Retail leasing risks under scrutiny

Running a retail business means running risks, and where leasing is involved these can be downright dangerous. Here is a watch-list, but also 10 tips on how to get the best deal. By MIKE PRESTON.

By Mike Preston

When it comes to leasing retail premises, most SME owners have one of two experiences – tough but workable, or downright terrible.

Joanne Howarth falls into the second category. In 2004, Howarth started negotiations to lease premises for her Arizona Bar and Grill business in the Erina Fair shopping centre on the NSW central coast.

Howarth claims she was told by the owner of the centre that her premises would be located in a thriving town-centre style precinct, with live entertainment and family activities provided to pull customers to the area, and, she says, signed the lease on that basis.

But, Howarth says, the promised entertainment extravaganza she believes she was promised did not eventuate. Customer traffic levels were substantially below those expected.

“From day one there was no traffic flow – some days I wouldn’t see a customer all. I had done my due diligence and believed $50,000 turnover per week was very realistic, but we found ourselves doing $10,000. And we weren’t the only ones, and one-by-one the businesses in the precinct fell over,” Howarth says.

Eventually, after two years of struggle and having lost $2 million in fixtures and rent, she had no choice but to close her doors.

Looking back, Howarth wishes she had written down everything said during negotiations to give her a stronger hand should she decide to take action against the owner of the centre.

But, Howarth says, there is deeper issue that underlies her predicament, and that causes trouble for retail tenants everywhere – a lack of market power.

This basic issue lies at the heart of the various reviews into retail leasing that have been conducted over the years, including the inquiry currently being conducted by the Productivity Commission.

The Productivity Commission has received 139 submissions, most of which are from retail tenants or industry groups, and the same issues come up again and again:

• Turnover information: Tenants are usually required to provide detailed turnover information to the lessor. Shopping centre owners argue this is necessary to help them manage their property, but many retail shop owners believe the information is used to give landlords the upper hand in lease negotiations.
• Longer leases: Different states have different laws on lease terms and renewals, but many tenants believe minimum lease periods no longer leave them with enough time to make back the money they spend on expensive shop fit-outs. The problem is compounded because renewal time is often when landlords impose big rent hikes.
• Guarantees: Retail tenants are often forced to agree to personally guarantee rent sums in order to win a lease, thereby putting not only their business, but also their family home on the line.
• Big shops pay less: The superior bargaining power of large supermarkets means they often pay significantly less rent per square metre than independent retailers.
• High rents: For most tenants, the basic problem they face is high rent. Many tenants argue the rental increases of 100% commonly imposed by landlords only take place because shopping centre owners have an unfair degree of market power.

Underlying each of these complaints is the perception that shopping centre owners exercise superior market power over their tenants. For many tenants, this means lease negotiations involve just one choice – agree to the landlord’s offer, or walk away.

Unsurprisingly, shopping centre owners’ have a different perspective on these issues. Shopping Centre Council of Australia executive director Milton Cockburn accepts that in some cases centre owners will have more power than tenants, but, he says, this is simply a product of normal market operations.

“Everyone retailer wants to get into a shopping centre – rents and other conditions are a function of supply and demand, and if there is very high demand for space then clearly market rents will be pushed up,” Cockburn says.

He believes, in many cases, retailers simply need to accept the fact that they can’t afford to lease the location they want – or when renewing that sometimes it will make more sense for them to walk away.

“A lot of retailers have to be a bit more realistic and say I can’t afford to be there and I’ll look for a cheaper alternative site. No-one has a right to be in a particular centre, and the reality is that there is a lot of competition for places in those high traffic locations,” Cockburn says.

But for retailers, accepting market realities doesn’t make it any easier when you’re on the ground attempting to negotiate that lease. Katherine Sampson, founder of the fast-growing Healthy Habits sandwich franchise, says while her dealings with leasing agents have been conducted in commercial, if robust, fashion, there is no getting around the fact that tenants will usually be price takers in lease negotiations.

“Leasing agents want to get certain rental returns for their centre, and although you might be in a better position if you are bigger or have an established brand, at the end of the day they will tend to have the stronger position, especially if they believe you won’t walk away,” Sampson says.

Sampson’s own experience with leasing as her business has grown is telling. With an established brand name and more than 20 Healthy Habits stores around the country, Sampson says she now finds it easier to get the premises she wants at a price she is prepared to pay. In the early days, however, she had to battle just to get a lease.

“When we first started expanding, the landlords had no idea who we were and wouldn’t give us a lease – we bought 12 businesses in 15 months and converted them to Healthy Habits stores because that was the only way we could get in,” Sampson says. “And we overpaid for those businesses; we had no choice but to pay high prices because it was our only way into the market.”

Which isn’t to say that leasing a retail premises becomes smooth sailing once a business becomes more established. Peter Pitt, a director of the Hype DC footwear chain, says even with an established brand and 19 stores on the east coast of Australia, he still ends up providing turnover data and being hit with big rent increases when leases are renewed.

“We end up paying rent according to our ability to pay, absolutely,” Pitt says. “Once they have your turnover information, lessors know what they can charge before a retailer will walk away, and they will charge you 1% below that tolerance level when you go to renew.”

And, as if paying excessive rents from the business isn’t painful enough, landlords’ power in leasing negotiations also means tenants are often forced to put their personal wealth on the line through personal or directors’ guarantees.

Pitt says he has only managed to avoid providing some sort of guarantee in two of the 19 store leases he has negotiated for the business.

“Landlords are the only ones that get them for one reason: a gigantic lack of equal bargaining power. Each month we would pay our trade suppliers millions, compared to monthly rental of about 30 grand, but none of our trade suppliers get personal or bank guarantees because they have to compete to get their shoes on our wall. To me it is completely unjust,” he says.

So that’s the bad news – but as tough as the situation facing most retail tenants is, there are steps you can take to ensure you get the best deal possible. Retail advocates Peter Macaulay, principal of The Lease Police, and Stephen Spring, chief executive of Australian Retail Lease Management, shared their top 10 tips with SmartCompany.

1. Do your homework: Spend serious time and money researching the location for your business. It needs to be near the people who will be your customers, have the necessary level of traffic and not be choc-a-bloc with competitors. “Retailers often want to lease a place because they live round the corner – but just because it’s convenient that doesn’t mean your customers are there,” Spring says.

2. Consider strip locations as well as shopping centres: Depending on the location, leasing a shop in a strip mall will often be cheaper than one in a shopping centre. Unfortunately, that also means the quality strip locations are often harder to find.

3. Know your leasing market: You need to know what other people in comparable businesses are paying. If you don’t have access to that information, hire someone to negotiate for you who does.

4. Negotiate: It may seem obvious, but Spring says inexperienced tenants will often just accept the first offer put to them by a prospective landlord, especially if they have emotionally committed to a particular site. “You don’t lose anything from haggling – if you are prepared to pay $25,000, first offer them $5000,” Spring says.

5. Be prepared to walk away: Whether it’s your initial lease or a renewal, the only power you have in negotiating a lease stems from your preparedness to walk away. Know what you can afford, and if you can’t get it, move on – even if you haven’t fully paid off your fit-out, spending another five years losing money isn’t going to improve the situation.

6. Know what to ask for: Rent and term may be the most important parts of a lease, but they are just the beginning. For starters, keep in mind: rent reviews and how they work; who pays for repairs, outgoings, fixtures and fittings; what happens if you can’t pay the rent; exclusivity for your business category; what turnover figures you have to provide and when; and options to renew and when they fall.

7. Write everything down, and get lawyers involved before you sign anything: If it matters, write it down, and make sure both sides sign off on it. If it’s not in writing, it doesn’t exist. And once everything is down on paper, get a lawyer to check over your documentation – leases can be as long as 1000 pages, and it can be the two line clause at the bottom of page 762 that makes the difference between business success and failure.

8. Don’t get rushed into renewing: Start thinking about what you will accept in renewal negotiations well in advance. “Landlords will often leave things to the last minute and then try and put the pressure on, but it is usually better to go on to a periodic lease than agree to something you can’t afford,” Macaulay says.

9. Consider hiring a tenants’ advocate: It depends a bit on the negotiations involved, but you can often hire an experienced retail advocate for around $5000, not a huge amount in the context of a $50,000 a year lease.

10. Taking out a lease often means you are buying a job, not an asset: When renewal time comes, expect much of the profitability you have built over the initial term of your lease to be eaten up in rent. A landlord may leave you with enough to pay yourself a decent wage – if you’re lucky – but usually not much more than that.