When there are vacancies in commercial buildings, tenants may feel that they are in a good position to seek concessions from landlords on new leases or in exchange for extending or renewing existing leases. Landlords are apt to make deals for two reasons: (1) The landlord may be facing high vacancy rates, and (2) The landlord also recognizes that tenants may also be suffering from declining business during a recession and are less able to pay the high rentals.
The landlord will be looking for a formula or concession that will give the tenant an economic break, but at the same time allowing the owner to show a scheduled (on paper) rent roll that is sufficient to satisfy a banker who is providing financing for the property.
Alternative Idea In Rentals
There can be a variation in the typical retail rent formula that calls for a fixed minimum rental plus a percentage of gross sales over a specified minimum sales volume. Here are some possibilities:
- Graduated rent. Most people starting in business are short of money. If the negotiation establishes a graduated minimum rental that will give them a rent break in the early years, while producing the overall rental needed by the owner over the lease term, both might be happy. (Be sure and check with your tax advisor, as consideration should be given to IRC Sec. 467, which may require the rent to be “leveled” for tax purposes.)
- Rent differentials. There is no reason that the landlord must charge the same square footage rental for the entire leased premises. The rent charged for the showroom area and sales area may be higher than that charged for stock rooms or storage areas. In exchange for charging a lower rent for the non-sales area, the landlord may want the percentage rental on the sales area to kick in at a lower level or be at a higher rate.
- Base year rent. The parties might agree to a straight percentage rent for the first year instead of setting a minimum fixed rental for the first and subsequent years. Then that rent will become the base for all future years. This will allow the tenant to be assured that a slow start-up will not be a business-breaker because of the need to pay a high minimum rent. For the owner’s protection, he may have the right to cancel the lease if low sales in the early months or years result in a too low rental.
- Rent deferral. Deferral or free rent is the worst example of graduated rents. In extreme cases, a l0-year lease could offer free rent for the first year. (It might be better for both parties if the period of free rent could come somewhere in the middle of the lease term. This can assist the landlord to “amortize” the loss over the earlier years during which rent has been paid.)
Don’t just limit the negotiations to dollar amounts of the monthly rent. There are other things that can be just as important to both sides:
1. Recapture provisions. When the tenant incurs significant costs for leasehold improvements, the owner may agree that the tenant may recoup a portion of the cost from future percentage rents (but not minimum rents).
2. Turnkey deal. The owner might agree to make all leasehold improvements to the premises so that it is ready for the tenant to move in and begin fixturing.
3. Kickout clause. A performance kickout clause included in the lease may reduce the minimum fixed rental if sales do not achieve the level mutually agreed on.
4. Percentage rents. The point at which gross sales trigger the payment of percentage rents may be raised during a portion of the lease term or during the entire term
5. Escalation clause. In the typical lease, the tenant must pay a proportionate share of increases and operating costs as well as a percentage rental. There are adjustments that can be made here. A cap could be put on the maximum amount of escalation costs each year or on the maximum increase each year. Another way might allow the tenant to deduct a percentage of escalation costs from percentage rents; this could be an excellent negotiation for a tenant who expects to show significant increases in sales volume over a period of years.