October 2009 Franchising World
 
Take advantage of the best tenant market in decades to build stronger franchisees and a solid franchise system.
 
By Stuart Johnson 
  
After 30 years of escalating growth and skyrocketing rents, retail tenants finally have the advantage; both franchisors and franchisees have a lot to gain.
  
Like independent blocks that form the foundation of your company, the future value of your brand may depend on the profitability and, strength of every franchise unit open in your   system. An operator’s site characteristics and lease terms are just as important to a franchisor as they are to the franchisee.
  
Consider a franchisor’s investment in new site development—from lead generation to qualifying prospects—the enormous time and energy invested from their first inquiry to an open unit. Each site should be viewed with a 20-plus- year lifespan, and, possibly under several owners.
  
So, get in the game with your franchisees to meet your longterm, system-wide goals.  
  
Price Per Square Foot—Is That All? 
Obviously, the price rises to the top of the list but, there’s much more to consider. The market in commercial-investment real estate can be defined in many ways; however, the most common is often the least helpful: “What are other spaces renting for in the market?”
  
What’s missing? From the perspective of the landlord, each property has a different debt-to-equity structure that affect its flexibility. Whether the developer is large or small, the landlord’s equity in the specific shopping center will likely define their latitude to modify price.
  
From your brand’s perspective, not all shopping centers are created equal, despite similar characteristics. A nail salon might be a powerful co-tenant to a hair-care concept but may only be neutral to a fitness center, such as Anytime Fitness. Thus, the site’s value to you is subject to the specific benefit to your franchisee’s best customer.
  
Simply defined, the value of your rent investment is equal to the number of cars and prospects brought to the shopping center when those people are most inclined to buy your products or services.
  
Of course, you and your franchisee will keep that trump card close to your vest but, it’s important to impress upon your franchisee that less rent alone can become an expense rather   than an investment if they’re considering a move down the street without the right co-tenants.   
  
Where to Start 
Start with the lease. Know what’s inside and, how those terms impact the long-term value of the franchisee’s business and, by extension, your brand. While there are a lot of moving parts, begin with these five essentials to renegotiate in every exchange:
1. Price per square foot,
2. Tenant improvements,
3. Option/renewal periods,
4. Default notices and remedies, and
5. Assignment provisions.  
  
Collectively, these items significantly affect the value of the business because cash flow and sustainability, become the basis of valuation. If the business does not have a predictable economic structure in a stable location, the future value is in question.
  
Start with a written proposal, identifying each item and, the specific concession you’re seeking, supported with evidence and, the benefits to the landlord. Take the high road in the tone of the letter. It should be engaging and one that reflects a partnership rather than an adversarial list of demands. The quality of your presentation will set the stage for discussion and negotiation. 
  
Price Per Square Foot: State what you’re willing to pay and provide current listings as evidence in comparable properties. Three should do but, be sure to check the landlord’s current listings—if they’re advertising vacancy for less, that’s your first comparable. 
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Tenant Improvements: If the landlord completed those improvements originally, you’ll remind him that your rent paid, over time, reflects that investment and that it’s time to freshen-up the place. It’s good for both of you. On the other hand, if the franchisee invested in the build-out, you’ll argue that it’s the landlord’s turn to reinforce the strength of their tenant to the benefit of all in the shopping center. Again, be specific and research the investment to provide   real numbers.    
  
Option and Renewal Periods: Redefine the terms of the option period. Is the option cancelled if the lease is assigned? How does any default, monetary or non-monetary impact your franchisee’s option to extend the lease and, of course, you want your price defined, never left to market rates. Why? Who will define market at the time of renewal? The landlord can easily force a tenant out in lieu of a more attractive user or, just milk the tenant for $2 to $3 per-square-foot because a wide variance can easily be justified—just enough to increase the landlord’s profitability but not enough to justify a move for your franchisee.  
  
Default Notices and Remedies: Every tenant knows if they didn’t pay rent this month but are you notified of every other default? That’s the ”Black Hole” of non-monetary defaults which could be found in every provision of a 65-page retail lease. Any default should require formal notice and sent only to   the franchisee’s corporate address, with signature required, and copied to the franchisor. Make sure to prevent any delivery to the site by hand, fax or mail. Even if it’s something simple, like disallowed temporary signage, do you want your employees to pick up that fax? 
  
Assignment Provisions: This could be the most impactful provision as it relates to the future value of the franchisee’s business and your brand’s presence in that market. As the franchisor, you may want to assume ownership or convey the interests to a new operator but if the terms and conditions change that could be a deal killer. Aggressive assignment provisions might state that the landlord has the right to cancel the lease upon mere notice of intent to assign, never mind their approval to do so.
  
Does a cured default cancel an ability to assign? Is the cost to assign defined or left open to include reasonable attorney’s fees? These are variables to be kicked out or narrowly defined. Your brand presence and the rent paid are contributing to the landlord’s equity and you deserve the   same opportunity to create equity in your franchisee’s business, reinforcing your brand.  
  
What Else Should You Consider? 
1. Revise your lease rider to address “brand legacy;” too many franchise lease riders concern only trademarks.
2. Negotiate exit clauses or rent concessions if an anchor leaves or a significant loss of tenants occurs in the shopping center.
3. Strengthen exclusivity clauses for your concept.
4. Improve and increase your signage, and obtain greater flexibility using temporary signage and promotional advertising.
5. Rent abatement or “free rent.” This can vary from common area maintenance including property taxes and property insurance to only graduating discounted rent over a period of time.
6. Personal Guarantee. There are many ways to redraw this giant liability. Limit to only six months or to sunset in the option period, among others.
  
All in all, this is a great opportunity to redefine your real estate strategy with a system-wide, long-term view. All too often, site selection and, lease negotiation are left to local brokers who may not understand the specific needs of your brand.

Stuart Johnson, CCIM, is the president of Franchise Real Estate, LLC, the development arm of Anytime Fitness, Inc. He can be reached at 651-438-5012 or  stuart@freadvisors.com  .  

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