Last month’s lead article covered the basics of securing a favorable lease structure for long-term success as a franchisee. Today’s Part 2 covers tenant improvement allowances, the power of strategic exit clauses and renewal options, and provides a glossary of 20 essential lease terms for franchisees.
Tenant improvement allowances
A key component in making your business align with your brand’s vision is the ability to adapt and improve the physical space. Whether it’s a retail store that needs a bespoke layout or a restaurant requiring a professional kitchen installation, tenant improvements are often an inevitable part of setting up your franchise.
The cost of such improvements can be substantial. And while the figures for your specific industry may vary, the fact remains: tenant improvements are a significant investment.
Here is where the Tenant Improvement Allowance (TIA) comes into play. TIAs are funds provided by landlords to help cover the costs of customizing a space to meet your business needs. But while they provide relief, they’re not a silver bullet. Understanding how to negotiate TIAs effectively can be the difference between a supportive landlord relationship and unexpected costs down the line.
The first step is to thoroughly assess your improvement needs and costs. Collaborate with architects, interior designers, or contractors to estimate expenses. Be sure to include all costs: construction, furniture, equipment, even professional fees. Does the offered TIA cover these costs? If not, you may need to negotiate for a higher allowance.
Alternatively, consider negotiating for a rent-free period. This “free” time allows you to offset the cost of improvements while you’re not yet operational, alleviating financial pressure at the start of your lease.
However, be aware that there’s no such thing as a free lunch. Landlords often recoup TIA costs through increased rent or extended lease durations. Scrutinize your lease terms. Will you pay higher rent for the duration of your lease because of a generous TIA? Or will you be tied into a longer lease term than you initially planned for?
To truly unlock the value of TIAs, they must be balanced with the other terms of your lease. A successful TIA negotiation will not only cover your improvement costs, it will align with your overall lease strategy and business plan.
Strategic exit clauses and renewal options
In the world of business, the tides can turn quickly. This is why exit clauses and lease renewal options play an integral part in your lease agreement. They’re the safety net that keeps your brand afloat amid the unexpected waves of business dynamics.
Exit clauses like the “kick-out” clause and the co-tenancy clause are your shield against unforeseen underperformance or loss of an anchor tenant. Let’s delve a bit deeper.
A kick-out clause allows you to terminate the lease prematurely if the business does not reach specific sales thresholds. Suppose your business undergoes an unfortunate downturn. In that case, this clause could be your ticket to vacate the space without breaching the lease, potentially saving you thousands of dollars in contractual obligations.
Next, the co-tenancy clause. This provision reduces your risk in shared commercial spaces. If a major or anchor tenant leaves, your business may experience a decline in customer footfall and revenue. A co-tenancy clause could allow you to pay reduced rent or even terminate the lease if such an event occurs.
But having these clauses in your lease is not enough. They need to be robust and comprehensive. Analyze each clause. Does it cover a broad range of scenarios? Is the language clear and devoid of loopholes that could work against you? If the answer is no, it’s time to negotiate for more ironclad provisions.
In parallel with designing your exit strategy, also consider the sunrise, i.e., the potential renewal of your lease. Business growth might necessitate an extended stay. Negotiating favorable renewal options from the outset can safeguard your franchise’s long-term goals.
Does the lease offer an automatic renewal option? Are there provisions for negotiating rent and other terms at renewal? A favorable renewal clause can provide stability for your business, ensure continuity, and save on relocation costs down the line.
In essence, while lease negotiation may seem to focus on the present–the rent, the space, the location–it’s equally about future-proofing. By negotiating well-rounded exit clauses and thoughtful renewal options, you can secure a lease that caters to your business’s needs today and paves the way for its success tomorrow.
Terminology: A Glossary of 20 Essential Lease Terms for Franchisees
Finally, having a firm grasp of lease terminology can empower franchisees during negotiations. Here’s a glossary of key lease terms to familiarize yourself with. With these tools and insights, you can navigate the complex landscape of lease negotiation, securing terms that pave the way to long-term success.
Percentage Rent Lease: A type of lease where the tenant pays a base rent plus a percentage of revenue earned from the rented property.
Co-Tenancy Clause: A lease provision that allows a tenant to reduce their rent or terminate their lease if a key (or anchor) tenant vacates the property.
Triple Net Lease (NNN): A lease agreement where the tenant is responsible for paying property taxes, insurance, and maintenance costs, in addition to rent.
Right of First Refusal (ROFR): A provision in a lease or other contract giving a tenant the first opportunity to buy the property or lease additional space before the owner sells or leases to a third party.
Kick-Out Clause: A lease provision that allows a tenant to terminate the lease early, usually due to failing to meet specific sales levels.
Buildout: Custom alterations a landlord or tenant makes to a leased space to make it suitable for their business operations.
Tenant Improvement Allowance (TIA): An amount that the landlord agrees to spend on improvements to a rental property, such as refurbishing or fitting-out, to accommodate the tenant’s particular use of the space.
Personal Guarantee: A clause in a lease where the business owner agrees to be personally liable for lease obligations.
Gross Lease: A lease in which the landlord pays all the property charges, including utilities, repairs, and insurance.
Operating Expenses (OpEx): Costs associated with the operation and maintenance of a business property, often passed on to tenants in commercial leases.
Common Area Maintenance (CAM) Fees: Fees paid by tenants to landlords to help cover costs associated with overhead and operating expenses for common areas.
Rent Abatement: A period of time when the tenant does not have to pay rent or can pay reduced rent, often used as an incentive in lease agreements.
Assignment Clause: A lease provision that allows a tenant to transfer their lease rights and obligations to a new tenant.
Sublease: An agreement that gives a third party the right to use and occupy rental property leased by a tenant from a landlord.
Leasehold Improvement: Changes made to a rental property by a tenant to make the space more useful for their needs.
Step-Up Lease (or Graduated Lease): A lease agreement where the rent increases at set intervals over time.
Escalation Clause: A clause in a lease that allows the landlord to increase rent at future dates.
Anchor Tenant: The primary or lead tenant in a shopping mall or strip center, usually a well-known business that attracts a significant amount of customer traffic.
Exclusivity Clause: A lease provision preventing a landlord from leasing other spaces within the same property or complex to a direct competitor of the tenant.
Turnkey Property: A space that is ready for immediate use by the tenant without any need for improvements or modifications.
Jason Fefer is an associate director of Marcus & Millichap’s Net Leased Property Group on a large team alongside his partners Robert Narchi and Tyler Bindi. They structure sale-leasebacks and negotiate leases on behalf of some of the largest franchisees across all sectors including the restaurant, automotive, and retail space. He can be reached at 818-669-2388 or jason.fefer@marcusmillichap.com.