Getting the Best Lease

Retail leases, especially in malls, are more complicated and expensive than ever. The brain-numbing boiler-plate language has gotten longer – many leases now run 100 pages – and a growing number of non-negotiable clauses guarantee landlords a profit to the detriment of their tenants.

As these rental agreements bite deeper into revenues, jewelers must get the best contract they can at the least cost. Yet many continue to make costly mistakes when they negotiate or renew their leases. They aren’t alone. According to one lease-auditing firm, up to 90% of commercial leases contain errors – at the renter’s expense, not the landlord’s. Here are tips for sidestepping the pitfalls.

Location plays a role. There are big differences in rental contracts for enclosed malls, shopping strips, and freestanding or downtown stores.

Malls use thick, increasingly complicated “Standard Forms.” Many are “net profit” or “triple net” leases. That means tenants not only pay their own costs (including taxes, utilities, maintenance fees, and rents) but also often pay those of the landlord and even guarantee the landlord’s net profit. “Twenty years ago, all the landlord charged was basic rent,” notes John Michaels, chairman and chief executive officer of Michaels Enterprises of Waterbury, Conn., which operates 12 stores. “Now, if he has to pay anything to anyone, you the tenant end up paying for it.”

Shopping centers, strips, and freestanding stores use less-rigid leases, and their landlords are more likely to be flexible. One Midwest jeweler, for example, recently leased a corner location in a small shopping center at only $8 a square foot because its owner wanted an upscale retailer there, not a sandwich shop. Even so, negotiating is getting tougher at the smaller level, too. “More small centers are getting hold of, and copying, the leases used by the big guys,” notes Michaels.

Compare rates. This is good advice for both novice and veteran retailers before and during negotiations. Talk to jewelers and retailers in similar buildings or malls in the area, advises veteran lease negotiator Jon Bridge, co-chief executive officer of 57-store Ben Bridge Jewelers, based in Seattle. Ask area retailers what they spend in rent and associated costs. Look at their leases and amendments. Ask about the landlord and the operations. You’ll get a better idea of the typical charges in your market and what to ask for from your own landlord.

Read the lease carefully. Many retailers, especially smaller ones, don’t know details of their own leases and don’t push for changes that could save them money. After you discuss general issues with the landlord, such as location, rent, and other charges, carefully review the proposed lease. Michaels suggests even reading it twice, daunting though it may be. The document is just too important to skim. On the first reading, familiarize yourself with the lease’s language and provisions. Make marginal notes of what you will or will not accept for later reference in negotiations. Then, read it again with your attorney, giving special attention to those sections you want changed or reworded and how you want them changed.

Some experts suggest a final read-through after negotiations are done, with you and your landlord initialing each page – or significant clauses or paragraphs – to show mutual agreement. However, some landlords may refuse because it limits their legal flexibility.

Get professional input. Whether you have one store or many, it helps to have a fresh set of eyes review the lease. “Most jewelers are very good at running a jewelry business but not at reading leases or understanding their effects on their business,” says Michaels.

“Parcel your lease provisions out to people who will be affected by [the lease] and who can give you input about it,” says Bridge. “Your attorney will advise you on legalities and what happens if terms are violated. Your business insurance agent will see if the lease obligates you to carry insurance which has no bearing on your business. Your architect or contractor can look at sections concerning costs of building a store. Your banker can make sure you don’t agree to guarantees you can’t afford or which he won’t stand behind. Your accountant or bookkeeper can advise you on proposed fees and rents, their calculation and payment schedules.”

Above all, hire someone familiar with commercial leases, retailing, and real estate law to work with you during the lease negotiations and afterward, says Michaels. “If you spend money here, you will save money in the long run.”

Often this specialist will be a certified public accountant or an attorney trained in real estate law. For a referral to a specialist, Michaels suggests contacting the International Council of Shopping Centers in New York at (212) 421-8181. There also is a new category of advisers called “commercial lease consultants.” (see later in article).

Clout. Regardless of the size of the business, a jeweler does have some advantages when he or she sits down to lease bargaining.

  • First, notes Michaels, “the more a landlord needs or wants you as a tenant, the more concessions he will make in negotiating your lease.” And jewelers are in demand. Research by the Urban Land Use Institute shows they’re among the most prevalent tenants in malls and shopping centers because they’re so lucrative for landlords.

  • Second, don’t hesitate to question language and clauses in your proposed lease. True, some items are non-negotiable, such as the “common area maintenance split formula” the landlord uses to calculate maintenance fees. But you won’t know until you ask. Most landlords are willing to make reasonable compromises, notes Bridge. Indeed, if a landlord won’t make any concessions, look elsewhere because he or she will be even less flexible after the lease is signed.

  • Third, and most important, many changes you want probably already exist in writing. Most landlords and developers have a “playbook” – usually a thick, three-ring binder – filled with alternative clauses and phrasing they have okayed in their dealings with other tenants, notes Michaels. Indicate that you know they have them and ask for alternative phrasing for clauses you dispute.

Common area maintenance (CAM). This can be a hotly contested area in negotiations. “The landlord will try to pass all his [maintenance] costs to you, the tenant,” says commercial lease consultant Charles E. Krohn. “You can overpay [monthly] CAM charges by as much as $1 or $2 a square foot.” This happens often enough that it’s “advisable to have [CAM costs] reviewed regularly by an outside auditing firm or by an attorney to ensure that you aren’t overcharged or charged additional fees,” adds Bruce van Kleek, vice president for member services of the National Retail Federation.

In negotiating CAM charges:

  • Consider outside maintenance, parking lot cleanup, lighting, and snow removal – and who is responsible for paying for them.

  • Ask how CAM charges are apportioned among tenants and who is responsible for paying the costs for businesses that close or move before their leases expire. Normally, the landlord, not the tenant, should bear the proportional costs for unoccupied retail spaces in a mall.

  • Compare your CAM charges with national averages. Such information is available from the Urban Land Institute at 1025 Thomas Jefferson St., N.W., Suite 500 West, Washington, D.C. 20007-5201; (800) 321-5011, www.uli.org. Another source for this information is ICSC at 665 Fifth Ave., New York, NY 10022; www.icsc.org.

Ask the landlord for a copy of the CAM budget, broken down by square footage. Compare it with your own proposed or current costs and those of tenants in the same mall or building.

  • The landlord’s lease usually has a clause saying CAM charges “include but aren’t limited to” various operational expenses. “Cross that out,” says Krohn, and “push for an amendment in plain English that specifies expenses that are excluded.” These should include fees that reduce the landlord’s cost of doing business; charges that favor some tenants over others; or costs that aren’t directly related to CAM expenses, such as structural repairs or depreciation. It isn’t uncommon for landlords who recapture the cost of mall equipment through depreciation to add the cost of replacing that equipment to CAM charges, notes Michaels.

  • Request that your lease include a cap limiting increases in CAM costs to no more than 50%, says Michaels.

Bargaining points. There are several other areas in negotiating a lease in which jewelers can save themselves money:

  • Breakpoints. In addition to normal rent, malls ask retailers to pay 5% to 10% of sales – or percentage rent – above a specified breakpoint. For example, the “natural” breakpoint for a jewelry store with a normal rent of $50,000 and a 5% rate is $1 million in annual sales ($50,000 divided by .05), or $83,333 in monthly sales. So, in addition to the normal rent, a jeweler would pay 5% of that portion of sales that exceeds the breakpoint.

Michaels recommends that jewelers push for “unnatural” or higher breakpoints, such as $1.2 million instead of $1 million. These often come as tradeoffs. For example, if you must put a significant amount of money into a mall’s renovation, you can argue for a higher breakpoint. There are also “stepped” breakpoints, in which the increase is graduated – for example, 3% at $1 million, 4% at $1.1 million, 5% at $1.2 million.

  • Your lease also should specify what is excluded from your sales. Among these items are no-profit sales ( i.e., sales to employees or sales on repair services) and low-profit sales (i.e., big-ticket items sold to insurance companies or corporations). The landlord may also try to include in the total any sales you make by telephone, via the Internet, or through a catalog. Try to keep these out of the lease.

  • Hours. Check operating-hour requirements. You don’t want to remain open when other stores are not or later than the hours specified in your lease.

  • Escalator clauses. Look carefully at these. Without pre-negotiated caps, your rent can keep going up. That may happen, for example, if another department store comes in and the landlord wants to offset rent concessions made to the new tenant, or if the cost of living climbs.

  • Rules and regulations. A landlord is entitled to set reasonable operational rules and regulations but shouldn’t use them to override something in your lease. For example, if your lease lets you close your mall store at 10 p.m., the landlord shouldn’t impose a new rule requiring tenants to close at 11 p.m. Michaels recommends that you push for an amendment that says subsequent regulations will not supersede anything in the original lease.

Dispute resolution. More than half of today’s standard leases include procedures to resolve disputes between landlords and tenants – but these procedures usually tilt in the landlord’s favor. A tenant may have only a very limited time to file a complaint, or the grievance procedure may be needlessly complicated. Argue for language “clearly defining a fair and effective dispute-resolution method,” says Krohn. Otherwise, he says, any disputes you have with the landlord will “always be interpreted and resolved in his way – you pay or you’re evicted.”

Lemonade from lemons. Use clauses that you dislike or have little chance of changing as bargaining chips. Here are three examples:

  • “Radius restriction” is a common clause in mall leases. It prevents you from putting up another store in the area because your landlord fears it may reduce the volume of your mall business and thus your percentage rent. If you agree to this restriction, use it to bargain for reductions on other high fees, such as CAM costs or the schedule of percentage rents.

  • If a landlord asks for a bigger operational commitment – such as longer hours on holidays, opening on Sunday, or money to renovate the mall or for group advertising – use this to bargain for lower common maintenance fees.

  • Include a clause that says if the mall, shopping strip, or building is less than 100% occupied for a specified period, or if a major anchor store leaves and isn’t replaced, there will be an adjustment in rents or other fees or requirements.

How not to economize. Don’t move to a less-desirable location in the mall or building in an effort to save money on rent. “Jewelers think business won’t be affected because they are ‘destination’ retailers,’ ” says Michaels. “But often that isn’t the case.” Leaving a prime location usually reduces a store’s traffic and revenues. It’s a case of being “penny wise and pound foolish,” says Michaels.

Space check. Verify that the amount of space you rent is the same as that specified in your lease. In one out of five leases today, the actual retail square footage is less than that specified in the lease agreement, says Krohn. “Don’t swallow the landlord’s claim that the square footage is ‘approximate,’ ” he cautions. “When was the last time you sent in a check for the ‘approximate’ rent?”

Lease Abstracts

A lease abstract is an important money- and time-saver, though fewer than 5% of tenants ever bother to compile one, say leasing experts. As soon as you finish negotiating a lease, suggests commercial lease consultant Charles E. Krohn, “go through it and make a one-page summary of all key points in it and any amendments which are likely to save or cost you money. Include with each item the page reference where it is located.”

Why compile an abstract when you have the lease itself? There are several reasons.

While you, the jeweler, negotiated the lease, your accountant, store manager, bookkeeper, and attorney, among others, are the ones who administer its details. Today’s mega-paged, single-spaced leases are too cumbersome for them to refer to constantly for specifics on costs and operations. Even if they do, key provisions in the middle of pages of boiler-plate language can easily be missed.

An abstract of key points – such as remodeling allowances, insurance limits, renewals, agreed-to rates, and scheduled changes – prevents unintentional mistakes and overpayments. It enables your staff to check the validity of invoiced charges, prevents your business from paying unnecessary or higher-than-agreed-to costs, and avoids the need to comply with new rules (such as changes in operating hours or new maintenance costs) that deviate from the original lease.

Also, notes Krohn, abstracts are useful when you compare rents and costs in other locations before moving or opening an additional store. They also serve “to refresh your memory on a key issue in the lease,” he says.

Two veteran lease negotiators – Jon Bridge of Seattle-based Ben Bridge Jewelers and John Michaels of Michaels Enterprises, based in Waterbury, Conn. – agree that an abstract is useful. Bridge draws up an abstract of every lease he negotiates so those in Ben Bridge’s accounting department “know what is going on and what is required.” Michaels likes the convenience of a handy summary that affected personnel – such as those in advertising, security, or marketing – can quickly refer to without having to reread the entire lease.

Commercial Lease Consultants

Though commercial lease auditors or consultants are a new business category, established less than five years ago, they are increasingly used by businesses to review and verify their rental contracts.

A lease consultant “digs deep into a lease, looking for key issues which can save or cost a tenant money,” explains Charles E. Krohn, a former financial analyst for several Fortune 500 firms. He became a commercial lease consultant himself in 1994 after he saw how many of his clients were regularly overcharged in their leases. Today, about half his customers are retailers. “Small retailers in particular are taken advantage of in lease negotiations because of their low-leverage bargaining position,” says Krohn. Many times they are unfamiliar with real estate law and the arcane language of leases.

Landlords and their lawyers spend years “honing the legalese” in leases so the language is “intentionally vague and can be interpreted for the landlord’s benefit,” he notes. For example, are tenants’ operating expenses based on their share of the total building or mall or on their share of the premises actually leased? Other examples, he says, include a commonly used clause that obligates a tenant to pay unlimited future increases in expenses; one that makes a tenant responsible for costs of other tenants who overuse their utilities; and a third that lets a landlord evict if the tenant doesn’t maintain a high enough volume of business to pay a percentage of sales.

A lease auditor carefully looks for such language and interprets it in the way that is most favorable to the tenant-client or suggests ways to reduce costs or prevent overcharges. For example, “a carefully worded lease amendment is one defense against a landlord’s blank-check property management,” says Krohn.

After a lease is signed, a lease auditor can review all statements, invoices, and correspondence the landlord sends to the business. The consultant can then ensure that the tenant’s bookkeeper – who wasn’t involved in negotiations and may not know the details – doesn’t overpay or comply with costs excluded by the lease.

Use of a lease consultant depends on the situation, says Krohn. “But if a jeweler has the least suspicion he is being taken advantage of, then he can benefit from hiring one.”

Because it is a new field, commercial lease consultants and auditors are only rarely found in phone books. However, a number of them have Internet Web sites, including Krohn (www.comles.qpg.com). Look under “Commercial lease auditor or consultant.”

Krohn’s new booklet, “Slash Your Rent: A Commercial Tenant’s Explicit Guide,” provides detailed advice on what expenses can be excluded from leases for tenants in various bargaining positions. The booklet costs $25 and is available on Krohn’s Web site or from Commercial Lease Consulting, 3867 W. Market St., Suite 250, Akron, OH 44333.