As a former restaurant owner and as a restaurant broker I have negotiated over 800 leases. As a result of my experience I thought it would be helpful in this issue and the next issue to discuss some of the most important aspects of negotiating a lease. In addition to the topics discussed below I’ll be covering the following topics in the future – assignment and sublease rights, use clause, options and determining rent in the option period, first right of refusals, options to purchase the building and landlord contributions.
1. YEARLY RENT INCREASES – Yearly rent increases should be tied to either pre-negotiated fixed yearly rent increases or the Consumer Price Index (CPI) with a maximum or ceiling and preferably no minimum or floor. Typical yearly fixed increases range from 2 to 4% and yearly CPI adjustments have a ceiling of 5 to 6% and if you have to agree to a floor or minimum they range in the 2 to 3% range. Needless to say it is helpful if you can lock your rent in for several years at a time and have adjustments every 2 to 5 years.
2. PERCENTAGE LEASES – If the Landlord insists on a percentage lease you should cap the percentage to 5 to 6% of yearly sales. In exchange for a percentage rent you should negotiate a below market minimum rent and have the Landlord make a monetary contribution to any remodeling you plan to do. If you have a NNN lease where you are paying the real estate taxes, building insurance and common area expenses (CAM) which includes landscaping, security and other maintenance costs you should negotiate a RECAPTURE PROVISION whereby you can deduct from your percentage rent dollar for dollar any of these NNN expenses. For example if your total rent is $80,000 per year, of which $60,000 is base rent and $20,000 is additional percentage rent and your NNN expenses are $15,000 you should be able to deduct those $15,000of NNN expenses form your percentage rent. So instead of paying $95,000 ($60,000 base rent + $20,000 percentage rent +$15,000 NNN expenses = $95,000) a year of base rent plus NNN expenses you are only paying a total of $80,000 ($95,000-$15,000 of NNN expenses against your percentage rent =$80,000) rent which is a savings of 16%.
3. DETERMINING MARKET RENT – If you are negotiating a new lease or renewing a lease the best way to determine what the market rent is to talk to several reputable commercial brokers who do retail restaurant leases in the area of your restaurant. Also drive your area and look at for lease signs and call the brokers and ask what the rent is. Then talk to several restaurant owners in your area and ask them what their rent is. Then take an average of the rents you’ve surveyed and use this number as a basis for negotiating with the landlord. If you are negotiating a new lease and have had a good prior track record as an operator use your past background to get the landlord to give you a favorable rent. If you are renewing a lease capitalize on your past success as a tenant in terms of paying your rent on time, keeping the premises maintained, etc as a tool to negotiate a favorable rent.
4. ASSIGNMENT AND SUBLEASE RIGHTS – Having the proper language in this section of the lease is extremely important in helping you sell your business. This language should include the words “the Landlord will not unreasonably withhold consent” in consenting to an assignment. Additionally you want to have the right to sublease and keep any of the excess monies from a prospective sublease ( this is called a spread- the difference between the rent you are paying the Landlord and the rent you are receiving from the Sub lessee or at the minimum being able to share this spread 50/50 with the Landlord).
5. OPTIONS – These are helpful to you in giving you the added years necessary to operate your business as well as making it easier to sell your business. Try to get the first years rent of each term of the option nailed down up front so you aren’t the victim of runaway rent increases which make it economically unfeasible to operate. Try to stay away from the market rent formula and try to have the rent tied to a rollover of the Cost of Living (CPI) in the proceeding year. For example if you have a five year base term with a five year option and the rent in the fifth year of the base term is $4000, set up the rent in the first year of the option period to it is tied to CPI (assuming CPI is 3% for the proceeding year the rent for the first year of the option would be $4,120 or $4000 x 103% = $4,120). Make sure that the options are assignable too.
6. RIGHT OF FIRST REFUSAL – This is a very helpful tool for you and gives you the right to purchase the building should the Landlord put the building on the market during your tenancy. The way this works is that if the Landlord gets an acceptable offer from a third party buyer he has to come to you to give you the opportunity to match or exceed that offer usually between 15 to 30 days from the date this offer is received.
7. LANDLORD CONTRIBUTIONS – Having the landlord contribute capital improvement money to you based on so many dollars a square foot (i.e. $25 per square foot) is helpful in reducing your initial investment. If the Landlord is willing to do this have it structured so are not obligated to pay back this contribution through increased rent.
8. CAPPING NNN EXPENSE PASS THROUGH – Make sure you have language in your lease to protect you should the building be sold or transferred and the building is reassessed and you are responsible for paying a pro-rata share of the real estate taxes. This language (capping your real estate tax liability) will result in your real estate tax liability being limited only to the assessed value of the building to your lease inception date and will limit your future tax liability. Have caps also built into your lease for insurance and Common Area Maintenance (CAM) expenses to minimize future expense increases in these categories as well.
If you are negotiating a new lease or renewing your lease please feel free to get in touch with us at Restaurant Realty at 415-945-9701 to help advise you through this important process.