How Buyers Evaluate a Restaurant, Bar or Club Business to Determine if it is the Right Opportunity – Part 1
The three primary areas buyers focus on in doing their analysis to determine if the restaurant, bar or club opportunity is the right one for them is as follows: a. Price Valuation, b. Location Overview and c. Lease Terms. In this article I will discuss Price Valuation and Location Overview and in the next edition I will discuss Lease Terms.
Price Valuation
A buyer evaluates the price of the business to determine if it is reasonable based on a couple different methods.
Assets in Place Method of Valuation – If the business is not making money or is marginally profitable this is called the Assets in Place purchase. With these types of purchases the buyer is usually interested in the fixtures and equipment, lease, leasehold improvements and any licenses that go with the business and they are not normally interested in the name and menu of the business. The buyers for this type of business have their own menu and concept in mind. The criteria for pricing the Assets in Place business is the ratio between the sales price and sales.
For example if is a business is generating $500,000 in yearly sales and the sales price is $125,000 -the sales price is approximately twenty five percent (25%) of the yearly sales. ($500,000 yearly sales x 25% = $125,000 sales price), My experience in selling these types of businesses, which is the majority of the businesses I sell, is that businesses doing $350,000 in yearly sales or less sell on an average of thirty five percent (35%) of yearly sales. For example if a business in doing $300,000 in yearly sales the average sales price is approximately $105,000 ($300,000 yearly sales x 35% = $105,000 sales price). Businesses doing $350,000 to $1 Million in yearly sales sell at an average of twenty five percent (25%) of yearly sales. For example if a business is doing $750,000 in yearly sales then the sales price will be approximately $187,500 ($750,000 yearly sales x 25% = $187,500 sale price). Businesses doing $1 Million to $2 Million in yearly sales are selling at an average of seventeen percent (17%) of yearly sales. For example if a business is doing $1.5 Million in yearly sales it will sell for approximately $255,000 sales price ($1.5 Million yearly sales x 17% = $255,000 sales price). My experience in selling businesses doing $2 Million or more in yearly sales is that they sell for approximately fifteen percent (15%) of yearly sales. For example if a business is doing $2.5 Million in yearly sales it will sell for approximately $375,000 ($2.5 Million yearly sales x 15% = $375,000 sales price).
When buyers are eyeballing buying opportunities they are not necessarily familiar with the ratios indicated above but if they have been in the market long enough they develop an innate sense of value based upon how the subject business they are evaluating compares to other comparable businesses for sale.
Going Concern Method of Valuation – The Going Concern Method normally means that the business is making money and when the buyer purchases a going concern business they usually want to operate the business the same way the seller did and maintain the name, menu, operating systems and personnel in place. With this method the lease, leasehold improvements, fixtures and equipment, name, menu, concept, goodwill and cash flow are all included as part of the sale. The primary valuation method used for a Going Concern Valuation is the yearly adjusted cash flow method which is also referred to as discretionary earnings. This means that the net profit on the tax return or on the year-to-date income and expense statement is adjusted by adding back the following items to the net income: one working owners salary and payroll taxes, any personal expenses the owner is charging the business (food for consumption at home, life, health and disability insurance premiums, auto expense, entertainment and vacation expense, etc.), depreciation, interest and amortization expense on any loans the buyer will not be assuming and net operating loss carry forward charges if any. Additionally any extraordinary expense and or non-reoccurring expenses such as extra legal or accounting bills related to a particular lawsuit or unusual situation would be added back to the net income too.
Once the yearly adjusted cash flow is determined a sales price multiplier will be used to determine the value of the business. The sales price multiplier for independently owned, non-chain, non franchised food service operations will vary from one to three times yearly adjusted cash flow depending on the risk factors and other factors listed below.
The risk factor is determined by the following criteria: 1) the degree of difficulty in operating the business, i.e. an espresso operation has a low degree of difficulty as it is an easy operation to run but an upscale dinner house operation has a high degree of difficulty because it requires a high degree of expertise and sophistication to run this type of business successfully and 2) how long the business has been in operation and the past history of the business in terms of profitability and sales growth. A business with an easy to operate format coupled with a well-seasoned profitable earnings history will utilize a higher sales price multiplier versus a business with a high degree of difficulty without a track record.
The other factors which determine the sale price multiplier are as follows: 1) the lease value, (whether the lease is at market, below market or above market and the length of the lease),
2) the potential upside of the business (i.e. a business currently serves dinner only and has only a beer and wine license and there is potential for a strong lunch and/or brunch business and hard liquor sales) and 3) the future growth opportunities of a particular location (i.e. if there are some major new development(s) that will add new potential customers to the area without a lot of extraordinary new competition).
An example of a Going Concern Valuation is indicated as follows. If the yearly adjusted cash flow of the business is $75,000 and the multiple to be used is 2.5, the value of the business would be calculated as indicated : $75,000 (yearly adjusted cash flow) multiplied by 2.5 (the appropriate multiplier to be used based on the facts discussed above) which equals $187,500 ($75,000 adjusted cash flow times 2.5 = $187,500 sales price).
Location Overview
You may have heard the saying that the three most important ingredients for a successful business are location, location and location. Obviously there are other factors which are very important as well which are discussed in this article and elsewhere but you cannot compromise on location. Choosing the right restaurant location is one of the most important factors in contributing to ones success in the business. The restaurant business is very challenging to be successful in and having a strong location will enhance your chances for success. The key factors to consider in choosing the proper location which are discussed in detail below are as follows: 1. built out market, 2. stable demographics, 3. growth potential, 4. diversified clientele, 5. strong visibility and easy access, 6. heavy pedestrian and vehicular traffic, 7. major market generators in the area, 8. rent affordability and 9. trade area draw.
1. Built out market – You want to locate in an area that has combination of commercial businesses and residential population built out. If you locate to an area with a lot of open space you will be vulnerable to have new head on competition versus being in an area that is already is built out.
2. Stable demographics – Having a solid demographic base of long term well educated residents grounded with a strong commercial base of businesses and office tenants in the area is important.
3. Growth potential – Although you want to be in a well built out area it is always helpful to be in an area where there is opportunity for existing commercial businesses to expand.
4. Diversified clientele – It is helpful to have a mix of residents, commercial activity including retail businesses and offices buildings as well as hospitals, schools and religious institutions in the area.
5. Strong visibility and easy access – Strong visibility means that the business is easily visible to pedestrian and vehicular traffic and easy access means it is easy to get to the location by either foot traffic or vehicular traffic.
6. Heavy pedestrian and vehicular traffic – With these two qualities the business will have more exposure and have a greater opportunity to increase sales.
7. Major market generators – Strong traffic generators include hospitals, theaters, colleges, shopping centers and tourist attractions.
8. Rent Affordability – This means that you can afford the rent you will be paying. Frequently operators pay more rent then they should and this can contribute to them going out of business. Restaurant operators should not pay more than 6% to 8% of their sales in rent. This 6% to 8% factor also includes any additional costs you may be paying the landlord which may include real estate taxes, fire insurance and CAM charges (common area maintenance costs) which include security, gardening, common area utilities and maintenance costs, etc. This means that if you are doing $600,000 in yearly sales your rent should be no more than $48,000 ($600,000 sales x 8% = $48,000) in yearly rent.
9. Trade Area Draw – This is the distance an average customer will travel to come to your restaurant. Most neighborhood restaurants draw customers from a one mile radius of the site. Outstanding planned dining restaurants such as the French Laundry in Yountville, Michael Mina and Gary Danko restaurants in San Francisco may draw customers from hundreds of miles away.
The price of the business, location of the business and the lease terms (which will be discussed in the next edition) are the three most important variables a buyer will evaluate to determine if the business is right for them. If you are considering selling your business it is important to consider these items in determining how marketable your business will be and consult with a professional like Restaurant Realty Company to give you an unbiased assessment.
How Buyers Evaluate a Restaurant, Bar or Club Business to Determine if it is the Right Opportunity – Part 2
The three primary areas buyers focus in on in doing their analysis to determine if the restaurant, bar or club opportunity it the right one for them is as follows: a. Price Valuation, b. Location Overview and c. Lease Terms. In the most recent article I discussed Price Valuation and Location Overview and in this edition and the next edition I will discuss the major components of Lease Terms. In this edition I will cover the following topics: a. term of lease, b. rent, c. yearly rent increases and d. additional occupancy expenses. In the next edition I will discuss the following topics: e. the guarantor, f. use clause, g. assignment and subletting and h. options.
The Major Components of the Lease
a. Term – Term is the length of the lease in number of years. It is recommended that the operator obtains minimally a five year term, which is called the base term and a five year option which is discussed below, so the tenant has enough time to get a return of his investment and return on his investment. Some landlords do not grant options in which case it is recommended that the operator obtain a ten year or longer lease term. The advantage of having a shorter base term with options is that the tenant is only personally liable for the base term and if the business is not successful the tenant will not exercise the option and will minimize his personal liability. Generally the more that is invested in the business by the tenant the longer the lease term the tenant requires in order to be able to recoup his investment and obtain a reasonable profit on the money the tenant has invested in the business
b. Rent – Rent is the monthly payment the tenant is required to pay to the landlord for the tenants right to occupy the space. Most rent amounts are determined by the amount of square feet the tenant occupies times the market rent per square foot for the space. For example if the operator occupies a 2,000 square foot space and the market rent is $2 per square foot the monthly rent will be $4,000(2,000 sq ft x $2 sq ft = $4,000 per month).
Determining the Market Rent
If the operator is negotiating a new lease or renewing an existing lease the best way to determine the market rent is to talk to several reputable commercial real estate brokers who specialize in retail restaurant, bar or night club leases in the area of the proposed business. It is also a good idea to talk to real estate appraisers that have access to commercial rents in the area as well as checking out reputable commercial real estate websites such as loopnet.com to see what is currently for rent in the same area. Rents in large metropolitan areas will vary dramatically depending upon which specific site the business is located. For example in San Francisco monthly market rents will vary between $1.50 square foot to $10.00 square foot. Another method for determining market rent is to drive the area of the proposed location and look at for lease signs and call the brokers of these sites and ask them what is the asking rent for these spaces. The operator can than take an average of the rents he has surveyed and use this survey as a basis for negotiating the base rent with the landlord. Additionally the operator can call existing restaurant, bar and night club owners in the area of the operators proposed site and ask them how much rent they are paying. In most cases the owners will not give you this information as they feel this is proprietary information and in many cases the owners may have older leases with substantially below current market rents. If the operator is negotiating a new lease and has a good prior track record the operator can sometimes negotiate a below market rent as the landlord feel s his risk factor has been reduced based on the operators past success. If the operator is renewing a lease he/she should capitalize on the operators past success as a tenant in terms of paying their rent on time, keeping the premises well maintained and being a asset to the building as a tool in negotiating a favorable lease.
The Landlord Perspective on Rent
Although the landlord wants their tenant to be successful they are very concerned with obtaining the maximum market rent for the space leased as this determines the value of their building. For example if a tenant is paying $60,000 a year rent and the formula for determining the value of the landlord’s building using a capitalization method and a 6 cap rate, the value of the landlord’s building is $100,000 ( $60,000 annual rent / .06 cap rate = $100,000). If however the market rent for this space is $75,000 per year and using the same valuation formula above the building is worth $125,000 ( $75,000 annual rent / .06 cap rate = $125,000). So the higher the rent the more valuable the building,
c. Yearly Rent Increases – Yearly rent increases should be tied to either pre-negotiated fixed yearly rent increases on the Consumer Price Index (CPI). A consumer price index (CPI) is an index number measuring the average price of consumer goods and services purchased. The average CPI in the San Francisco-Oakland-San Jose area in the past several years has been approximately 3% a year. When the CPI is used it is common to have a minimum yearly increase, also called a floor and a maximum yearly increase, also called a ceiling. When floors and ceilings are used with CPI rents floors usually are in the range of 2 to 4% a year and CPI ceilings are in the range of 5 to 7% a year.
1) Flat Rent – Although rents are usually adjusted yearly on the anniversary date from the commencement date of the lease, in some cases, if the operator has a strong track record or the rental market is weak and it is a lessees market, the operator can negotiate a flat rent. A flat rent means that the rent is fixed at a certain level for a given number of years . For example there is a ten year lease and the rent for the first five years is $2,000 per month and the rent for second five year period is $2,500 per month. If there are additional rent expenses required with a flat rent such as property taxes, fire insurance and common area maintenance expenses usually the landlord will pass through to the tenant the yearly increases for these expenses as he does not want to be out of pocket for these costs
2. Fixed Rent – This means the rent is fixed either at a stated fixed dollar amount or at a yearly fixed percentage. An example of a stated fixed amount dollar rent is as follows: in a five year base term lease the monthly rent is stated as follows: year 1 – $2,000, year 2 – $2,100, year 3 – $2,200, year 4 – $2,300 and year 5 – $2,400. An example of a stated fixed percentage rent is as follows: there will be a yearly 3% increase of the base rent as follows: year 1 – $2,000, year 2 – $2,060, year 3 – $2,121.80, year 4 – $2,185.45 and year 5 – $2,251.02
3) Percentage Rent – If the landlord insists on a percentage rent the operator should cap the percentage to 5 to 6% of yearly sales. In exchange for a percentage rent the operator should negotiate a below market minimum rent and have the landlord make a monetary contribution to any remodeling the operator plans to do without having this landlord contribution amortized as additional rent. The rational for percentage rent is that since the landlord is making a monetary contribution to the tenant the landlord is in effect becoming a minority partner so to speak with the tenant and is entitled to a percentage of sales based upon his investment. Percentage rent usually kicks in at a determined natural break point which is as follows: if the base rent is $60,000 per year and the percentage rent is 6% of gross sales and the natural break point is $1 million per year of sales, the operator does not pay percentage rent until he does at least $1 million sales a year. This is determined as follows: take the annual minimum rent of $60,000 and divide this by the percentage rent which is as follows: $60,000 minimum rent / .06% percentage rent = $1,000,000 natural break point of yearly sales. This means that if the operator does $1.5 million sales in a given year his rent will be as follow: $1.5 million sales times .06% percentage rent = $90,000 rent.
4) Sliding Scale Percentage Rent – In some cases if the landlord is making a large landlord contribution toward the tenants remodeling a sliding scale percentage rent formula may be negotiated. With this method the landlords rent is calculated using different percentages at different sales levels. An example of a sliding scale percentage rent formula is as follows: on the first million dollars of sales the operator does in a given year the landlord will get 6% of yearly sales, and on any sales the operator does in the same given year between $1,000,001-$1,500,000 the landlord will get 7% of yearly sales and on any sales the operator does in the same given year above $1,500,001 sales the landlord will get 8% of yearly sales. In the above mentioned example if the tenant does $2 million in sales the tenants rent formula would be as follows: the percentage rent formula on the first $1 million of sales is $1,000,000 x .06% = $60,000 + the percentage rent formula on sales between $1,000,001 and $1,500,000 of sales is $500,000 x .07% = $35,000 + the percentage formula on sales between $1,500,001 and $2,000,000 of sales is $500,000 x .08% = $40,000. The total rent owed to the landlord would then be $60,000 + $35,000 + $40,000 = $135,000 for that given year.
d. Additional Occupancy Expenses – In addition to base rent the tenant may be charged what is called triple net expenses (NNN) which means that in addition to the base rent the tenant will be charged monthly for real estate taxes, fire insurance on the building and common area maintenance costs (CAM costs). CAM expenses can include landscaping expenses, security expenses, common area utility expenses and building maintenance costs. These expenses are determined by a predetermined formula which is spelled out in the lease. The formula is usually tied to a pro rata share of the total building NNN costs based on the percentage of space the given rentable space has relative to the total rentable space for the building. For example if the given rentable space is one third of the entire rentable space of the building the NNN expenses would be equal to one third of the yearly real estate taxes, one third of the yearly building fire insurance expense and one third of the yearly CAM charges. Specifically if the buildings yearly real estate taxes were $24,000, the yearly fire insurance expense was $12,000 and the yearly CAM charge was $6,000 the total buildings yearly NNN expenses would be $42,000. The tenant for the given rentable space would then be responsible for paying one third of the $42,000 NNN expenses on a monthly basis as follows: $42,000 x .333% = $14,000 or $1,166.67 per month ($14,000 per year / 12 months = $1,166.67 monthly NNN expense). This NNN rent is paid monthly in addition to the base rent and the tenant is usually billed monthly by the landlord with the invoice breaking down the various components of the NNN expense. In the above example if the tenant is occupying 100% of the building the tenant would then be responsible for paying 100% of the $42,000 NNN expense or $3,500 per month NNN expense ($42,000 yearly NNN expense / 12 months = $3,5000 monthly
NNN expense).
There are some cases where the tenants additional occupancy expenses may be limited to only a single net lease (N) where the tenant only pays real estate taxes or a double net lease (NN) where the tenant only pays real estate taxes and the fire insurance on the building.
How Buyers Evaluate a Restaurant, Bar or Club Business to Determine if it’s the Right Opportunity – Part 3
This is the last of a three part series where I discuss a continuation of lease terms from the prior issue. This issue will include some of the major elements of the lease which include as follows:
a. The Guarantor, b. Use Clause, c. Assignment and Subletting and d. Options.
a. The Guarantor . What is a guarantor? – The tenant is financially responsible to perform the terms and conditions of the lease and is the guarantor of the lease. The guarantor personally guarantees that he/she will pay rent on a timely basis and will perform all the terms and conditions of the lease. In smaller transactions and for entry level buyers the individual tenant is normally required to personally guarantee the lease. This means that if the tenants does not meet the terms and conditions of the lease that he/she can be personally removed from the premises through a legal action and the landlord can go after the tenant for any lost rent and other costs he incurs as a result of legally removing the tenant from the premises. Before a tenant is accepted by a landlord the tenant must be operationally and financially qualified and in many cases the landlord requires that the tenant owns a home with equity. The reason for this is that if the tenant fails and the landlord has to take legal action against the tenant the landlord can get a judgment against the tenant. Subsequently the landlord can get a lien secured against the tenants home or other property the tenant owns to force the tenant to legally pay the landlord for all lost damages including loss of rent, attorney’s fees and commission costs for re renting the space, Tenants with a long successful track record can usually negotiate having an entity such as a corporation or limited liability company guarantee the lease. For a landlord to accept an entity other than an individual as a guarantor the entity has to be adequately capitalized to assure the landlord that the entity can meet the financial requirements of the lease.
b. Use Clause This is a very important section as it states the allowable use a tenant is allowed to have in a given rentable space. The best restaurant use clause a tenant can get is the one with the broadest language such as “a restaurant serving alcoholic beverages.” This clause gives the tenant the right to have any type of restaurant and serve a full alcohol menu. In most leases that are in a shopping center or in office building where there are multiple restaurant tenants the language in the use clause will be very specific such as “ a café serving breakfast and lunch items excluding submarine sandwiches, deli sandwiches and specialty coffee drinks”. The exclusion of submarine sandwiches, deli sandwiches and specialty coffee drinks is because there is probably already a sub/deli sandwich business and specialty coffee business in the complex. Most landlords of retail spaces where there are multiple food service tenants do not want to have head on competitors. They’ll normally allow only one of each type of food service operation such as Chinese, Thai, Vietnamese, Korean, Mexican, Italian, hamburger franchise, coffee specialty operation, hot dog operation, etc. in the given complex. This is to provide exclusivity to the existing tenants to allow them to have a reasonable market share of the food service customers in the complex. Having diverse food service tenants also attracts more customers to the complex and provides a synergistic effect which is helpful to many of the tenants. If a tenant is having a problem making his operation be financially successful and he needs to change the menu and concept he’ll be limited to only concept and menus that are not already in the complex. Having a broad use clause in the tenants lease also makes it easier to sell the business.
c. Assignment and Subletting – Having the right to assign the tenants lease or to be able to sublet a tenant’s space is very important as there is a high probability that the tenant will not be successful and will want to minimize his financial exposure to continued lease liability. The key language to look for in the lease which is advantageous for the tenant is “the landlord cannot arbitrarily withheld consent to an assignment.” This language means that if the proposed new tenant is operationally and financially qualified the landlord cannot arbitrarily deny the proposed new tenant the right to have the lease assigned to him/her. When an assignment occurs the two parties in the assignment are the assignor who is the existing tenant and the assignee who is the proposed new tenant. In an assignment agreement it is stated that the assignee assumes all of the rights and obligations of the lease being assigned and this agreement is executed in writing by the assignor, assignee and the landlord. In most assignments the assignor has secondary liability for the remaining term of the base lease. This means that if the assignee’s business fails and the tenant can’t continue to pay rent or meet the other conditions of the lease and the landlord is unable to recoup their financial losses from the assignee the landlord can go after the assignor to be made whole financially. If you are an assignor try to negotiate a release of continued lease liability which becomes effective at the close of escrow. This is hard to do unless the assignee is significantly stronger financially and operationally than the assignor and even in these circumstances the landlord will want the assignor to have continued lease liability for at least one or two years of the remaining base term of the lease being assigned. There can be situations in an assignment whereby the assignee wants to change some of the terms and conditions of the lease and this is called a modification of the lease and requires a modification section in the lease assignment. It is generally understood in a lease assignment that the assignor has secondary liability and the assignee has primary liability. Secondary liability means that the landlord must exhaust the financial resources of the assignee that has primary liability before he comes after the assignors financial resources. This means that if the assignee breaches the lease the landlord has to take legal action to be made whole against the assignee before the landlord takes legal action against the assignor to be made whole. However there are many attorneys that take the position that both the assignor and assignee have primary liability and draw no distinction between primary and secondary liability in an assignment. This is exemplified in some situations where the assignee defaults and the landlord takes legal action against both the assignee and assignor at the same time. It is also generally understood that if there are options in the lease other than the remaining base term that the assignor has no continued liability for the options.
Subletting – In this situation the existing tenant is called the sublessor and the new proposed tenant is called the sublessee and the document that is executed between these two parties is called the sublease. A sublease situation requires the written permission of the landlord in most cases as does the lease assignment. Unlike an assignment the sublessor who is the existing tenant still has primary liability to the landlord and the sublessee has secondary liability. This means that if the sublessee fails to pay the rent or meet the other conditions of the lease the sublessor is responsible to the landlord. In many sublease situations the rent is paid directly by the sublessee to the sublessor and the sublessor pays the rent directly to the landlord and frequently there is wording in the sublease agreement that if the sublessee breaches the sublease the sublessor has an expedited method of taking over physical possession of the premises. In some situations if there is a base term of the lease and an option in the future there is wording in the sublease that if the sublessee is in good standing in the base term of the lease he will have the right to exercise the option in which case the sublease will be converted into an assignment of the lease and the sublessee now becomes the assignee and the sublessor becomes the assignor and the primary liability shifts to the new assignee who was formerly the sublessee. In both the assignment and sublease it is important that the existing tenant has a comfort level with the new proposed tenant’s financial and operational history to assure himself that the new proposed tenant will be successful and the existing tenant is not vulnerable to have to bail out the new proposed tenant at its expense.
d. Option – An option is a legal tenants right to extend their right to occupy the premises for a given period of time. For an option to be enforceable it needs to be in writing and included as part of the lease. In some cases the option is personal to the tenant and the option right cannot be assigned to a proposed new tenant. To make certain that the option is assignable to the new tenant it is best to state in the assignment agreement that the assignee will have the right to exercise the option if he is in good standing with the lease. The option language will usually spell out the number of years of the option period and any changes regarding the terms and conditions of the lease which will occur in the option period. Option periods can vary from as little as one to three years to as long as ten years or more. Most option periods are for five years. Mot options keep the same terms and conditions of the lease other than the rent and the formula for the yearly increase in the rent. If there is not specific language in the option as to what the rent will be there will most likely be one of two formulas stated in the option which have been traditionally used which are both tied to the fair market rent for the premises. Fair market rent means a similar rent to what other restaurants that have recently signed a new lease in the area are paying for rent. One formula that is frequently used is tied to binding arbitration. Binding arbitration is a legal procedure whereby if the landlord and tenant cannot agree on the fair market rent they agree to have the fair market rent determined by the arbitrator whose decision is final and cannot be appealed. An arbitrator is usually a retired judge or an attorney that understands the law and the landlord and tenant who are also represented by counsel each presents their research as to what they feel the fair market rent is and they present their respective findings to the arbitrator in a formal arbitration hearing. After the arbitrator hears both sides presentations he makes a ruling as to what the fair market rent will be. This decision is final and there is no appeal so if the tenant is dissatisfied with the arbitrators decision he has no further obligation to occupy the premises after his lease term expires and then he gives the landlord notice he wishes to vacate and then he can remove his trade fixtures in most cases. Arbitration is expensive and can range between $10,000 to $20,000 and the arbitrators cost is split 50/50 between the landlord and tenant and each party pays their own attorney fees. The other primary method that is used and generally the preferred method to determine the fair market rents is the commercial real estate broker method. The tenant and landlord each choose their own experienced commercial real estate broker that has recently completed comparable retail leases in the area of the proposed tenant’s site. Each broker comes up with a recommended fair market value rent and if the brokers cannot agree on the fair market rent the two brokers agree to choose a third qualified commercial real estate broker which both brokers agree to who then determines the fair market rent. Again with this method as in the arbitration method if the tenant does not agree to the new fair market rent he can then give notice to the landlord and vacate the premises at the expiration of this lease and remove his trade fixtures in most cases. In the option section of the lease there is specific language which spells out what is the minimum and maximum amount of time prior to the expiration date of the lease that the tenant is allowed to give written notice by certified return receipt mail to the landlord regarding his interest in exercising the option. For example, no earlier than 360 days before the expiration date of the lease and no later than 180 days before the expiration of the lease. The reason that there is usually a 180 day maximum time frame to notify the landlord regarding the tenant’s desire to exercise or not exercise the option period is to give the landlord enough time to find another tenant to rent the space should the existing tenant decide not to exercise his option and continue as a tenant. There is usually language in the lease that gives the landlord the right to put up a for lease sign and start showing the space to perspective new tenants so many months before the expiration date of the lease. There are situations where the tenant has the right to have more than one option in the lease. If this is the case the tenant has to be in good standing prior to exercising each subsequent option and the terms and conditions for each subsequent option can be different although they are usually the same. If the tenant has more than one option and does not exercise the previous option in a timely manner he loses the right to exercise subsequent options to the lease. Many landlords do not like options as they work primarily to the benefit of the tenant in terms of tying up the premises. If a landlord is considering selling his property in the near futures and wants to maximize his right to get the highest price for his building and if he wants to have flexibility to sell the building to an owner operator and wants to have the ability to deliver the building without a tenant the landlord will not be receptive to a having an option in the lease.
If you need consultation on any items regarding the lease please call Restaurant Realty Company for further information.