Committing to a new retail store lease is one of the most important decisions a retailer can make in setting up or growing a business. There are many pitfalls that are not that obvious at the outset for the untrained retailer who goes through this process, sometimes for the first time.
The total value of the commitment is often not realized, especially in shopping centres. In the below example of typical commercial lease terms, consider what the commitment will cost over the period of the lease, which is usually five years.
- Rent: 100sqm at $2,000 per metre, escalating at CPI +2.5 per cent
- Outgoings: $100 per metre
- Marketing fees: $5,000 p.a.
- Fit-out: $1,500 per metre
So let’s look at what you are committing to when you put pen to paper both at the upfront stage and over the term of the lease.
- Rent (if CPI is 3 per cent): average of $235,000 p.a., equating to $1,177,609 for the term
- Outgoings: average of $12,400 p.a., equating to $ 62,000 for the term
- Marketing fees: average $ 6200 p.a., equating to $ 31,000 for the term
- Bank guarantee (3 months): $50,000 upfront
- First month’s rent in advance: $16,666 upfront
- Fit-out: $150,000 upfront
- Total commitment when signing: $1,487,279
- And there could be more, depending on the location and deal.
Based on the above calculation, the typical commercial lease terms add up to almost $1.5 million. That is a serious commitment for anyone. Yet we see retailers committing to a scenario like this without doing quality research and investigation into all aspects of building a five-year scenario for the business.
This is becoming more and more important as we enter a phase of lower bricks-and-mortar sales growth, yet we are locking ourselves in for significant annual increased costs.
The recent ruling that landlords now have to provide sales per square metre data for their centres helps, but that is only part of the equation in trying to assess the likely sales potential of a site.
We need to know that, but also how our business is likely to perform against that metric, and why we think we can match or exceed it, if that’s our forecast.
The most common mistake made by retailers is over-estimating the potential sales of a new store. This is one of the most important metrics that needs to be considered and understood why the business will succeed in that location.
In addition, we should consider the demographics and psychographics of the prime catchment areas, the level of competition within that catchment area, the average spend in the centre, any future developments in the centre and area, and the level of vacancies.
In terms of how your business will shape up, you should plan on the conservative side and know what occupancy cost percentage you can afford. Do not be tempted to exceed that as a percentage to sales. As a rule of thumb, a specialty business can afford a percentage to sales that is circa one third of the gross profit percentage. That is, if your gross margin is 45 per cent of sales, you can afford an occupancy cost of around 15 per cent. An occupancy cost percentage of 20 per cent will likely erode all your profit.
Few people ask for help in the lease negotiations because they do not know, what they do not know! Remember, you are up against leasing executives that are doing this every day and are trained and paid to get the most for the ‘space’ they are selling. It can be likened to a professional against and amateur. As retail gets tougher, their rental targets will also get tougher to achieve. If you are a ‘soft touch’ they could exploit that, and you could end up with a worse deal than was necessary.
For a relatively small investment in getting assistance in the negotiation, there is often significant money to be saved. If the base rent can be reduced by say 10 per cent, and a contribution of say 50 per cent of the fit-out costs can be negotiated, then the saving over five years would be circa $165,000, using the example above. People who know what and how to do it are achieving this on a regular basis in today’s retail environment.
Here are some tips to consider when negotiating for a retail premises:
- Know whom you are dealing with and know your legal rights.
- Always have a rental budget limit in mind before starting to negotiate.
- Have a ‘wish list’ including your ‘must have’ non-negotiable points and your ‘nice to haves’. Do not compromise on your must haves.
- Research the market, have some options and be prepared to walk away.
- Investigate the per square metre sales that similar retailers are achieving and have a conservative sales expectation on which to base your rental budget.
- Don’t pay the ‘asked for’ base rent. There is usually some ‘fat’ in the first stated amount.
- Know if your business is reliant on passing foot traffic or whether customers will come to you.
- Always ask for a free rent period, especially in a buyer’s market, which 2019 will be.
- Don’t let your heart rule your head.
- Once you have reached a verbal agreement, get it in writing ASAP. Do not wait for the ‘formal’ documentation.
- Always get a disclosure statement about the premises/centre/future plans as well as outgoings and any other potential costs.
- Make sure that your ‘usage clause’ suits your business and any additional categories that you might want in the future.
- Get an experienced retail consultant to negotiate for you, it will save you much and have the best chance of getting a fair deal.
Settling on the right lease for your business could have the biggest impact on your retail business. Don’t risk making a mistake, as it lasts a long time and has a serious impact on how your business will perform and could make or break your business.
First published in InsideRetail on 12 December 2018.