Spring 2006 Leasing Retail Space: Temp to Perm
“Going temp to perm.” That’s leasing shorthand for making the move from a temporary seasonal space to a permanent year-round one. Some temporary specialty retail tenants move to permanent spaces from carts, kiosks or in-line stores. Being in a short-term retail space first allows retailers to get their businesses going, fine-tune operations, get a feel for potential sales and even expand their product lines in response to customer buying patterns.
Specialty retailers can “gauge their potential to succeed in a temp-to-perm conversion after experiencing sales as a short-term store,” says Anita Saleh, vice president of specialty leasing for The Taubman Company. Tenants in short-term specialty leasing programs have knowledge on their side: knowledge about the center’s traffic, their specific customers and their businesses’ chances for year-round viability.
Specialty retail programs, often referred to as “incubators,” allow a retailer with an unproven sales history—and who therefore may not be accepted as a permanent tenant with a lease term of three to ten years—to come into a center under a short-term license agreement and move to a year-round long-term lease at a later date, assuming the retailer meets the center’s qualifications. “It’s easier to get into a temporary location, it’s less expensive, the lease is simpler and [the developer] might be more lenient,” says Christy Ronconi, public marketing manager for CrepeMaker, Inc. (Miami, FL). Plus, she adds, a temporary space at the outset gives retailers the chance “to see how their clientele enjoys the product. It’s good for [the retailer]. It’s good for the mall.”
Leasing retail space on a short-term or temporary basis can “give the owner some breathing room to get the business established and get the sales up high enough to warrant a long-term commitment,” writes Barry Fleisher in his book, How to Lease Space in Shopping Centers: A Guide for Small Business Owners (iUniverse, Inc., 2003).
Sometimes, however, the problem is being able to stay in a temporary space, especially an in-line store. Tenants operating on a temporary basis are vulnerable to market forces that may force them to vacate a location, even if sales are soaring. If, for example, a national retailer that drives lots of traffic into the centers in which it operates wants an in-line space occupied by a short-term tenant, it’s time for that tenant to pack up the inventory and move out.
“We moved three times in six months in 2003,” says Deepak G. Nachnani, owner of Coastal Edge (Virginia Beach, VA). “We lost two to three weeks worth of business every time we moved… It got exhausting for our customers as well as ourselves.” A primary benefit of signing a permanent lease is having a permanent location for your customers, your employees and yourself, and not hearing, ‘You have to move to the other end of the mall and cultivate your traffic all over again.
Moving can come at the worst of times, as it did for Robert Harnsberger, a Pro Image franchise owner in Baltimore who had to relocate during the December holiday rush. Harnsberger may have been lucky, though. Some retailers have been asked to leave altogether. When Neiman Marcus voiced concern over a kiosk in front of its store, the retailer, a CrepeMaker franchisee, had to close because there were no other spaces available for relocating.
“As most major mall developers have a 24-hour relocation/revocation clause, a business can be required to move literally overnight,” says Heidi L. Cardall, director of specialty leasing for CBL & Associates Properties. “Hopefully, the temporary [retailer] gets moved to another location within the mall and the mall assists in redirecting the customers with signage, etc., until the customer base can get back up to speed,” she says.
For specialty retailers considering a long-term lease, the first step is analyze sales to gauge if going temp to perm is a viable option. The shopping center management certainly will. Center managers typically want to see a track record of six months to a year to be sure a retailer has staying power. Some short-term retailers enter a center during the holiday season and become overconfident that sales will remain at holiday levels throughout the rest of the year, says Bill Gardner, senior leasing manager for CBL. Specialty retailers need to get a feel for sales levels during both busy and slow seasons before feeling confident about their true sales potentials, he says.
Looking the part
Sales aren’t the only item on shopping center management’s radar, though. Although most tenants operating on a temporary basis don’t want to invest a lot of money outfitting a space they soon will be leaving, these retailers do need to “dress the part” of a permanent tenant. In other words, the cart, kiosk or store should already look permanent to show management the retailer has a long-term (and professional) perspective.
“You have to be creative in the layout of your store,” says Mauricio Chediak, owner of B. Fashion (Davie, FL), who went from short-term cart and kiosk locations to three permanent stores and expects to expand to as many as 14 permanent locations. “You need to hire people to help you with your windows and your lighting. And then [management] will get good comments about your store.” The bottom line? “Put your money where your mouth is,” he says. “Use a little bit of vision—and capital.”
And be patient. Sometimes finding the right permanent space takes time. “It took about four months to get a spot I thought was beneficial” for a Pro Image store, says Harnsberger. “I turned down a couple [locations]. I said yes to one, but a national got it.” To evaluate a potential location, Harnsberger would sit on a bench near the space, to see how many of his potential customers walked by. He also evaluated locations based on the cost the improvements needed to turn a vacant space into an attractive store, a process called “build-out.” The build-out cost for one space was estimated at more than $100,000, which his sales didn’t justify, he says.
According to Fleisher’s book, How to Lease Space, “a small store with a basic build-out will likely cost a minimum of $60,000 to $75,000.” However, many developers help with tenant allowances (more on allowances later).
Provided the numbers justify going from temp to perm and the mall management agrees with that assessment, the next hurdle is negotiating a year-round, multi-year lease, an entirely different entity from the license agreement for temporary space.
Negotiating the terms of the lease is often considered one of the hardest aspects of the process for specialty retailers. Some retailers do their own negotiations, but the ones who do it successfully usually have years of experience. For novice retailers, this isn’t the time to go it alone. “For Pete’s sake, hire a great attorney! And hire a negotiator,” says Nachnani, who also received help from vendors, manufacturers and a leasing agent. Attorneys and negotiators are “very expensive but worth every single penny. They breath in and out this [lease] language.”
“So many tenants are paying so much money over a long period of time, they can’t afford to do it wrong,” says Dale Willerton, founder and CEO of The Lease Coach (Los Angeles) and the author of Negotiate Your Commercial Lease (Self Counsel Press, 1998). Approximately half of his clients are independent retailers who often “think whatever they’re being offered must be fair and reasonable,” he says. The problem is, retailers “can’t ask for what they don’t know they’re entitled to.”
Rent vs. sales
Mention the words “negotiate” and “lease” in the same breath and the next word that comes to a prospective tenant’s mind is “rent.”
“Temp-to-perm leases can be as much as four times the temp rent, but depending on what the temp rent is, and the location, and mall, etc., sometimes the lease is transitioned with little to no increase,” says Shannon Dyess, short-term leasing manager for Simon Property Group. Harnsberger bears that out: “I’ve paid more in temporary rent,” he says, adding that he once paid $30,000 for December on a short-term agreement.
When evaluating rent figures, specialty retailers should keep in mind that just because a store will be taking on a new permanent status, that doesn’t mean sales or profits will increase. In fact, some costs may put more pressure on the bottom line. “We’re pretty much at the same place as before regarding our profit margin,” says Ronconi of CrepeMaker. “There was an adjustment period. We needed more employees, more equipment and a bathroom.”
When evaluating a new location, Nachnani advises retailers to focus squarely on sales and ask themselves: “Is it worth doubling or tripling your occupancy costs? Truly look at what [sales] you’re doing right now.”
More than store décor
Another substantial figure in the lease-negotiation process comes in the form of build-out. For starters, the permanent tenant needs to hire an architect and submit floor plans for mall approval. In fact, mall management will want approval on just about everything, including signage, color schemes, floor coverings—the whole gamut. Once everything is approved, the installation—and the expenses—begin.
But there is good news: the tenant allowance. The mall often provides a sum of money to help offset the cost of build-out, paid usually after construction is complete. To get maximum bang for the buck, retailers need accurate build-out cost estimates in advance so they can effectively negotiate the amount of the allowance. However, accurately estimating build-out costs is tricky, cautions Ronconi. “You almost can’t estimate,” she says. In her experience, “The [final] cost is always higher” than the estimate.
Estimating construction time is another tricky area. This becomes critical because rent payments start on the permanent space once a pre-determined commencement date arrives, whether the retailer is ready to open or not. Timing becomes even more critical when closing one location to move to another. “We underestimated the time it would take for the build-out,” Ronconi recalls. “We had to pay double rent because we miscalculated commencement. The mall will give you a certain number of months for your build-out. Whatever you think it’s going to take, it will take a few more months.” On the plus side, Ronconi says CrepeMaker used the delay “as an opportunity to change our look. Once you have a perm location, you can make the investment in your look… You create more branding.”
Improving the look and image of your store may also enhance sales, says Andy Cohen, owner of Leatherhous (Roanoke, VA). “I made a lot of changes,” he says. “I remodeled with a construction allowance from the mall. I put in more inventory.” The payoff came when his sales increased in the new location, he says.
Other important parts of the lease aren’t in the form of a number. Specialty retailers are already familiar with the “use clause,” which outlines the products or services the tenant will sell. But as with everything else, the use clause gets a bit more refined (and sometimes complicated) when it comes to a permanent lease. Fred Delibero, senior manager for retail leasing for Copaken, White & Blitt, advises retailers to “clearly define the use clause at the time the lease is negotiated.” Although it’s not possible to predict “every item you might sell at some point in the future, be as thorough as possible to prevent future use-clause negotiations.”
A similar clause is the “exclusive,” wherein the center management agrees not to lease space to another tenant selling the same goods or services. Sounds great, doesn’t it? However, an exclusive may not be extended to specialty retailers moving into their first permanent space. Most often, the exclusive “is for a large national tenant for a limited, specific use,” Fleisher writes in How to Lease Space. “Small tenants are seldom given an exclusive,” he writes, adding that there’s no harm in asking, and that “for a very specific, one-of-a-kind use,” an exclusive might be granted.
Retailers should also be aware of a lease’s “kick-out clause.” This clause lets either the landlord or the tenant terminate the lease if a future condition, usually tied to sales performance, isn’t met. Here’s how it works: Let’s say the lease starts in 2006, but by 2008, several big employers in the area have laid off most of their workforces and sales are half of what they were when the lease was signed. The kick-out clause can kick in, allowing the retailer to leave the center before the end of the lease term without incurring penalties for an early departure.
There are plenty of other ins and outs of a permanent lease that may be negotiable, including your share of charges for expenses such as common-area maintenance and center marketing or advertising. These expenses can add up—all more reason for bringing in a professional who’s well-versed not only in lease language but also has experience dealing with shopping centers specifically.
The entire process—from scouting a new location to negotiating the lease to build-out and finally opening day—can take up to a year. But not always. “Sometimes retailers go perm in the space they’re in,” says Dyess of Simon.
No matter how long it takes, specialty retailers who have made the transition from temp to perm seem to agree: if your concept is a hit, going perm might be the next logical step for your growing business.
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