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Leasing Retail Space – Due Diligence Research

Initial Research

Leasing retail space seems like it should be easy. You just drive to shopping centers which are near your house and select one which is convenient for you. Then you call the leasing agent and ask them to send the lease. Then sign the lease, mail it to them and you are in business — right? Of course, this is just about the worst way to approach leasing retail space.

Leasing retail space begins by deciding upon the type of retail or service business. That decision is beyond the scope of this article. Once you have determined the type of retail business, your first step in leasing retail space is to research your competitors and the industry.

Map Your Stores and Competitor Stores

Start by preparing a map of space leased by your firm and your competitors firm within your metropolitan area. Either color code or use a number system to identify which leased spaces are occupied by each of your competitors. If you are contemplating a ubiquitous type of business such as a nail salon or convenience store, map properties within a sector of the city or metropolitan area.

Analyze Trends

Next review the map and analyze store locations for trends. Are well-established professional firms already in the business? How many stores should they have in the metropolitan area? What is the distance between stores? How would you describe the level of income, education and growth for the areas they have chosen?

Visit Competitor Stores

Next, visit the retail space in your metropolitan area occupied by your competitors. What types of retail had they chosen? In other words, are they in unanchored strip centers, shadowing anchor strip centers, anchor strip centers, anchored neighborhood centers, unanchored neighborhood centers, community centers, regional malls or freestanding retail locations? If they are in a shopping center, what type of space do they have? Is it an end cap, in-line space, or an elbow space? Are they on the first floor or the second-floor? Make notes on their signage, visibility, and ingress and egress from the center. Are they in a location with easy access convenient to public transportation?

Research Competitor Stores

Visit stores which seem to be more prosperous. Make notes regarding the amount of space, layout, signage, merchandise mix and pricing. Shop the store. Ask questions of the retail sales staff. In some cases, you may want to tell them you are considering opening a competing store in another part of town. Most people are friendly and want to help if it won’t hurt them. Ask is your store successful. Ask questions about their clientele. What types of people shop at the store? Who are their best customers? What do customers want? Is price most important or service more important? What merchandise moves best? Which distributors do they like best?

Visit Stores in Other Cities

Travel to retail spaces occupied by competitors in three to five other cities. Repeat the process of making notes regarding relevant items and speaking with the retail sales staff. Attempt to learn the best practices and new trends. Do your competitors in other cities employ an approach not used in your city? Is it successful? Most business success comes from incremental improvements. Few people make the breakthrough improvements such as inventing the telephone or the electric light bulb. However, by doing research regarding what is working best for your competitors in your city and in three or five other cities, you radically improve your chance of successfully serving customers and having a successful business.

What Makes a Location Successful?

The next step is to compile data to infer what makes a retail space location successful. For perhaps 5 to 10 (total) of the more prosperous stores within your metropolitan area and in other cities, compile data for the relevant radius regarding demographics and psychographics. Demographics includes information such as the number of households, population who lives in the area, population who works in the area, income level of people who live in the area, income level of people who work in the area and population growth trends.

Psychographics

Psychographics is a relatively new concept in terms of regular application by business. Psychographics considers the income, education and attitude of the residents. People are divided into six plus groups based upon a series of criteria. Many businesses set down that psychographics are more insightful in estimating the location of a business versus demographics. A successful location will need to meet certain demographic criteria. However, locations which meet these criteria can be evaluated more carefully using psychographics.

Leasing Retail Space – Location Facilities and Future Development

Parking

Research whether the retail space you are considering has adequate parking. Consider both the local Government code and feedback from tenants within the center. Also consider visiting a center four to six times prior to signing a lease.

Multiple Visits

If you visit the center for the six times at different times in the day and week, it will give you a better feel for the adequacy of parking as well as other potential issues related to the center. It would be overkill to visit each center you are considering four to six times. However, this can provide invaluable intelligence for retail space before you make a serious financial commitment.

Allowable Use?

Retail space is often subject to rules established by the landlord, deed restrictions and local government restrictions. Research these issues prior to investing much time or money in a retail space option. For example, a tenant within the center may have obtained the exclusive right to sell food within the center. If you are considering opening a coffee shop which also sells pastries and sandwiches, you would either have to obtain a variance or move on to the next option.

Approval Process

If the approval process for the deed restrictions or local government are subjective, obtain written information regarding the restrictions and the approval process. Also consider visiting with both the retail tenant rep broker and tenants within the retail property.

Condemnation Plans?

Research the possibility of a condemnation proceeding. Visit with the relevant city, county or highway department officials to determine whether there are any plans to widen any of the streets contiguous to the retail center. If there are firm plans for roadway expansions, research the details thoroughly. It is difficult to develop a successful retail establishment. It would be most unfortunate to develop such an establishment and have to move after only one or two years.

Why Did Previous Tenant Leave?

This section considers the history of tenants who previously occupy the space you are considering and special issues for a new center. Once a space has made it to the “short list”, research why the previous tenant left the retail space. If it was a location for a chain which filed for bankruptcy or an individual who retired and shut down the store, it is not too troubling.

If Previous Tenant Failed

However, if it is someone who operated a business similar to the one you are contemplating, and the business fails, serious due diligence is appropriate. In this event, you should attempt to speak to the proprietor who previously occupied the space. You may also want to speak to the tenant who occupied the space prior to him. Visiting with other tenants regarding the history of the space as well as the history of the center and the prosperity of their businesses can provide excellent insights.

Proposed Center

If you are considering renting space in a proposed shopping center, serious caution is warranted. Is the concept or theme for the shopping center tested? Or is the developer trying to introduce a new team or mix of businesses for this retail property. There is clearly much higher risk that the property will not be successful if the owner is experimenting with a new concept. While you may decide it is the ideal location for your retail space, be aware that the risk of a poorly performing retail center is higher with an experimental concept.

Have National Tenants Committed?

You will certainly want to research which other tenants have committed to the shopping center. If nationally recognized retailers have committed to lease in the shopping center, you can feel comfortable that they had done meaningful due diligence and believe the concept is workable.

Developer’s Experience

Separately, what is the developer’s experience? Is this his first retail development or has he developed 10 or 20 properties over the last five years? If the proposed property is a retail strip center, and the fundamental characteristics of the center are sound, leasing from an inexperienced developer is probably a reasonable risk. Also consider obtaining the work history or résumé of the developer. Does his recent history indicate a pattern of successes or failures?

Strip Centers

Desirable characteristics for a retail strip center include a hard corner location, space which is parallel to at least one of the streets, and a relatively modest size (perhaps 10,000 or 20,000 ft.²). Ideally, it would also have an anchor tenant, perhaps a nationally recognized convenience store. However, many strip centers do not have an anchor tenant.

Don’t Do It

Renting space from an inexperienced developer building an experimental concept is probably taking an unnecessary and inappropriate level of risk.

Leasing Retail Space – Defaulting on the Lease

Relocation Clause

Many retail space leases provide the landlord the option of relocating the tenant at the landlord’s expense. For example, consider a local retailer leasing 2000 square feet of retail space in a regional mall. The landlord is attempting to lease 10,000 square feet of space to a national retailer. However, to consummate the lease they need the 2000 square feet of space occupied by the smaller, local tenant.

You Lose

Even if the landlord pays 100% of the cost to move your store, you will incur a loss. In addition to the time spent planning and executing the move, it will disrupt your business. Some previous customers will believe you have gone out of business and instead of realizing you’ve moved to a different location within the mall. Relocation clauses are another issue where the interests of the landlord and the tenant diverge.

Event of Default

An “event of default” is when either party does not perform as agreed upon in the lease. In some leases, the landlord has the right to terminate the lease if the tenant defaults. This can include both objective and subjective issues. An objective issue is timely payment of rent. A subjective of issue could be a product or service offered by the tenant which was not initially contemplated.

Non-Financial Event of Default – Example

For example, the tenant initially sold skateboards but is now also selling clothing for skateboarding. (Leases often define precisely what business the tenant may perform in the retail space. From a technical perspective, even a slightly different type of business is a violation of the lease, which is an event of default.)

Financial Event of Default – Example

Most landlords and most tenants act reasonably. However, some people are unreasonable. Consider the following example. Retail space is leased at a fixed rental rate agreed upon 10 years ago. The contract rent is $ 15 per square foot but the market rent is $ 30 per square foot. The lease continues for another 10 years at the same rental rate. Due to a clerical error, the tenant forgets to send a rent payment one month. The tenant has an exemplary history of timely payment for the previous 10 years.

However, this is an event of default on the lease. Instead of calling the tenant to inquire regarding the current month’s rent, the landlord sends the tenant a notice of default. The notice of default informs the tenant the lease has been terminated and demands the tenant vacate the premises within 30 days.

What is Reasonable?

A reasonable solution is for the landlords to provide written notice in the event of a default. The tenant should have a reasonable period of time to cure the default. This issue becomes more complex when it is not possible for either the tenant or the landlord to cure the default.

What if Landlord Can’t Perform?

For example, a lease includes an affirmation by the landlord to comply with local laws and regulations. However, city council retroactively increases the parking requirements. (The number of parking spaces required per 1000 square feet of space.) This issue is being intensely litigated by local retail center operators. However, final resolution of the litigation is not expected for three or four years. Should the tenant have the right to terminate the lease in this situation?

Dispute Resolution

Most retail space leases address the venue for resolving disputes between the tenant and landlord. In most cases, the venue is state district court in either the location of the retail property or where the landlord is headquartered. The former is prevalent. There’s a growing trend to require binding arbitration for disputes. The advantage it is a less expensive process to resolve differences of opinion. The disadvantage is forgoing some of your rights for a process which can be even more arbitrary than state district court.

Right to Terminate

Finally, tenants should consider providing themselves an escape clause. When starting a business, a high level of optimism and the excitement is typical and understandable. However, the actual business results sometimes fall far, far short of what was expected.

Right to Terminate – Example

For example, assume you had expected sales of $ 20,000 per week for your retail store and thought the very lowest level that could possibly occur would be $ 5,000 per week. Even though the $ 5,000 per week seemed like a very pessimistic scenario, you were comforted that the business would be profitable at this level. At least you’d be all the pay your expenses and pay yourself a barely adequate salary.

Example Continued

Unfortunately, the pessimistic scenario turned out to be wildly optimistic. For whatever reason, the stores only generating sales of $ 1500 per week. This is inadequate to pay your cost of operations.

What Rights Should You Require?

Should you have a right to terminate your five-year lease in this scenario? If you do terminate the lease, what is a reasonable amount to pay for expenses incurred by the landlord?

Beware of the Consequences

Although termination clauses and personal guarantees may seem like an arcane nuance when negotiating the lease for your new business, they are critical factors. If you personally guarantee the lease and do not have an option to terminate the lease if your business performs poorly, in a worst-case scenario you are faced with personal bankruptcy or funding an operating deficit for a long period of time.

Conclusion

This concludes the article on leasing retail space. By researching best practices for your competitors, carefully analyzing the demographics and psychographics of successful stores, identifying an appropriate submarket for your store, performing thorough due diligence regarding the retail space you are leasing and carefully negotiating the lease, you have substantially improved your chances of success. In addition, you will have mitigated your exposure in the event your retail establishment is not successful.

Leasing Retail Space – Negotiating the Right Deal

Letter of Intent (LOI)

Retail space negotiations are complicated and time-consuming. Once you have located the retail space which is ideal for your business, the next step is to negotiate an agreement which protects you and is acceptable to the landlord. Industry practice for retail space is to negotiate a letter of intent before negotiating the lease.

Use an Attorney!
Engage an attorney to assist in the letter of intent negotiation. It probably seems that the letter of intent is informal and can easily be negotiated without an attorney. However, there are issues you should address in the letter of intent which may not be obvious if you have not previously negotiated letters of intent for retail.

Wow! This is Complicated
Common factors for a retail space letter of intent include: defining the parties (leasor and leasee aka landlord and tenant), defining the space, defining the rent including any percentage rent, defining the basis for calculating sales or net income if they are involved in calculating rent, the initial term, any renewal options, rent for renewal options period, the day at which lease payments commence, the date of occupancy, the condition of the space when the landlord provides it to the tenant, tenant improvement allowances provided by the landlord, who performs the tenant improvements, is the tenant required to use union labor for tenant improvements, is the tenant required to use a general contractor for tenant improvements (TI), who pays for the cost of the ADA compliance, who maintains what (i.e roof, HVAC, electrical, plumbing, etc), who pays which expenses, calculating the payment for CAM (common area maintenance), free rent, and identification of the broker and payment of the brokerage fee if relevant.

You Mean There is More!
Other issues which you may want to address in the letter of intent include expense escalations, co-tenancy issues, eminent domain, foreclosure, maintenance standards, definition of the amount of leaseable space, personal guarantees, purchase option, subleasing, required hours of operation, dedicated parking, who is responsible for obtaining variances related to signage and usage of the retail space, expansion options, first right of refusal, can the tenant keep the TI allowance not needed for construction, can the landlord relocate the tenant if the space is needed to accommodate another tenant, late payment fees, the mechanics of providing notice of default and any options for the tenant to cure the default, mechanics of dispute resolution between the landlord and tenant, and a right to terminate if your sales do not stabilize at a minimum level.

Complete LOI First
Complete and obtain an executed copy of the letter of intent before beginning on the lease agreement. The primary objective of the letter of intent is to negotiate and agree upon the business issues. The lease documents these agreements. Discuss fees to negotiate the lease with your attorney. Agree upon an hourly rate and estimate of the total fees. Agree the attorney will call if it appears the cost is going to exceed the estimate.
The following sections of the leasing retail space article focuses upon issues which merit commentary.

Percentage Rent
Percentage rent — make sure the agreement regarding percentage rent is clear. If percentage rent is based on sales, define sales. For example, is sales-tax remitted to the city and state included in sales? It is even more difficult to define net profits, which is why most percentage rent leases are based upon sales instead of profits. Attempt to look at the definition of net profits from a detached perspective. If you gave the definition to a six grader, could they understand it?

Renewal Options
Renewal options — tenants love them and landlords prefer to avoid them. In general, a larger number of shorter renewal options are better for the tenant. In addition, shorter notice periods to announce the tenants intend to renew are desirable for the tenant. Landlords prefer as much notice as possible regarding whether or not the tenet plans to renew.

Renewal Option Rental Rates
Renewal option rental rates — tenants typically want fixed rental rates for renewal periods. Landlords typically want the rental rate based upon market rent. Agreeing upon market rents can be difficult and expensive. Reasonable people can disagree regarding the level for market rent for a retail space. For example, should the premium for an end-cap space be 10% or 100%? Retail space is not fungible. It recently signed lease for retail space within the same center provides insight into market rent. However, in most cases it will not clearly defined market rent.

Leasing Retail Space – Using a Broker

Tenant Rep Brokers

Tenant rep brokers are a great option for your retail space search. Their fee is paid by the landlord in most markets. They are retail space experts. Every day, they work on finding and negotiating agreements regarding retail space. Even if you started the retail space search with an online search service, using a retail tenant rep broker will probably generate the most cost-effective retail space for your business.

Get an Expert!

If you select a tenant rep broker to help find your retail space, find an expert. Do not hire the person who helped you purchase your house. Retail space tenant rep brokers are full-time experts. It is a very specialized area. You would not even want to utilize the tenant rep broker who helped find office space for your administrative staff.

Identify Tenant Rep Brokers

Use a search engine to identify perhaps 5 or 10 retail tenant rep brokers in your area. Do your initial research by reviewing their website. Are they retail space experts? Call and interview perhaps five to seven by a phone.

Phone Interviews

Ask about assignments they’ve recently completed, how many years they’ve been in the retail space tenant rep business, how much retail space they leased in the prior year, and which retailers they represent in the local market. You may feel comfortable selecting retail space tenant broker after the phone calls. It is certainly helpful to find someone who has helped other retailers in your same line of business. They will have insights which could be meaningful.

Meet Tenant Rep Brokers

Set up meetings with two or three of the tenant rep brokers if you have not chosen one after the first round of phone calls. The objective is to visit more regarding their retail assignments, obtain their thoughts on an appropriate retail space for your business, and determine whether you will feel comfortable working with them.

Obtain Actionable Advice

While you make the final decision when selecting a retail space, you will want to feel confident the retail space tenant rep broker will provide actionable advice.

Paid by Landlord and Advices You?

The compensation arrangement with the tenant rep broker is often not intuitive. In most cases, the tenant rep broker will be paid by the landlord. He has a fiduciary relationship to the landlord. His relationship with the perspective tenant is to provide honest information. Your retail space tenant rep broker will go out of his way to accommodate you and help with the search process. However, remember that his client is the landlord. If you discuss your negotiation strategy or the maximum amount you’re willing to pay, the broker has an obligation to provide this information to his client, the landlord.

Houston Retail Space Leasing

Houston retail space leasing can help retail building owners to increase revenue, vendors to increase sales and provide a variety of industry personnel with data and reports to facilitate decision-making and communication. Retail center owners can review rental rates for nearby properties to insure their rental rates are competitive. Vendors to the Houston retail building community can focus their marketing and sales efforts. OConnor & Associates provides comprehensive retail building data for the Houston metropolitan area. This Houston retail building data is used by investors, management companies, brokers, prospective tenants, vendors, appraisers and other industry participants. O’Connor & Associates Houston retail building data is updated quarterly. Retail rental rate and leasing information is obtained directly from owners, management companies and leasing agents.

Benefits of O’Connor & Associates Houston retail building data include:

Retail building owners can increase revenue by increasing rental rates after comparing rental rates for their property with the rental rates for competing Houston area retail buildings. Rental comparables can be targeted based on year of construction, building size, anchored versus non-anchored, and location.;
Investors can increase acquisitions by targeting properties which fit their acquisition criteria. Information regarding both properties which are for sale and those which have sold are available.;
Retail building investment brokers can increase their sales by utilizing the ownership information to contact retail building owners and can also use the statistical data reporting package to perform analysis for clients. Comparable sales data is available for some properties.;
Retail building leasing agents can efficiently identify space which meets a clients requirements. Retail leasing brokers can search by location, rental rate, anchored versus non-anchored, year of construction, building size, location, type of retail property, (strip center versus neighborhood center versus community center versus mall) and many other factors.;
Retail building vendors can use the ownership information to focus their sales effort on the most appropriate retail buildings;
Retail building owners and management companies can use the statistical reporting package to understand and analyze market status and trends. By reviewing both current market trends and construction which is currently underway and proposed, owners can gain insights into probable market trends for the next 12 to 24 months. Historical data for the Houston retail market is available from 1988 for occupancy, rental rate, absorption and many other factors.;
Retail building owners, brokers and management companies can compile data and reports for clients and internal reporting;
Appraisers can use the data for rent comparables and to calculate submarket occupancy, rental rates, rental rate trends, absorption, and review properties proposed and under construction. Appraisers will also benefit from data regarding comparable sales.
Houston area retail buildings are classified by type (strip center, neighborhood center, community center, regional mall and single-tenant).

Features of O’Connor & Associates Houston retail building rental and leasing data include:

Rental rates, occupancy, management company, leasing company and ownership information updated quarterly;
Details on over 20 physical building features such as year built, net rentable area, type of center, etc.;
On-line access to live database;
List of tenants currently at property;
Ownership information including contact person, owner company, phone number, and address;
Management company information including contact person, phone number and address;Historical data since 1999;
Robust options to search for properties. There are over 40 fields of data which can be used to search for targeted properties.;
20 options for reports including a detail sheet for each property, rental rates by property type (strip center, neighborhood center, community center and regional mall), occupancy by type, absorption by type and many additional reports. O’Connor & Associates is receptive to adding report formats of use to multiple users.

Sample reports are available below:

Detail sheet
Rental rates by type
Occupancy rates by type
Absorption by type

OConnor and Associates has provided comprehensive retail building data for Houston since 1988. Our retail building data includes rental rates, occupancy rates, contiguous space available, amenities, ownership information, management company information and extensive details regarding each retail building. Our staff can also provide retail building market studies and feasibility studies. In addition, our staff can help you evaluate options for improving performance at a property. Other services include highest and best use analysis, market rent analysis, lease audits, lease abstraction, investment and portfolio analysis, and custom consulting.