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Retail leases; Getting started

Gerald Morganstern (2) (1)
GERALD MORGANSTERN

By Gerald H. Morganstern, Partner, Goetz Fitzpatrick LLC

Retail leasing is not as straight forward as office leasing.  So before you ask for a lease to be drawn and after doing all the legwork, you should make some preliminary investigations, and craft a detailed letter of intent.

The considerations below should be your concern.

Any retail business needs a high traffic area.  The nature of the business will determine how up scale the neighborhood and the price range the tenant can afford.  Be aware that in some locales the basic rent will be significantly increased by additional charges, such as real estate taxes, utilities, common area maintenance or percentage rent.

First on any list is a check of the zoning.  Standard retail zoning is enough for many businesses.  But, there are always exceptions.  A sporting goods store may want the ability to sell hunting equipment (bows, arrows, guns, ammunition) which may require a special license or variance.  Restaurants have special requirements.  The parking ratio for a restaurant at a shopping center higher than a dry goods store and is based on the size and number of seats in a restaurant.

A liquor license is customary as part of a restaurant use.  This entails assuring that the restaurant is not located too close to a church or school and that the landlord has a clean record.  Some municipalities automatically reject permit applications for restaurants requiring the operator to obtain a variance (often called a conditional use permit) at a zoning board hearing before approving any restaurant.

For some businesses signage is extremely important.  Sign restrictions may exist in some municipalities.  These include:

  • limitations on size and location;
  • uniformity in color and design in a shopping center or other designated area;
  • Prohibition of LED, flashing or other garish signs;
  • Prohibition on any signs on landmarked buildings or historic districts.

Landmark issues may also eliminate desired canopies or awnings.  The tenant may be able to obtain a permit for a flag or banner or a window sign, but should know this in advance.  In New York City, landmarks commission approval is necessary in a landmarked district even if no exterior building changes are proposed.  This needed approval can add six months to the obtaining of a building permit.

Once one or two desired locations are found, a terms sheet or letter of intent with the landlord should be drafted so there are no major surprises in the lease.  The letter of intent should spell out all important provisions to be contained in the lease.

Basic rent, additional rent in the form of real estate taxes, common area maintenance (“CAM”) and utilities should be clear.  Unlike an office lease which provides for payment of increases in real estate taxes and operating expenses above those for the year the lease is signed, retail tenants pay their share of all real estate taxes and CAM for the land and building.  The share of real estate taxes and CAM will be a negotiation point if the business is in a mixed use building and must be allocated between office, residential and retail uses.

A few landlords still seek to share in a successful tenant’s revenues in the form of percentage rent.  The tenant would pay the percentage rent if sales exceed a stipulated “break point”.  At the end of the article is an explanation of percentage rent and an example showing the natural breakpoint where percentage rent would take over.  More likely it is used as substitute for basic rent when the landlord violates a lease and the tenant’s sales suffer so the tenant only pays a percentage of actual sales instead of a fixed amount.  This can occur if the landlord violates an exclusive use clause or the requirement that there be an anchor tenant (called a “co-tenancy” clause).

The letter of intent should spell out tenant’s assignment and subletting rights since retailers often want to sell successful businesses or transfer within the family.  Often the letter of intent will have a renewal right, but even more important is the right to terminate the lease.  If the business is not successful at this location, a tenant will not want to be locked into a long term lease.  A right to terminate the lease after one, two or three years if sales don’t reach a certain level could be very important.  The tenant may have to reimburse landlord for some unamortized expenses, pay a fee and lose its security, but it is better than continuing at a loss, or worse; going into bankruptcy.  At the same time, the landlord may want an option to terminate the lease if the tenant does not meet expectations.  A tenant with poor sales devalues the property and makes leasing or renewing other spaces more difficult.

Do the legwork before you draw up a retail lease
Do the legwork before you draw up a retail lease

Other subjects for a letter of intent are:

  • tenant’s exclusive right to sell certain merchandise;
  • tenant’s radius restriction as to other stores;
  • co-tenancy provisions;
  • continuous operation and hours of operation;
  • if applicable, franchise requirements;
  • landlord construction or construction allowance;
  • rent commencement date;
  • delivery dates.

When all is investigated and determined, a letter of intent can be signed and used as a basis for the lease documents.  A lawyer should review the letter of intent before submission to the landlord.  Often a lawyer will look to negotiate changes from the letter if he or she has not first reviewed it.  This can lead to delays or animosity.  If all major lease points are covered, the letter of intent could be deemed itself a binding lease.  So, language expressly stating the letter is not binding should be included.  Further, in some states such as California, when you sign a letter of intent there is implied a duty on the parties to negotiate a lease in good faith.  Make sure whether there is an implied duty, and either plan on it being applicable or see if it can be negated.  This article is not intended to give legal advice so it should be discussed with your counsel.

PERCENTAGE RENT – NATURAL BREAKPOINT

Retail Space                $1,000/square foot

Rent                            $   500/square foot

Total Annual Rent      $500,000

Percentage Rent            Breakpoint

2%                    $25,000,000

5%                    $10,000,000

8%                    $  6,250,000

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