Hidden costs lurk behind base rent
Tenants tend to have a laser focus on the base or net rent when it comes to negotiating a new store lease. But in reality there are many other charges and fees that can significantly add to the total occupancy cost. Here are six to consider:
1. CAM and operating expenses
Common area maintenance or CAM charges are always a hot-button issue for tenants. Depending on the property, CAM can be a nominal amount, or it can add up to a staggering additional cost. Before signing a lease, prospective tenants should get a detailed breakdown of CAM charges so they can see exactly what is or isn’t included.
Every owner does CAM a little differently. Some landlords may include costs such as insurance and trash removal as CAM, while others charge those separately.
“The bottom line is that CAM is intended to be pass-through costs for tenants and not a profit center for the shopping center owner or manager,” says Spencer Bomar, a principal, retail advisory services at Avison Young in Atlanta. Tenants should negotiate to have rights to audit those CAM costs on an ongoing basis.
Another negotiating point is to push for a cap on how much CAM charges can escalate on a year-over-year basis as an added protection from a sudden spike. Some retailers are willing to leave a little on the table to know that CAM will always be fixed at a certain rate and they won’t be blind-sided by unexpected costs, adds Bomar.
2. ‘Right-size’ the space
An operator may be tempted to jump at a rare opportunity to lease space in a prime location. However, it is important to choose a space that fits the business needs. If a space is 10 percent bigger than the typical footprint, that adds 10 percent to the cost when it comes to the base rent, not to mention an extra 10 percent on other costs such as CAM and taxes. The bigger space also can add to build-out costs and operating costs, such as utilities.
3. Percentage rent
Percentage rent, which is more common among restaurant leases, is an “extra” rent cost that layers on top of the base rent. The premise behind percentage rent is if a landlord does a good job of drawing customers, it creates a win-win for both tenants and landlords and the landlord wants to share in the upside. Generally, the landlord will collect a percentage of gross sales once sales surpass a center set level or breakpoint.
Percentage rent is an important point to negotiate as it can add up very quickly. Tenants need to be well versed in what the natural breakpoint is and how much percentage rent they may end up paying in the event they achieve that level.
“Tenants sometimes pay a windfall in percentage rent, and it is always important to keep the percentage rent factor in line with your all-in occupancy expenses,” says Rachel Rosenberg, an executive vice president in the Los Angeles office of RKF, a real estate brokerage and consulting company. Tenants should run potential scenarios to make sure the combined cost of base rent and percentage rent is sustainable as it relates to overall occupancy cost, she adds.
4. Recycling space
Restaurant operators often believe that moving into a former restaurant space can save them big bucks, because infrastructure and FF&E (furniture, fixtures and equipment) are already in place. However, that is not always the case. Those former restaurant spaces can hold some hidden costs. For example, the existing equipment may be out of warranty or outdated and may need to be replaced.
The best advice is to conduct a site investigation report. A third-party consultant can come in and evaluate existing conditions and the suitability of re-using some or all of the existing systems and equipment in the new operation.
“It might be the best couple thousand dollars that you spend, because it could prevent you from moving forward on a lease, or at least let you know what your budget is going to be so that you can negotiate a different deal or have different financing in place,” says David Orkin, executive vice president and restaurant practice leader, the Americas for CBRE.
5. Buildout requirements
Malls and large shopping centers may have specific criteria related to store design and buildout for tenant spaces. It is important to read that criteria very carefully before signing a lease to avoid any surprises.
“There may be items that the tenant was not anticipating doing in conjunction with the build-out that are required once they sign the lease,” says Adam Cummings, senior vice president and retail occupier mall practice leader for CBRE. For example, some malls might require a tenant to use union labor or adhere to green building standards.
Some spaces might look very “clean” at first glance. However, if that space is 15 or 20 years old, it may need costly upgrades to HVAC, power or plumbing to bring it up to current building codes, adds Cummings.
6. Infrastructure add-ons
Restaurants are increasingly located in vacant space that was originally designed for a retail use. That can create added costs related to adding adequate infrastructure.
Restaurants use more water and plumbing as compared to traditional retailers, such as an apparel or shoe store. For example, some existing retail spaces may not have sufficient sewer capacity allocated. There also can be utility hook-up fees.
Also, restaurants may be required to install and maintain more sophisticated ventilation systems that clean or neutralize food and cooking odors. “Depending on the size of the restaurant, that cost could be $70,000 to $100,000 plus another $10,000 to $15,000 per year to maintain it,” says Orkin.