Understanding and Negotiating Rental Rates – For Franchise Tenants

As we explain in our new book, Negotiating Commercial Leases & Renewals FOR DUMMIES, every tenant wants to pay the least amount of rent possible. Every landlord, however, wants to get the most rent possible. In negotiating your rental rate, it’s important to realize that not all tenants pay the same rent per square foot – that is negotiable, based on many factors. It’s equally important to understand that the landlord’s asking rental rate is based on what they need to collect to satisfy their mortgage and financial commitments – not necessarily on what the tenant can afford to pay.

If you are a new or established franchisee (who may be facing an upcoming lease renewal and a rental increase), here are a few things you need to know about rent on commercial or retail space.

Understanding the Importance of the Rent Figure. It should come as no surprise that rent can be one of your three major business expenses, if not the largest. Your rent is not only important as a big part of your day-to-day expenses – second only possible to salaries and the cost of goods – but also a major factor if, and when, you sell your franchise business. Many franchisees have come to The Lease Coach over the years complaining that they are unable to sell their business because prospective buyers think the rent is too high are essentially scared off by the overhead. Never underestimate the importance of leasing a commercial property at the right rental price. Rent can make or break your business. If you are struggling to pay the rent it’s not necessarily an indication that your rent per square foot is too high – it could be a sign that your sales are too low.

Exploring How Landlords Set Rental Rates. If your landlord is smart, they don’t just pull a rental figure from the air. A typical commercial developer sets their rental rates based on a simple formula whereby the rental revenue from the tenants covers the mortgage and provides the landlord with a decent capitalization rate (or return on investment). Mathematically, this is an easy calculation for the landlord which involves two factors - face rate versus net effective rental rate. The face rate is the dollar amount of rent you pay and the amount that appears on the lease agreement. The net effective rental rate is the amount left after deductions for real estate commission, inducements and incentive packages, the landlord’s work they do on the space and so on. With a $24.00/square foot rental face rate, the net effective rent the landlord is left with can easily be reduced to $17.00/square foot after these deductions.

Revealing Why All Tenants Don’t Pay the Same Rent in the Same Property. Although knowing what other businesses in the building you lease space in are paying is a good idea, expecting their rent per square foot to be the same as yours isn’t always realistic. There are legitimate reasons why various tenants pay differing rates in the same property, These include the size of space the tenant requires, the length of lease term the tenant has agreed to stay, the strength of a tenant (is the tenant a “Mom and Pop” convenience store or a national franchise?), landlord inducements, timing (the first and last tenants into a newly-developed property may pay different rates), industry and physical location within the location of the commercial retail unit. We had a recent situation with a very savvy tenant who we were putting into a Walmart Supercentre property with four out-buildings spread out around the building. The rental rates on each of those out-buildings were different – the one by the road had the best exposure while the one furthest from the road had the least exposure. Our tenant wisely chose the building closer to the road – even though she would pay a higher rental rate.

What the Rental Rate May Not Include. Most leases are triple net leases. This means that all costs related to managing the property are passed through to the tenants. These Operating Costs or Common Area Maintenance (CAM) and property tax charges are typically stated as separate or additional rent, which the tenant must pay. In some cases, the Operating Costs are equivalent to, or even more, that the tenant’s base rent.

Dale Willerton and Jeff Grandfield - The Lease Coach are Commercial Lease Consultants who work exclusively for tenants. Dale and Jeff are professional speakers and co-authors of Negotiating Commercial Leases & Renewals For Dummies (Wiley, 2013).