LEASE RENEWALSTIPS AND TRICKS TO ENHANCE PROFITABILITY

T: 403.303.2767 E: INFO@ORANGEGROUP.CA ORANGEGROUP.CA

Why some of the worlds most progressive companies are changing the way they approach renewals.

EXTERNAL VERSUS INTERNAL:Quantifying the difference between internal and external modelssee page 4

FINANCIAL METRICS OF RENEWALS:What is the value across a portfolio and the potential impact on EBITDA?see page 8

While some companies view lease renewals as a process that is often associated with words like paperwork and necessity, there has been a shift in philosophy amongst some of the more progressive companies in North America.

In the ongoing quest to increase profitability and establish competitive advantage, today’s savvy executives view lease renewals as a great opportunity to evaluate and review the evolving needs of the business. For companies where location has a tangible effect on the Profit & Loss Statement, it is one of the most critical (if not THE most critical) business decisions that can be made. For most retail and service companies, the lease underpins the value of the business and rarely do companies operate without the need for adjustment for periods that exceed a typical lease term. Without certainty of lease term or functionality of

location, the value of an operation that relies on real estate / location to access customers is greatly diminished, if not eliminated entirely.

Not only is a renewal a great situation to reset and review one of the most fundamental elements of their business’ long term agreement, it affords a tenant the opportunity to re-evaluate market positioning, terms and future growth. Whether its an adjustment of lease terms (size, rent, configuration, additionals, fees, etc.), or the potential to relocate, more companies are taking full advantage of the possible rewards in today’s dynamic environment.

Most leases have a provision whereby the tenant can renew or extend the lease for

a further period of time, typically from 5 to 10 years. Typically a renewal offers the tenant a new lease, while an extension typically keeps the lease “unbroken” and in place.* Depending on how the original lease was crafted, renewals and extensions can be either fixed (whereas upon notification to the landlord, pre-defined lease terms are merely exercised)

or non-fixed / silent (whereby you have an option to extend the term of the lease if you can agree upon the parameters). Lease extensions and fixed options decrease (but do not entirely remove) the tenants ability to address issues.

Following is a list of tips ranging from basic common sense to some more advanced recommendations that have been developed and tested by some of the most knowledgeable real estate experts.

*exceptions apply on leases whereby the tenant has agreed to execute an updated lease.

BEGINNER TIP

KEEP CLOSE TRACK OF YOUR LEASE

EXPIRY AND RENEWAL

NOTIFICATION DATES

BEGINNER TIP

UNDERSTAND THE IMPACT LOCATION

HAS ON YOUR BUSINESS

BEGINNER TIP

EVALUATE AND REVIEW

YOUR LEVERAGE

Keep a lease abstract program with automatic notifications in advance. Keep a backup system for renewals by engaging a third party under NDA. Most renewals require between 6 - 12 months of notice be provided to your landlord. Missing renewal notifications or failing to understand certain nuances when exercising a renewal in tight vacancy markets can be devastating - especially when you occupy high profile locations. This brings us to our next point...

As mentioned, retailers, restaurants, service and many light manufacturing companies are greatly impacted by location. Without well positioned locations and certainty of lease term, the value (and future) of the business is jeopardized. Conversely, options to renew along with well crafted assignment and sublet provisions can provide certainty and flexibility. This in turn increases the broader business value with the reduction of risk.

Your ability as a tenant to impact the outcome of a renewal is almost solely derived from leverage. Understanding both the market factors and those that are applicable to you as a tenant is very important in the process. Understanding, analyzing and then capitalizing on the broad array of factors will go a long way to obtaining a better deal. Even modest savings can have a substantial effect when multiplied over numerous locations.

ADVANCED TIP

USE TIMING

TO YOUR ADVANTAGE

Don’t assume that a landlord cannot be approached at any time or specifically when it suits your purposes. Volatility in market conditions, vacancy rates, interest rates, economic shifts, demographic shifts and the dynamic nature of retail and service companies requires constant attention - and therefore adjustments may be prudent during a lease term. Sometimes landlords approach tenants mid lease in order to procure additional term in order to secure financing,...and the proverbial door swings both ways.

• Vacancy (available options)• Inventory & the economy• Competition for space• Active direct competitors (restaurants)• Desireability of location • Interest rate fluctation* / Financing

• Covenant • Size of company • Desireability of product / service / tenant • Size of occupied space• Tenant mix• Number of locations with landlord

2 ORANGEGROUP.CA | LEASE RENEWALS

ADVANCED TIP

USE RENEWAL WINDOWS TO

EVALUATE YOUR LOCATION IN

RELATION TO YOUR NEEDS

Relatively few companies take the opportunity to regularly review and update their needs and wants in relation to the opportunities at hand. A renewal is a narrow window of time whereby there is increased flexibility on a variety of operational and locational fronts. There are many elements to the review process but we’ll list a few:

• Evaluate your market position. Are there superior alternative locations available?

• Review what is happening in the market. Are the dynamics of the trade area changing?

• Are the quality and quantity of traffic flows shifting? • Evaluate your competitive situation. Where are your competitors positioned?• Evaluate your size in relation to operations. Great time to shed wasted space

and become more efficient. Great time to ask for additional space if you are cramped!

• Is the property suffering from deferred maintenance? Are large chargebacks looming?

• Review your historical costs as well as operating costs? How much have they increased during the last term in relation to your sales? In today’s environment, many businesses are seeing operating costs exceed the pace of revenues yet doing nothing about it.

EXPERT TIP

OUTSOURCE,OUTSOURCE, OUTSOURCE!

More and more firms are outsourcing renewals. It may seem counter-intuitive to let a third party handle something that is so internal and important to a firm’s long term success, but there are several reasons why it’s critical.

First and foremost, when a tenant calls a landlord directly, they instantly tip their hand they are “ready to renew”. At best, it’s like playing for a tie.

Rarely if ever do markets stay completly stagnant for periods of 5 - 10 years so why do 95% of tenants automatically”renew without analysis?

3ORANGEGROUP.CA | LEASE RENEWALS

When I get a call or letter directly from a tenant to renew one of their locations in my property, I typically rub my hands together in anticipation. I immediately know they want to stay and that gives me negotiating leverage. Knowing they want to stay, there’s a good chance we are going to get the rental increase that we’ve budgeted, and typically don’t have to address anything in the lease.

When I get a call or letter directly from a broker or consultant to renew a location, I rub my temples and reach for the stress ball. Not only is my tenant likely to be evaluating and aware of other opportunities, they have far more information at their disposal. What’s even worse is that their agent is often motivated financially to move them to another location which reduces my negotiatng leverage. Knowing that I’m going to have to deal with comparables , market information, potential lease modifications, a review of operating costs, relocation options and a pesky agent, I’m less likely to get automatic increases. Securing new tenancies interrupts my cash flow and can be expensive while financing during renewals is a factor as well.

~VP Real Estate: One of North America’s largest landlords (we guaranteed their anonymity)

4 ORANGEGROUP.CA | LEASE RENEWALS

The (perceived) inability to accurately quantify the difference between a renewal that is negotiated by an internal employee versus an outsource expert can be challenging. As a result, companies are often tempted to allocate renewal negotiations to junior or mid level employees with limited expertise or resources. However, this almost always creates a huge latent expense which is inevitably uncovered when businesses are properly valued. Whilst low risk in theory, the ability to replicate the knowledge, expertise and market knowledge of a firm that specializes in renewals is difficult if not impossible. As we will demonstrate, the resources required to internally amalgamate market data, track comparables, relocation options, understand lease document nuances etc., isn’t worthwhile and far exceeds the cost of retaining an expert.

The Financial Metrics of a Renewal

EXPERT ADVICE

Senior executives are often challenged by the intangible nature of how much value is either created, saved or lost with respect to hiring outside consultants. The same goes for real estate and renewals.

The balance between control, flexibility, departmental overhead, communication, confidentiality, process are all considerations that can make for a difficult decision. As the market becomes more efficient with specialists and all the factors are considered, both the rationale and the math for outsourcing increasingly favors the outsourced model.

THE RATIONALE: Moreso than operations, marketing and finance divisions, work volume in a typical real estate department can fluctuate greatly depending on the period. Periods of high renewal volume and growth are interspersed and cyclical, thereby creating scenarios where staff are either underutilized or overworked (and potentially unable to commit the necessary resources). In an attempt to minimize departmental overhead, many of today’s real estate departments are already understaffed. When significant projects or lease renewals arise, there is little or no time to commit the resources required and (although not immediately or readily apparent), the financial ramifcations

Income fund managers and private equity firms are some of the early adopters to outsourcing as the extra couple points on EBIDTA make the decision worthwhile...

The ability to interally replicate the experience, expertise and market knowledge of outsourcing renewals is difficult if not impossible to achieve.

OVERCAPACITY

5ORANGEGROUP.CA | LEASE RENEWALS

Local Market Expertise will Save you at Least 5%

EXPERT ADVICE

Under this scenario we see the costs are roughly equal between internal and outsourced. This in itself isn’t significant. How about flexibility? Employee turnover (and continuity)? sickness, vacations, abseentism, severance, scalability? This is typically sufficient rationale to tip the scales especially for those firms that seek to be lean, efficient and flexible to outsource. However, private equity firms and fund managers are increasingly seeking to capture value with external results: What can a specialist do and/or use to their advantage?

Company B Potential Rent Renewal Savings on $25 base rent: 5% on $25 = $1.25 * 3,000 sf = $4,000 * 5 years. = $20,000 credit.

.......PER STORE!

Distilling it Down

• Market Rental Comparables• Relocation Opportunities & Options• Vacancy Rate Information• Complimentary Tenant information• Local Market Information & Nuances: such as

transportation changes, demographic shifts, competitor shifts)

• Landlord Information: (financing, motivations, personnel changes... (*see inset)

• Property Information

6 ORANGEGROUP.CA | LEASE RENEWALS

Understanding the market, obtaining comparables, knowing the landlord, understanding their debt structure and objectives, knowing whats happening in the vicinity of the premises, understanding whether the property is suffering from deferred maintenance and knowing about relocation opportunites is all critical. Accumulating a knowledge base on these (and other) elements all play into developing leverage. This leverage is difficult if not impossible to accomplish when your consultant or employee has never been to the site or is located in another country and your likely better off not to outsource. Is it worth paying an extra ten thousand dollars in rent for EACH of the next 5 - 10 years in EACH location so that renewals can be done by one group/person “cheaply and easily”? While getting a “volume deal” for a company to handle reneals “en masse” out of one central office may look appealing, a much larger price is often paid later. Therefore, striking the right balance is important. Here are some recommendations:

Mathematical SummaryBased on our previous example, Company B benefits from added flexilbity, scalability, information and third party expertise. Second, they benefit from a potential $10,000 savings in departmental costs. Finally, they stand to gain rental renewal savings of $20,000 per store after the external consultants are already paid. Based on 20 stores, that amounts to $400,000. Even if this amount for the entire term is aggressively discounted at 10% to present value, the savings exceed $250,000.

Bottom line is that a specialized / outsourced firm has more tools and more resources at their disposal than what could reasonably replicated internally. These tools and resources, combined with the additional 3rd party leverage that can be created, is certain to yield both economic and functional savings. Even if an outsourced consultant is only able to achieve a one percent rental decrease / savings, the scale of the results can have a tremendous impact on EBITDA.

SEEK to hire consultants that: Have experience in renewal programs Have major market coverage AND local market expertise Know the landlords and regularly negotiate with them Allocate senior personnel to your account

AVOID hiring consultants that: Primarily focus on listings/landlords (conflicts of interest) Try to handle renewals remotely from other markets Have one person (or juniors) handling the account Refuse to consider benchmarks & performance bonusing

EXPERT TIP

OUTSOURCE WISELY:

HIRE RIGHT FOR THE SITUATION

Nothing makes me happier than getting a call from some consultant from California trying to negotiate a renewal in Toronto, Canada. It becomes evident very quickly that the tenant has hired someone whose never seen the site, doesn’t know the market and is renewing sites “en masse”... 30% above market is my target but at least I ALWAYS get 10...

Some landlords underestimate the value of renewals as well... which provides an excellent leverage opportunity. Sending in an experienced renewal expert armed with local market knowledge against a junior property manager can often yield very profitable results.

If an outsourced consultant saves even

one percent, the savings for Company B would exceed

FIFTY THOUSAND DOLLARS!

ORANGEGROUP.CA | LEASE RENEWALS

Everything is negotiable. Period.Landlords often have budgets and pre-determined rental extpectations that they wish to achieve. Sometimes in order to get the rental increases, they will give up on other terms. For example, in return for a rental increase, what are you getting? How about an allowance? How about some free rent? How about additional options to renew? Signage rights? Promotional items, options on other space? Experts consider things like this and understand their leverage.

A Little About Us: We provide real estate brokerage, advisory and on-going management services to clients in Canadian markets with a focus on businesses where location has a tangible effect on the P&L. If rent & location is an important factor in your business, we would like to work with you. We increase profitability through market knowledge and expert real estate advice.

We are balanced in our approach whereby we have regional offices in Vancouver, Toronto and Calgary to ensure national consistency and coverage of programs and process. Further, we ensure our clients benefit from local market knowledge in smaller markets with our agent partners in Edmonton, Winnipeg, Montreal and the Maritimes.

Please visit our website at www.orangegroup.ca or call Grant Kosowan at 403 209 4291 for more information or to book a presentation.

EXPERT TIP DON’T ASSUME

NON-RENT ELEMENTS CAN’T BE NEGOTIATED DURING YOUR

LEASE RENEWAL

7

BUSINESS BROKERAGE

COMMERCIAL REAL ESTATE

RESEARCH & DEMOGRAPHICS

T: 403.303.2767 E: INFO@ORANGEGROUP.CA WWW. ORANGEGROUP.CA

We’re asking a $2.00 psf

rent increase

Uh... we don’t normally do

that...

Okay, we’ll take another

allowance!

Okay, since an allowance was amortized onto our

original rent rate we’d like to have a new store

front built for us.

LANDLORD LANDLORD

TENANTTENANT