By Dylan O’Donnell, Managing Director, Victoria – Lpc Cresa
Most retail tenants do not realise (or even consider) the true value they bring to a lease negotiation. Often, simply being aware of what a deal is worth to the landlord can help a tenant to structure a lease in a way that works financially for both parties. Whether you are a small business owner with a single lease or a large retailer with a national portfolio, understanding the true value you bring to each individual owner you are dealing with can be a gamechanger for a retail lease negotiation.
How profitable your business is could depend on how you leverage that value.
Who really brings the value to a retail lease deal? Of course, the simple answer to this question is both the owner and the tenant.
It could be argued that in certain circumstances one brings more value than the other, but in every circumstance a lease is being negotiated, each party is bringing something of value to the other, and more often than not in relatively equal proportion.
The problem is that most tenants don’t realise what their true value is to a property owner, let alone give thought to how they can use it to their advantage in a lease negotiation. There tends to be an imbalance in knowledge in favour of a property owner. Agents representing owners will almost always exploit this imbalance and this means a lost opportunity for the tenant, which often results in a less favourable deal which may cost the tenant a significant amount of money over the term of the lease.
But here’s the good news. The maths behind working out the value your business brings to an owner is actually pretty simple and doesn’t even have to be that exact for you to benefit from just attempting to understand the value you bring.
Let’s look at a scenario where your business is considering a 3-year lease with an asking rent of $50,000 per annum plus GST and plus outgoings. For the purpose of this exercise, we will assume your research has shown the owner’s asking rent is within a fair market value range – that is, it is comparable on a rate per square metre with other deals completed recently for similar properties in the area. With some minimal additional research, you can also find out the expected yield (or the income returned on an investment) an investor would be seeking for this property type with a secure three-year lease in that same local market. Let’s, for arguments sake, say that yield is 5%.
A three-year lease with a net rental of $50,000 per annum plus GST with an expected yield of 5% translates to a capital value of $1M for the property (quite simply divide $50,000 by 5% to arrive at this number).
By submitting a counter proposal for a three-year lease with net rental of $40,000 per annum plus GST, the impact to the capital value of the property is a reduction to $800,000. That is, should they accept your proposal, the owner may lose $200,000 of capital value (the equivalent of four full years of their asking commencing rent!).
On the flip side, let’s say it is a competitive environment and the property is in high demand. Another prospective tenant arrives on the scene and offers the owner net rental of $55,000 per annum plus GST. By accepting that offer, the owner may achieve a gain of $100,000 in capital value from the original $1M.
Okay, good to know, but why should you even care if there are plenty of vacant shops in the area and relatively few prospective tenants competing for the space? Well, it actually does matter for your business, because by having an understanding of what you are asking the owner to consider when submitting an offer to lease, you are more likely to be able to structure a lease that not only gets a deal done but maximises the return your business gets from the value you create for the owner.
In the example above, the owner may not even be able to accept your offer of a lower rent if there is a mortgage attached to their property being valued at, for arguments sake, $950,000. Rather, the owner may be more open to an offer that keeps the commencing net rental at $50,000 but includes an additional incentive of the equivalent amount in a rent-free period and/or a cash contribution towards your fit-out. In this instance, the capital value of the property is maintained but the net result for you over the lease term is the same.
There are of course other circumstances where an owner may not be as concerned with maintaining the capital value of the property but is instead more concerned with immediate cash flow. This is quite common where an owner has invested in a property to fund their retirement and any rent received is their direct income. For an owner in these circumstances, a period of prolonged vacancy or a rent-free period can be quite damaging financially, so a lease deal structured in a way that provides them with cash flow but at a discounted rate could be more palatable. Perhaps that offer of $40,000 per annum in net rental will work for them if you agree to start paying immediately upon commencement.
So what value is your business bringing to an owner in a commercial lease deal? Are you supporting the owner with cash flow or are you maintaining or improving the capital value of their asset? Most likely, it is a combination of the two. Often a commercial lease negotiation is not just about knowing what you can ask for, but how you should ask for it. There is no one-size-fits-all approach. Knowing your landlord and asking the right questions along the way can give you the answers you need to ensure your business ultimately gets a full return on the value you bring to the table.
Lpc Cresa is the leasing and tenancy consultant to the National Retail Association. NRA members can contact Lpc Cresa by calling the NRA hotline on 1800 RETAIL (1800 738 245) for a complimentary 10 – 15 minute consultation to discuss their retail lease.