If you are involved in lease negotiations on behalf of retail asset owners, you already know a couple hard truths: The deals won’t happen without the help of solid, hard-working commercial retail brokers (who can be worth their weight in gold) and at least some tension inevitably arises while moving the deals along. This article gives focus to the tension, and suggests that the tension is not only desirable but important to help improve negotiation results for all concerned.
First, a reality check: No matter how great your retail asset (in your mind), no matter how desirable you know it to be, typically retail tenants do not clamor at the owner’s doorstep begging to lease space. The retail commercial broker is instrumental: sifting the wheat from the chaff, navigating the chaotic tenant marketplace and bringing to ownership the gems with a reasonable chance of success. The derogatory fiction is espoused by some: that the broker brings a prospect to ownership, then assumes the job is done and waits to earn commission. But nothing could be further from the truth. Capable, high quality brokers in fact take on many roles and do far more than “find someone.” A seasoned commercial retail broker knows the industry, follows the trends, watches the local market, knows the players, has the relationships, gladly joins discussions even at odd hours, relies on practical data to sift through the prospects, knows the owner’s “hot buttons,” negotiates the letter of intent (LOI), frequently reports to ownership, guides the owner and legal counsel throughout the lease negotiation on business term nuances, and often plays the role of friend and informative professional (and perhaps even psychologist). This is what it really takes for a broker to succeed, and retail asset owners rely heavily on these skills.
Let’s consider Jimmy, a talented, knowledgeable optimist who truly understands the retail market, where he works finding new prospective tenants. And let’s consider Larry, an asset manager at CAm SHare Assets COWorkers, Inc. (CASH COW). CASH COW has worked with Jimmy on many deals. Larry knows Jimmy well. In the course of finalizing the deal terms in an LOI, and subsequently during the lease negotiation, their views periodically differ. But from those differing views—from that tension—Jimmy and Larry end up with a better deal, because tension is the antithesis of the blinders we all wear.
Jimmy and Larry know that where there’s tension, there’s a good chance that two parties have given disproportionate focus to different sides of the topic. There is genuine benefit in constructive dialogue with a trusted colleague who disagrees with your view. The dialogue will flesh out the concern, help avoid “one-issue focus” and bring owner’s attention to other considerations that also address mutual needs.
For example, Jimmy advises Larry about the latest prospective retail tenant, a small local coffee shop with a large following of devoted customers, whose lease in a nearby, lower quality property is ending soon, and who wishes to come to Larry’s shopping center. Java Me Now has good credit, a solid track history over the last three years, a workaholic principal and a drive to succeed. During the LOI and the subsequent lease negotiation, three topics especially become points of tension: the breadth of the use, the duration of the term and the obligation to report sales. Following are the discussions and the compromises, proving the tension cleared away the blinders and brought about good results:
Jimmy urges the use should be far more open than a typical coffee shop. Jimmy feels vested in the tenant’s desire for success and Jimmy wants to allow Java Me Now to expand into other food categories and grow its business. Jimmy notes that coffee shops rarely only sell coffee and Java Me Now has to have latitude to grow. Says Jimmy, “Look at what the national coffee shop chains do!”
But Larry had said “just bring me a coffee shop.” Larry’s vision for the center was, well, a coffee shop. Larry is worried about causing competitive friction among the existing tenants. Larry notes the center has a grocery store, three restaurants and a small bakery.
Jimmy correctly notes that only the grocery store has an exclusive against competition and its language allows one coffee shop.
If Larry ignored the broker’s guidance, Larry might lose the deal or, arguably worse, strong-arm the local tenant into accepting an overly restrictive use clause that may well damage its chances of success—which translates to inability to pay rent.
If Jimmy’s expansive inclination to very much broaden the use were to govern, there could be problems with the grocery store’s exclusive, and there could be resentment from the other unprotected tenants (those without exclusives who feel put upon by undue competition). That resentment might color their decision-making on whether to remain at the center in the long run. Worse, the desire to give Java Me Now all it wants on use might tempt the coffee shop to lose sight of its primary mission and purpose. It would not be the first time a tenant bit off more than it could chew, trying to be everything to everyone and losing its consumer appeal.
After discussion, the tension results in a middle approach which addresses the concerns and proves superior to either initial position: Java Me Now can expand into incidental food sales typical for a neighborhood coffee shop (a win for Java Me Now) but cannot violate the grocer’s restrictions (that would be a given anyway), and gross sales from incidental prepared ready-to-eat food cannot exceed 20 percent of total revenues—a compromise that addresses the food sales desire of tenant but is sensitive to other tenants’ concerns about undue competition. E pluribus unum—the competing views collide and result in the best reasonable approach.
Duration of Term
In today’s retail market, Jimmy knows tenants have greatly varying wishes on term, often a struggle over three, five or ten years for an initial term. Jimmy believes in the prospect; Java Me Now has great potential and will well serve the center’s draw of customers. Java Me Now will be the envy of nearby shopping centers and Jimmy wants to lock it up for as long as possible, which surely is in the best interests of ownership. Jimmy has caused Java Me Now to agree to an LOI that it will accept an initial ten year term with a five year renewal option at market rents. (Author’s note: For the cynics who say, “Sure, but Jimmy just wants more commission”—know that ownership has an arrangement that mostly compensates the first five years of term only. Jimmy is acting out of genuinely good motives for ownership’s best interests).
Says Jimmy, “We will regret it if we do a short-term deal and a neighboring shopping center snaps this gem up from us in three years.”
But Larry is worried that Java Me Now is a local player with the greater risks of failure that come with its one-store position in the marketplace, including lack of “chain appeal.” Larry wants to give Java Me Now a chance, but not a 10 year chance. And Larry does not want to grant a renewal right.
Says Larry, “I need to keep my options open.”
After discussion, the compromise benefits all while protecting all as well. Larry will agree to a 10-year initial term and one option to renew for five years, but with protection against lackluster performance by measuring sales. If gross sales during the third year do not reach a milestone amount, then Larry can terminate the lease—but only if Larry chooses to do so within 30 days after those first three years. If gross sales do not reach another milestone amount in the fifth year, either party can terminate the lease, again only if either party so elects within 30 days after the fifth year ends. The renewal term option cannot be exercised unless gross sales per annum averaged over the last five years of the initial term have reached still another annual milestone amount. In this manner, Java Me Now is assured of the long-haul term it wishes, while having protection half-way through the term if its performance is failing, and ownership has financial milestone protections throughout. Again, the tension yields a better result than the two initial approaches alone.
The common perspective of tenants is, if there’s no percentage rent to pay there is absolutely no reason to report sales. The tenant may feel it’s an “invasion” of their business information; it’s just none of the landlord’s business and it’s an administrative irritation and burden, a waste of time. Java Me Now has a similar view. Java Me Now is especially concerned that its competitors could learn the most profitable products from its sales data. Java Me Now considers the information private and was adamant it would not share the information… until it was no longer adamant when agreeing to sales milestones. Nonetheless, Java Me Now wants to report sales only for the period where a milestone requires analysis and only wants to report a single, gross sales number. Jimmy supports the position of Java Me Now.
Says Jimmy, “Larry, you will get the data you need and they do not pay percentage rent. It’s an overreach to insist on more sales data; we just don’t need it. Let’s get this deal done!”
But Larry has other reasons for wanting data. Larry wants to be able to act proactively, not reactively, to a failing tenancy. The frequent reporting of gross sales allows Larry to know and timely react if a problem is growing. Larry could seek a replacement tenant, enter into a remarket agreement with Java Me Now, or even make business suggestions to help before the doors are permanently shut. Larry suggests a confidentiality clause will protect the concern about privacy, but Larry wants the data reported every month. Larry also wants to have aggregate sales data for all his tenants so CASH COW can assist leasing efforts by touting an enviable average sales per square foot of all its tenants (assuming the numbers are enviable, of course). Where to go from here?
Again, from the tension comes a compromise that reasonably addresses all the concerns: The tenant will report its sales on a quarter-annual basis, by email (to make it simple and without administrative burden), giving just the gross sales figure without breakdown by category (addressing tenant’s concern about disclosing its “gem” profitable items). The lease will have a good confidentiality clause, but the landlord is permitted to use the data as part of the centerwide aggregate statistic without attribution of any specific amounts drawn from tenant’s operation. Out of tension, an improved result for all.
The lessons to all in lease negotiations, as in much of life, are many, and a few especially seem clear: Do not shy away from controversy and disagreement but embrace it for its value; recognize we all wear blinders to some degree by virtue of our own experiences and biases; and welcome the opportunity to improve results for all through constructive dialogue and the resulting newly enlightened compromises.