Renegotiating a Lease

BEA 2005NEW YORK, NEW YORKJUNE, 2005

ABACUS

ABACUS is an initiative to create a benchmark for the measurement of independent bookstore operations.

The numbers generated by the ABACUS study were used to

create…

THE 2% SOLUTION

Discussed an achievable means of moving from negative profitability (loss) to positive profitability (a gain)

Isolated the prime movers affecting profitability

Suggested that progress comes one small step at a time

THE 2% SOLUTION

Identifies four prime factors on which to concentrate:

Sales

Margin

Compensation

Occupancy cost

In this session we’re focusing on Occupancy cost

The “average” bookstore

GM

40.32%

COGS

59.51%

The importance of occupancy cost

Compensation51%

Occupancy21%

Adv/mktg5%

All Other23%

Occupancy cost is a bookstore’s second largest expense

The importance of rentMost of occupancy cost is rent

Rent includes common area maintenance charges, real estate taxes, insurance, etc.

Isn’t Rent a Fixed Cost?

Your rent is determined by your lease, and your lease is a binding agreement between you and your landlord. So yes, rent is a fixed cost.

But…

Your lease is a contract, and given the right set of circumstances, any contract can be renegotiated.

Reasons to Renegotiate a Lease Your current lease is coming due Your rent is significantly higher than

the current market value of your space

Your occupancy cost is higher than the benchmark for profitable bookstores

You can’t afford to pay it

Some general principles of negotiation Know your “opponent”

Plan ahead

Leave room to compromise

Don’t say no, offer alternatives

Give the impression you have other options

Stay cool,don’t be too anxious

Know how to close the deal

Steps to renegotiate a lease

Plan ahead

Do your homework

Make your case

Be realistic

Offer something back

Close the deal

Plan aheadKnow that rent is going to be a problem

before it becomes a problem

Project sales and expenses (P&L) for the coming year

Know your rent for the coming year– check your lease for scheduled rent escalations

Remember to include additions to base rent:– Common area maintenance (CAM) charges – Real estate taxes– Insurance

Calculate how much rent you can afford to pay

Example of a projected P&L statement

Give plenty of notice that you want to renegotiate the lease

No business person likes surprises

Property managers need lead-time to get approval from owners

Giving notice shows you’re a responsible tenant

Leave yourself time for an alternative plan if the renegotiation doesn’t work out

Stay current on your rent leading up to the negotiation

Plan ahead

Do your homework

Talk to real estate brokers and neighboring tenants to find out:

– The market rate for your space– If your landlord has given rent concessions to

other tenants

Collect articles/studies on the retail environment in your area

Find out the vacancy rate in your area– Ask real estate brokers

Plan ahead

Know your lease

Does your lease:– Allow you to sublet all or part of your space?– Give you the right to renew your lease at below

market rent?– Guarantee “quiet enjoyment”?– Include a non-compete clause?

Is your landlord required to:– Preserve a “first class” building?– Carry out regular maintenance?– Keep other retail spaces occupied?– Not disturb your business?

…these points may be critical in your negotiations

Plan ahead

Make your case Approach the negotiation as a partnership

Explain why you want to renegotiate– Focus on causes that are outside your control (e.g.,

a superstore opening)– Focus on causes within the landlord’s control (e.g.,

you’re in a mall that’s gone downhill)

Explain what you’re doing to help yourself– Show your plan to:

• Increase sales• Increase margin• Control compensation

Present your landlord with a concrete plan

Show how much rent you can afford to pay– Use industry benchmarks (ABACUS) to show

how much rent bookstores pay– Use a projected P&L to show how occupancy

costs affect your business

Focus on additions to base rent if these are substantial– Challenge maintenance charges that do not

benefit your space – Ask your landlord to contest real estate taxes if

you think the assessment is too high

Make your case

Suggest ways your landlord might help

Improve the building Do more maintenance Make sure adjoining spaces are occupied Advertise more Enforce non-compete clauses Stop disturbing your business

Make your case

Challenge the methodology for calculating rent escalations– If you have stepped-up rent escalations and think the

step-ups are too steep, ask the landlord to re-consider them or switch you to indexed rent

– If you have indexed rent and think you’d be better off with step-ups, propose a step-up schedule

– If you have indexed rent and think the index is inappropriate, ask the landlord to use a different index

Challenge the landlord’s calculation of the size of your space

Make your case

Landlords don’t like vacant space– Stress how responsible you are being in

addressing the issue before it becomes a “problem”

– Mention the vacancy rate in your area

– Mention the cost of finding a new tenant if your business fails

• Lost rent while the space is vacant• Brokerage fees• Build-out” costs

Make your case

These costs can be substantial

Be realistic

Don’t ask for an unrealistic rent reduction…it makes you look less credible

If your landlord won’t reduce the scheduled rent, ask for a temporary “abatement”

Know whether your problem is temporary or permanent

Offer something backSuggest a percentage rent

arrangement

The advantage of percentage rent– You pay less rent when business is bad

The disadvantage of percentage rent– You pay more rent when business is good

How percentage rent works

Suggest a percentage rent over a higher than natural breakpoint

In a typical percentage rent arrangement, the landlord stands to gain, even when business is relatively flat

One way of compensating for that is to set an unnaturally high breakpoint

Offer something back

How an unnatural breakpoint works

Notes on percentage rent arrangements

Your landlord will have access to your books

Be careful what goes into the definition of “sales”

Offer something back

What to exclude from percentage rent

Suggest “back loading” rent

Advantages of back loading rent– You get immediate rent relief while the landlord

still gets the same amount of rent over the lease term

Disadvantages of back loading rent – If sales don’t improve, you could be facing an

even worse rent problem in a few years time

Offer something back

How back loading works

Offer to give up some space

Allow the landlord to take some space back

Sublease some of your space to a complementary business

Offer something back

The effects of giving up space

Offer to make improvements to your space

The improvements will benefit your store, hopefully increasing sales (and maybe even alleviating your rent problems!)

The improvements will be capital costs not expenses…which means that your cash flow should improve, and your P&L may look better

Remember, you’re only offering to make improvements in exchange for rent relief.

Offer something back

Offer to extend your lease at a new rent– This also gives you an opportunity to re-

negotiate CAM charges, and other terms of the lease

Offer to give up some rights– Renewal rights– The right to not have competing tenants

Offer something back

Close the deal

Don’t allow your landlord to put you off

End your negotiation with clear agreement on all relevant terms

Tell your landlord when you need the new terms to start

Follow up in writing

Get a signed agreement

Steps to renegotiate your lease

Plan ahead

Do your homework

Make your case

Be realistic

Offer something back

Close the deal

Renegotiating your lease

And if you can’t renegotiate your lease but you have a good location that you want to keep…

Think about buying your building

(but that topic will have to wait until a future seminar)

The End!

Thanks for listening!

$ % $ % $ % $ %

Net Sales $1,500,000 100.00% $1,515,000 100.00% $1,530,000 100.00% $15,000 0.99%Cost of Goods Sold $903,150 60.21% $909,000 60.00% $914,175 59.75% $5,175 0.57%Gross Profit $596,850 39.79% $606,000 40.00% $615,825 40.25% $9,825 1.62%Total Compensation $319,337 21.29% $309,670 20.44% $298,950 19.73% -$10,720 -3.46%

Wages & Salaries $278,917 87.34% $270,000 87.19% $260,000 83.96% -$10,000 -3.70%Payroll Taxes $24,062 7.54% $23,220 7.50% $22,400 7.23% -$820 -3.53%

Employee Benefits $15,028 4.71% $15,000 4.84% $15,000 4.84% $0 0.00%Payroll Service $980 0.31% $1,100 0.36% $1,200 0.39% $100 9.09%

Total Other Payroll Exp $350 0.11% $350 0.11% $350 0.11% $0 0.00%Total Occupancy Expense $129,535 8.64% $129,957 8.58% $176,150 11.63% $46,193 35.54%

Rent $103,807 80.14% $103,807 79.88% $150,000 115.42% $46,193 44.50%Repair & Maintenance $9,511 7.34% $10,000 7.69% $10,000 7.69% $0 0.00%

Utilities $15,115 11.67% $16,000 12.31% $16,000 12.31% $0 0.00%Total Other Occupancy Exp $145 0.11% $150 0.12% $150 0.12% $0 0.00%

Advertising/Marketing $31,137 2.08% $32,000 2.11% $32,000 2.11% $0 0.00%Telcommunications $11,469 0.76% $11,000 0.73% $10,000 0.66% -$1,000 -9.09%Professional Services $8,169 0.54% $8,000 0.53% $8,000 0.53% $0 0.00%Office Expenses $21,577 1.44% $20,000 1.32% $19,000 1.25% -$1,000 -5.00%Depreciation $14,584 0.97% $15,000 0.99% $15,000 0.99% $0 0.00%Travel & Entertainment $6,034 0.40% $6,000 0.40% $5,500 0.36% -$500 -8.33%Insurance $9,355 0.62% $9,000 0.59% $8,500 0.56% -$500 -5.56%Interest Expense $9,812 0.65% $10,000 0.66% $9,500 0.63% -$500 -5.00%Credit Card Services $19,515 1.30% $20,000 1.32% $20,500 1.35% $500 2.50%Dues & Subscriptions $6,136 0.41% $6,000 0.40% $5,500 0.36% -$500 -8.33%Freight Out $10,462 0.70% $10,000 0.66% $9,000 0.59% -$1,000 -10.00%Miscellaneous Taxes $6,666 0.44% $7,000 0.46% $7,000 0.46% $0 0.00%Web Expenses $3,800 0.25% $5,000 0.33% $5,000 0.33% $0 0.00%Other Operating Expenses $14,014 0.93% $13,000 0.86% $12,000 0.79% -$1,000 -7.69%Total Operating Expenses $621,600 41.44% $611,627 40.37% $641,600 42.35% $29,973 4.90%

Net Income before Tax -$24,719 -1.65% -$5,627 -0.37% -$25,775 -1.70% -$20,148 358.06%

Projected P&L Statement

Last Year - actual This Year - projected ChangeNext year - projected

Return

Start Date Estimated Cost

. Remainders & sale books Aug-05

. Calendars Sep-05

. Greetings cards/gift wrap Oct-05

$2k fixtures

. Start store favorites display with staff picks Jul-05

. Introduce Book Sense display Jul-05

. Move high margin merchandise to front of store Aug-05

. Upgrade window displays Jul-05 $2k

. Put in planters flanking entryway Jul-05 $1k

. Re-paint entrance lobby, etc. Jul-05 $1k

. Replace carpet Aug-05 $5k

. Re-paint walls Aug-05 $2k

. Replace signage Aug-05 $1k

. Upgrade web site Aug-05 $2k

. Do more in-store events Sep-05 $5k/year

. Introduce newsletter Oct-05 $3k/year

. Do joint promotions with local movie houses Oct-05

. Introduce (ABA's) gift card program Aug-05 $500

Improve store promotion

Other initiatives

PLAN FOR IMPROVING SALES & MARGINS - 2005/06

$5k fixtures$25k inventory

Bring in new, higher margin merchandise

Improve merchandising

Improve outside of store

Improve inside of store

Return

Lost rent(Assuming space is vacant for 6 months)

$30,000

Brokerage fees(Based on the value of a new 10 year lease)

$30,000

Contribution to new tenant's build-out($20 per square foot)

$60,000

TOTAL $120,000

Example of landlord's costs for re-renting a 3000 square foot space at $20 per square foot

The cost of getting new tenants

Return

Return

Sales $1,500,000

Base rent(3000 square feet at $20 per square foot)

$60,000

Natural breakpoint(Point at which base rent is equal to 6% of sales)

$1,000,000

Percentage rent(6% of sales above natural breakpoint)

$30,000

Total rent $90,000

Total rent as a percentage of sales 6.00%

Example6% of sales above a natural breakpoint

How Percentage Rent Works

Next

How an unnatural breakpoint works

Sales $1,500,000Base rent(3000 sq ft. at $20 per sq. ft.)

$60,000

Natural Breakpoint $1,000,000

By negotiating a higher break point, you protect yourself from paying percentage rent on some sales

$1,400,000

Percentage rent(6% of sales above unnatural breakpoint)

$6,000

Total rent $66,000

Total rent as a percentage of sales 4.40%

Example6% of sales above a negotiated breakpoint

Sales $1,500,000

Base rent(3000 square feet at $20 per square foot)

$60,000

Natural breakpoint (8%) $750,000

Unnatural breakpoint(In this illustration, the point at which base rent equals 7% of sales, but could be set at any level)

$857,143

Percentage rent(8% of sales above unnatural breakpoint)

$51,429

Total rent $111,429

Total rent as a percentage of sales 7.43%

Example8% of sales above a breakpoint set at 7% of sales

How an unnatural breakpoint works

Return

Return

Sales of gift cards or gift certificates (so long as the redemptions of the cards or certificates are included)

Recommended exclusions from the

definition of "sales" for the purposes of

calculating percentage rent

Deductions for bad debts

Sales to employees at substantial discounts

Sales of "amenity services" (e.g., ticket sales at low, or no, margin)

Shipping fees charged to customers if these are charged at cost

Merchandise exchanged for returned merchandise

Sales taxes (or any other taxes which are added to the selling price)

Commissions paid to credit card companies

Return

Year 1 Year 2 Year 3 Year 4 Year 5 Total

Store square footage: 3000Projected sales $700,000 $800,000 $900,000 $1,100,000 $1,300,000

Old rent:Rent per square foot $20 $20 $21 $21 $22

Annual rent $60,000 $60,000 $63,000 $63,000 $66,000 $312,000Rent as a percentage

of sales 8.57% 7.50% 7.00% 5.73% 5.08%

New rent:Rent per square foot $16 $18 $20 $24 $26

Annual rent $48,000 $54,000 $60,000 $72,000 $78,000 $312,000Rent as a percentage

of sales 6.86% 6.75% 6.67% 6.55% 6.00%

ExampleRent is re-apportioned over five years to lower rent in the early years

while providing the landlord with the same amount of total rent over the

How Back Loading Rent Works

Return

Old space: Old space:Square footage 5000 Square footage 5000Rent per square foot $20 Rent per square foot $20Rent $100,000 Rent $100,000Sales $1,100,000 Sales $1,100,000Sales per square foot $220 Sales per square foot $220Rent as a percentage of sales 9.09% Rent as a percentage of sales 9.09%

New space: New space:Square footage 3000 Square footage 3000Rent per square foot $20 Rent per square foot $24Total rent $60,000 Total rent $72,000Sales $1,100,000 Sales $1,100,000Sales per square foot $367 Sales per square foot $367Rent as a percentage of sales 5.45% Rent as a percentage of sales 6.55%

Example 1A store gives up 2000 square feet.Rent per square foot remains the

same, and sales are constant

Example 2A store gives up 2000 square feet.

Sales are constant, but rent per square foot increases by $4

Reducing rent by giving up space

(It can make sense even if rent per square foot increases)