Negotiating a Commercial

Lease

SCORE Chapter One – Washington DC Metro Area

washingtondc.score.org 202-619-1000

SCORE Services

SCORE, a national, non-profit Association with over 10,000 volunteers in 364 chapters, is a resource partner of the US SBA. SCORE Chapter One has 50 Mentors, with diverse business and industry backgrounds, across the D.C. Area.

SCORE offers the following services:

• Low-cost workshops - washingtondc.score.org

• Individual free one-on-one counseling/mentoring

• Online workshops, tools, and more at www.score.org

SCORE teams provide counseling to assist you to:

• Increase the value of your business

• Identify and solve operating problems

• Recognize and capitalize on new business opportunities

• Develop business plans

• Find sources and qualify for financing

Disclaimer

• SCORE does not provide legal advice.

• The information contained in this presentation is for general

guidance on matters of interest only.

• It is not a substitute for consultation with professional

accounting, tax, legal or other competent advisors.

• Before making any decision or taking any action you should

consult a professional.

Richard Rose – SCORE Mentor

40+ Years in Retail Home Furnishings

President & CEO - Town House Furniture

30+ Years as a Commercial Landlord

B.S. University of Maryland

SCORE Certified Mentor for 10 Years

Workshop Objectives

• Develop an understanding of the important

Terms & Issues in a commercial lease.

• Develop an understanding of the Process used

in negotiating a commercial lease.

• Develop an understanding of strategies that can

Mitigate Risk in a commercial lease.

What type of space are you looking for?

Retail

Office

Industrial

Warehouse

Understanding Commercial Rent

Calculating Rent

Rent is calculated per square foot - per year.

Example: You’re quoted $50 per sq ft for 2,400 square feet =

$50 X 2,400 Sq Ft = $120,000 per year or $10,000 per mo.

Is this your Total Rent? Probably Not!

Understanding the Terms

Understanding the Terms

Result: Triple Net Rent is Base Rent Only!

What happens in a Triple Net Lease?

Understanding the Terms

An Example – Rachel’s Bakery

Rachel is planning to open a bakery.

She’s Looking at 1,200 sq ft in a 32,000 sq ft Center

She’s been quoted $40 per sq ft Triple Net – NNN

Real Estate Taxes are estimated at $4.00 per sq ft

CAM and Insurance are estimated at $7.50 per sq ft

What is Rachel’s Total Rent?

Doing the Numbers

Triple Net Rent:

• 40 per square foot X 1,200 sq ft =

• $48,000 per year or $4,000 per month

Real Estate Taxes:

• $4.00 estimated per square foot X 1,200 sq ft =

• $4,800 per year or $400 per month

Insurance and CAM Charges:

• $7.50 estimated per square foot X 1,200 sq ft =

• $9,000 per year or $750 per month

Total Rent = $61,800 per year or $5,150 per mo.

What is Rachel’s Potential Risk?

Rachel’s Potential Risk

Five (5) Year Lease - $309,000

Ten (10) Year Lease - $618,000

Startup Costs - $238,598

Potential Risk - 5 years $547,598

10 years $856,598

The Take-a-Way!

Executing a Commercial Lease is a big deal.

There could be serious consequences if you fail.

Estimating Taxes, Insurance & CAM

Real Estate Taxes:

– $4.00 estimated per square foot X 1,200 sq ft = – $4,800 per year or $400 per month

Insurance and CAM Charges:

– $7.50 estimated per square foot X 1,200 sq ft = – $9,000 per year or $750 per month

How is the Exact Amount Calculated?

Why are Taxes, Insurance and CAM Estimated?

Pro-Rata Share

Tenants Pay Their Pro-Rata Share of Taxes, Insurance and CAM.

Calculating Pro-Rata Share -

Divide Tenant’s Premises in Square Feet by the Total Square Feet in the Building.

Rachel is looking at a 1,200 square foot space

in a 32,000 square foot shopping center.

1,200 32,000 .0375

Rachel’s Pro-Rata Share = 3.75%

Rachel’s Pro-Rata Share

Will the Tenant see the actual Real Estate Tax Bill?

Will the Tenant be told what’s included in CAM?

Will the Landlord be accountable?

Will the Landlord Negotiate these charges?

Understanding Taxes & CAM

* * * * * * * * * * * * * * *

Let’s Look at Rachel’s

Taxes and CAM

Common Area Maintenance Summary

Clarendon Real Estate Investment Trust

Year: 2015 Tenant: Rachel’s Bakery

Common Area Maintenance Pro-Rata Share - 3.75%

CAM Charges 187,585.39

Administration Fees 15% 28,137.81

Total 215,723.20

Pro-Rata Share-Rachel’s Bakery 3.75% 8,089.62

Amount Paid -9,000.00

Overpaid – Take Credit Next Month 910.38

Tax Summary

Clarendon Real Estate Investment Trust

Year: 2015 Tenant: Rachel’s Bakery

Real Estate Tax Summary Pro-Rata Share - 3.75%

Real Estate Taxes 142,000.00

Legal Fees – Tax Appeals 646.00

Refunds: 2014 Tax Year -735.60

Total 141,910.40

Pro-Rata Share-Rachel’s Bakery 3.75% 5,321.64

Amount Paid -4,800.00

Balance Due – Net 30 521.64

The Leasing Process

Step 1 - Prepare Yourself

Prepare a Quality Business Plan.

• Don’t be generic. Write the Business Plan yourself.

• Identify your value proposition, differentiation, sales goals and projections.

• Explain your assumptions and your marketing plans for success.

• Include a detailed schedule of start-up costs.

• Identify your Source of Funds.

Engage a SCORE Mentor or Advisor for Help

Prepare a Personal Financial Statement

Step 2 – Retain a Leasing Agent

Your Leasing Agent will:

Review your Criteria.

Assist in finding a space.

Arrange for you to visit spaces. Present your Offer. Negotiate your deal. (The LOI) Be paid by the Landlord.

Step 3 – Retain an Architect & General Contractor

• Before or during the LOI process, you

need to consult with an Architect and/or

General Contractor.

• Prepare a preliminary plan drawing.

• Check out existing systems.

• Your General Contractor should provide

an estimate for build-out costs.

• Be sure you understand the process and

time line for obtaining Building Permits

and the Occupancy Permit.

• What is a reasonable Time Line?

Understanding the Time Line

• Finding the Right Space 1.0 Month

• Obtaining Contractor’s Estimate 0.5 Month

• Negotiating the Deal – the LOI 1.5 Months

• Negotiating & Executing the Lease 1.0 Months

• Pre-Lease Execution 4.0 Months

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - -

• Obtaining Architectural Plans 1.0 Month

• Obtaining Building Permits 2.0 Months

• Construction Time 2.0 Months

• Construction Time Line 5.0 Months

Step 4 – Negotiate the Deal

• Offers are typically in the form of a non-

binding Letter of Intent – LOI - prepared

by your Leasing Agent.

• The Landlord will ask for your Business

Plan and Financials.

• If interested, the Landlord will negotiate

the terms of your offer.

• Your Leasing Agent will negotiate on

your behalf.

Now that you understand the Issues,

you’re ready to make an offer.

* * * * * * * * * * * * * *

Let’s Look at Rachel’s

Letter of Intent

Letter of Intent

1. The Tenant is a legal entity.

2. Location and size of premises.

3. Use of the Premises.

4. The Non-Compete Clause

Letter of Intent

5. The Lease Term –

3, 5 or 10 years?

6. Base Rent

7. Lease Commencement

8. Rent Commencement

Is there a Free Rent Period?

Letter of Intent

9. 3% Rent Increases – What’s the Impact?

Year Annual NNN Rent Monthly

1 48,000 4,000

2 49,440 4,120

3 50,923 4,244

4 52,451 4,371

5 54,024 4,502

6 55,645 4,637

7 57,315 4,776

8 59,034 4,919

9 60,805 5,067

10 62,629 5,219

Letter of Intent

10. Percentage Rent

6% Applied to Sales above a

Normal Break Point.

Monthly Rent divided by 6% =

$4,000/.06 = $66,667 in Sales

Rachel pays 6% of sales

in excess of $66,667 monthly.

Rachel’s 2016 Total Sales 6% Rent Over $66,667 Break

January 25,000

February 25,000

March 25,000

April 25,000

May 25,000

June 166,667 $6,000

July 25,000

August 25,000

September 25,000

October 25,000

November 25,000

December 166,667 $6,000

Total Sales $583,334

6% Monthly Percentage Rent Total $12,000

Rachel’s Monthly Percentage Rent

Understanding Percentage Rent

What if we calculate the Normal

Break Point Quarterly?

Quarterly Rent divided by 6% -

$12,000 / .06 = $200,000 in Sales –

The Quarterly Break Point

Rachel pays 6% of sales in excess

of $200,000 per quarter.

Rachel’s Quarterly Percentage Rent

Rachel’s 2016 Total Sales 6% Rent Over $200,000 Break

January 25,000

February 25,000

March 25,000

April 25,000

May 25,000

June 166,667 $1,000 July 25,000

August 25,000

September 25,000

October 25,000

November 25,000

December 166,667 $1,000

Total Sales $583,334

6% Quarterly Percentage Rent Total $2,000

11. Real Estate Taxes & CAM.

12. Option to Extend.

13. Utilities – separately metered.

14. The Condition of the Premises.

15. Tenant’s Work.

16. Tenant Improvement Allowance.

How is it paid?

Letter of Intent

17. Exterior Signage

18. The Initial Deposit

19. The Security Deposit

20. The Personal Guaranty

21. Radius Restriction

Letter of Intent

22. Lease Preparation

23. Brokerage

LOI Disclaimer -

The LOI is a Non-Binding Agreement

only when it includes a Disclaimer.

Letter of Intent

If the parties agree to the terms of the Letter of Intent,

the Landlord will instruct his Attorney to prepare a

Lease Agreement.

Step 5 – Lease Execution . . . Engage a Lawyer

The Lease Agreement is prepared by the

Landlord’s attorney in favor of the Landlord.

The terms of the LOI will be incorporated

into the Lease.

Your attorney will review the Lease.

Your responsibility is to read the Lease

completely, understand it, and ask for

changes in your favor.

Prepare for Success and Failure.

Additional Lease Issues

The Assignment & Sub-Let Clause

• The Transfer of an Interest in your business is

an Assignment.

• An Assignment or Sub-Let will almost always

require Landlord’s Permission.

• This clause is particularly important if you plan

to bring others into your business.

• The Assignment Clause is even more important

if your business is in financial distress.

Additional Lease Issues

Questions?

Resource Listing

Richard Rose, SCORE Mentor

richard.rose@scorevolunteer.org

Score National: www.score.org

Score Local: www.washingtondc.score.org

SBA: www.sba.gov