Negotiating a Lease Part 3

I wanted to continue to post on topics which will materially benefit potential cafe owners and especially baristas hoping to own their first shop. I can't think of any topic which is more important to the success of a coffee shop than negotiating your lease. I have already posted a couple of times with some helpful hints, but believe the spreadsheet I have created will greatly benefit coffee shop owners and arm them with the same tools landlords have in their arsenal.
Basically the spreadsheet measures the landlords costs and income related to the lease, and the tenants potential costs related to the lease. When a tenant enters asking price and other inputs they should be able to determine how much room the landlord has to negotiate which ultimately benefits the tenant (good guys). There are some terms which I should explain in more detail.
NPV is short form for Net Present Value. Net Present Value is the total value of the lease added, then each year multiplied by a factor related to the expected rate of inflation. This factor is available from a Net Present Value table similar to the one following.

The reason NPV is useful is it represents a value today to the tenant and conversely the landlord. On the landlord's side we would make the factor the expected rate of inflation plus the desired return. The difference between the tenants and landlords NPV is the negotiating room.

If you would like a copy of the spreadsheet, please let me know through the comments and I'll email it to you. In the interim I'll try to figure out how to make it available for download. Try entering numbers from listings of commercial space from online listings in your area and get a feel for the numbers landlords use to skew deals in their favour. I have made the calculations assuming a constant rate of inflation of 4% which may need to be adjusted over time. The key of this whole exercise is to realize that the landlords have these tools and they understand them fully in order to determine how to make you pay as much as possible. Get tough, learn everything you can about how your landlord thinks, and save yourself tens of thousands of dollars. Commercial Real Estate agents are reluctant to share these numbers with you since effectively their compensation is based on getting you to pay as much as possible as well, but ask your agent to prepare a similar breakdown for you. Let me know whether this is useful or not.
Good luck.

Tenant Allowance (Landlord Contribution)

I've alluded to this in a couple of posts relating to negotiating a lease, and controlling costs but I felt it required a post of it's own given the considerable funds that can be saved.
When negotiating a lease it is customary to ask the landlord for a tenant allowance in order to make changes and alterations to the space and make it more suitable for cafe use. A tenant allowance is normally valued at certain value per square foot/metre and is negotiable. Using a figure of 10-20% of the total value of the lease over 5 years is a good rule of thumb. I have been fortunate enough to benefit from $30 per square foot allowance adding up to over $32,000 on one build.

For example:
Let's say I'm looking at a 1000 square foot space that costs $20 per square foot plus $5 in CAM costs. The space costs me $25,000 per year in rent multiplied by 5 years = $125,000. Using this as a guideline, it is not unreasonable to ask for $12,500-25,000, or $12.50-$25 per square foot in tenant allowance.

Some landlords are extremely frugal in offering an allowance and in these cases it is best to walk away from the space. Recently I was informed that Starbucks received a $75 per square foot tenant allowance on a new build in Canada. (I don't want to be more specific because the info is confidential and could get my buddy in trouble) For a typical 1000 square foot build, that equals a contribution of $75,000 to improving the space for use. Anyone who has undertaken a new build understands how far 75k goes, and is a significant advantage weighing in Starbucks favour when trying to compete with them.
Chain wide the allowance granted to Starbucks is huge and could represent a $1,500,000,000 off balance sheet gift to the company. Given these depreciating assets are not paid for by Starbucks they are not on their balance sheet, certainly something to be concerned about if you're an investor in SBUX.
Remember the importance of reducing the depreciable assets appearing on your balance sheet (SBUX has), since it usually represents a 20% loss per year on your income statement, and having a healthy income statement is how your make money.

Negotiating a Lease Part 2

I wanted to provide an important update to my Negotiating a Lease post. The inspiration for this was provided by an old friend who suggested I structure a new lease offer differently in order to reduce depreciable long term assets in the form of leasehold improvements on the balance sheet in favour of rent which is expensed. The math goes like this:

Lets say we're looking at leasing a 2000' space for $20 per square foot and the space requires $100,000 in leasehold improvements. The rent on this space would equal $40,000 per year. If we're working from a 5+5 year lease, the improvements represent $5 per square foot over the course of 10 years. As mentioned in my first post on Negotiating a Lease, landlords sometimes offer tenant allowances for leasehold improvements and in this case asking for a $50 per square foot allowance covers the improvements. This is relevant because having the landlord pay for the improvements allows us to keep it off our balance sheet as a long term asset which we must depreciate over 5 years. By paying a little bit more per month over 10 years, you have effectively financed your build, avoided having long term debt and long term assets on the balance sheet, and instead structured it as an expense that reduces our tax at the end of the year.
Win, win, win.

What Went Wrong (with my lease negotiations)

Last week things went sour in my effort to obtain a lease for a third location in the downtown area of my hometown. I want to share with you my experience to show you that even when you make every effort to do things right, they can go wrong.
I have been looking for a third retail location for quite some time, with my primary focus on the downtown area of my city. This past summer I was approached by a landlord who had a corner space available, which I rejected it because the space required extensive renovation. I did however notice that there was a space in the same building that was of interest to me and asked the landlord if that spot was available. I suggested that he speak with the occupant to determine if they would be interested in selling the location (equipment and leaseholds) to me. I didn't hear back from the landlord so I moved on.
In late November I noticed a For Rent sign appeared in the window of the business I had asked about and immediately contacted the landlord to view the space. That very day I had a handshake agreement to purchase the equipment and leaseholds for $35,000. I viewed this as an excellent price for:

1. walk in refrigerator
2. double glass door cooler
3. double glass door freezer
4. single glass door cooler
5. large gas convection oven
6. gas grill
7. gas cooktop
8. gas stove
9. gas soup stock pot units
10. commercial dishwasher
11. cabinetry
12. flooring
13. 2 handicap washrooms
14. tables
15. health unit approval to use the space.

The main caveats were that I obtain a 30 day fixturing period to begin once I had a signed lease document, and that I obtain clear title to the equipment and fixtures. I asked my lawyer to put the verbal agreement into writing and submit an offer to lease based on my discussions with the landlord. Rather than negotiate the offer, their lawyer suggested we negotiate a lease document to save time which I agreed to. The month of December I waited on a document from the landlord which I could review and make changes to. When the document arrived, I made the changes I required and sent it back for signing. Early in the New Year after two weeks of no contact with the landlord's lawyer, I was informed that he didn't wish to sign a lease, but wished us to purchase the equipment and simply take possession and pay rent based on a verbal agreement. As I made clear in my post about Leasehold Improvements, those costs remain with the space after the tennant leaves. Given the landlord was refusing to provide a signed lease document, all of the money attached to leaseholds, as well as the money that would be spent on installation of equipment, would be lost should the landlord decide he wanted the space vacant in 60 days. While I could take the equipment with me, it is worthless unless I have a viable location to house the business.
Given the refusal of the landlord to provide a lease, I chose to pass on this location and keep looking. I remain disappointed because the space was ready to go with very little additional money required, and it afforded us an opportunity to bake and prepare our own food to be supplied to our other locations.
The main thing I hope to share is that no matter how many benefits a location offers, if there is a significant problem, walk away. In my case, the possibility that I could be evicted on 60 days notice wasn't worth the benefit of purchasing the leaseholds and equipment so cheaply.