-year commitment to a mall landlord. It’s not unreasonable for you to expect that management will continue to operate the mall so that it’s a viable retail project. And one major way they do that is to maintain a level of occupancy—have enough retail tenants—to attract and support customer traffic throughout the term of your lease. A co-tenancy provision protects you by offering remedies if the mall loses anchor stores or smaller in-line occupancy falls below an agreed-upon level. For example, say you’re signing with a super-regional mall that has four anchors and 92 percent small-shop occupancy when the lease is signed. In that case, it wouldn’t be unreasonable to ask that if occupancy falls to either fewer than three anchor stores or less than 65 percent of the small-shop tenants, then your base rent and ancillary charges would be reduced to eight percent of gross sales until the occupancy level is remedied… and that if that occupancy level were to continue for more than 12 months, you have the right to terminate the lease. But remember, you have to negotiate this before you sign.
Sales Volume Termination Right
For the retailer entering into a long-term lease, the financial investment and time commitment can be substantial. If you’re successful, the rewards can be well worth it. But if your sales can’t generate enough revenue to pay your operating expenses and earn you a living, then your business can quickly become an emotional and financial strain. A sales volume termination right, or “sales volume kick-out,” can protect you from being locked into the rest of the lease term if your failing retail venture would otherwise force you into bankruptcy.
You want to negotiate the right to close the store and terminate the lease if your gross annual sales don’t exceed a pre-determined level. If this happens, it’s common for the tenant to pay the landlord back for the unamortized value of any improvement allowance the landlord provided, plus an early termination fee. For example, in the case of a 10-year lease where the mall gave the tenant a total of $10,000 as an improvement allowance, mall management may agree to let the tenant out of the lease after the third year if the tenant’s sales that year don’t exceed $175/sf—provided the tenant pays an early termination fee of three months’ rent and reimburses the improvement allowance.
Nearly every retail lease contains some sort of assignment provision that defines the terms on which the tenant may assign the lease to someone else. This language is often one-sided in favor of the landlord—such as the right to terminate the lease when the tenant asks to assign it, or to increase the rent by as much as 25 percent if they do approve the assignment. This is fairly common and, obviously, offers little protection for the tenant. The landlord will also retain the right to approve an assignment and may also ask for a substantial fee from you, if they do approve it.
The assignment provision is important to you because it allows you to sell a successful business at a profit, or transfer ownership to a family member. So it’s important to negotiate a fair and even-handed assignment provision, one that requires the landlord not to unreasonably withhold approval of an assignment; not raise the rent if an assignment is approved; not terminate the lease if assignment isn’t approved for good cause; and limit the assignment fees. For an approved assignment, it’s customary for the original tenant to remain on the lease for the rest of the lease term, even though a new tenant is paying the rent. It’s also customary that the new tenant operate the premises under the same use clause in the original lease.
Finally, if you’re a sole proprietor when you sign the lease and you plan to incorporate one day, then negotiate the right to assign the lease—without first seeking landlord approval—to a corporation or limited liability company in which you are the majority owner.
Most retail leases contain a personal guarantee if the tenant isn’t a large company with dozens of proven locations. By signing the personal guarantee, you (and your spouse, if you’re married) essentially offer all of your personal assets as collateral for the full and timely performance of all of the lease provisions. Nearly every mall landlord requires a tenant to do so—even if the tenant is incorporated. To minimize your risk, negotiate limiting the duration of the guarantee, or put a cap on your financial responsibility in case of a default. For instance, you can ask that the personal guarantee last for only the first three years of a ten-year lease, provided you pay rent in a timely manner and are not otherwise in default. Or you could ask for a cap on your financial responsibility, up to the value of one year’s rent and ancillary charges if you default.
Many states have stringent environmental laws. Because many malls and shopping centers were built years ago, vacant spaces may contain environmental hazards like lead paint or asbestos. Clean-up costs can be staggering. So it’s important to negotiate a provision in which management agrees to be responsible for the costs of “remediating” any environmental hazard found while renovating the premises or during the entire term of the lease.
While most landlords won’t give a tenant the exclusive right to sell a specific item in the mall, it’s certainly worth asking for, if you believe it’s warranted. Another approach is to ask the mall to limit the total number of tenants in a given merchandise category. For instance, if you’re selling ice cream, ask that the mall be limited to two stores whose primary business is the sale of ice cream. While a little competition is good, too much hurts everyone.
Negotiating a lease isn’t easy. Your expectations will be high, but don’t let the buzz and the excitement of your “move up” distract you. Look ahead, and work to protect yourself from potential pitfalls down the road. Ask your attorney to go over the lease if you do your own negotiations. Or if you’re not comfortable negotiating the lease yourself, hire a commercial real-estate attorney or an experienced tenant representative to help you. No matter whether you go it alone or bring in expert help, keeping these points in mind is a good place to start.
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