Path of lease persistence

July 13, 2004

Few documents are more befuddling than a commercial property lease. But in the same way that fences make good neighbors, a well-written and clearly understood lease forms the boundary of a beneficial relationship between a pizza operator and a landlord. Without it, liabilities and obligations aren't clear and ultimately somebody loses — typically not the landlord.

Every lease is different, too, said Wayne Bridgeford, vice president of the retail group at Grubb & Ellis, a Houston-based real estate brokerage. Lessee beware, added Bridgeford: Every first-draft lease favors the landlord heavily. So make the deal as fair as possible and as quickly as you can by hiring a real estate attorney to scrutinize the lease.

"Don't have a regular attorney look at it, have a real estate attorney look at it," he said. "It's not inexpensive, but once you figure up the cost of mistakes and lawsuits, getting an attorney beforehand isn't quite that expensive. Lawsuits, however, are expensive."

Peter Cooperstein, president and CEO of seven-unit Amici's East Coast Pizzeria, called real estate attorneys "a tremendous help. You never want to do a lease without one." Navigating the

What's Important

Every pizza operator considering a lease agreement should hire a real estate attorney to scrutinize the lease before signing it.

Everything is negotiable in a lease, so be prepared for the give-and-take game. Use a real estate broker to lead you through the battle.

Experts say a pizza operation's total occupancy costs should not exceed 10 percent of gross sales. They also say no more than 7 percent of gross sales should go to rent.

linguistic loops of real estate agreements is not his strength, he said. "The lawyers just know so many things most operators don't. No doubt, it's money well spent to have an attorney help you."

In addition to having a lawyer comb through the lease's legalities, hiring a real estate broker to negotiate a favorable agreement is crucial, too. Bridgeford said this game of give-and-take between both parties is not only normal, the landlord expects it, and brokers are skilled referees in this arena.

"If you send the lease back without changes, he knows you don't know what you're doing," Bridgeford said. "There are things in the lease he expects will be deleted and other things he expects will be added."

Since both parties are approaching the agreement with the goal of making money, it's expected they'll represent fairly divergent viewpoints early on in the negotiations. And while the broker ultimately represents the lessee's interest, his job is to bring the two parties to a reasonable agreement under which both can make money.

"The broker is good for (telling the operator) to ask for this amount of improvement to the building, or to say he shouldn't put up with a particular clause that might cost too much," Cooperstein said. "Their experience is really helpful, and they often pick up on things the lawyer didn't catch."

Brokers are especially helpful in foodservice lease deals, Bridgeford said, because they know to look for — and sometimes recommend — industry-specific concerns such as odor clauses (especially in cases where wood-burning ovens are used), or provisions for grease traps.

The broker also helps pace the deal, helping the operator stay on top of reading and signing documents as the landlord presents them, and reducing any tensions that may brew between the parties. Sometimes that means serving as an expediter, keeping both parties focused on addressing the many documents flowing back and forth.

Cooperstein said the smart operator turns the paperwork around as quickly as possible in order to keep the deal moving.

"As much as possible, don't be at fault on your end," said Cooperstein, whose restaurants are located in and around San Francisco. "Don't be afraid to pursue the landlord and say, 'Hey, I haven't heard from you in a couple of days. How's the lease coming?' "

Rent 101

Though no two leases are alike, the majority of restaurant agreements address monthly rental charges in two basic ways: base rent and percentage rent.

Base rent is pretty simple: a flat rate paid monthly for the term of the lease.

Percentage rent is a rate based on a percentage of the restaurant's gross sales (defined as sales for food and beverages sold on premises minus taxes, comps and discounts).

Commonly a landlord is paid a combination

start quoteDon't have a regular attorney look at it, have a real estate attorney look at it. It's not inexpensive, but once you figure up the cost of mistakes and lawsuits, getting an attorney beforehand isn't quite that expensive. Lawsuits, however, are expensive.end quote

-- Wayne Bridgeford,
Vice President, Grubb & Ellis

of the two, meaning an operator will pay his base rent, say $5,000 a month, plus 5 percent of all sales above an agreed-upon number (such as $100,000 in monthly sales) called the breakpoint. In such an arrangement, an operator who posts sales of $110,000 ($10,000 beyond the breakpoint) in a particular month will pay the landlord $5,500 in total rent ($5,000 base rent + 5% of $10,000 = $5,500).

If possible, Bridgeford and Cooperstein advise operators to avoid paying percentage rent, but both said paying some percentage rent is not all bad. Not only can paying the landlord that little extra make the difference between landing a great location and losing it, a good landlord will reinvest that money back into the pizzeria to spur sales even further.

"If they just get a flat rate, then they don't have the same incentive to help increase your business. But paying percentage rent puts the landlord and the operator on the same team," Cooperstein said. "If he sees your business growing, he might say, 'Can we give you some more outside seating?' That's good for everybody because then he's trying to get your sales up."

If the landlord insists upon a percentage rent payment, make sure the breakpoint's as high as possible, Bridgeford said. "Get it as high as you can, so if you do go over that, you'll be glad to pay it to the landlord because that means your business is doing very well."

What's a reasonable amount of rent to pay? Since rates vary widely from market to market, a good rule of thumb is 6 percent to 7 percent of gross sales, according to "Avoid a Leasing Horror Story," a report published on and co-authored by Jim Laube and Movses Shrikian. According to the authors, "As rent payments exceed the 6 percent of sales benchmark, a restaurant's prospects for adequate profit and return on investment begin to deteriorate."

Don't be surprised

An operator needs to be aware of his total cost of occupancy, not just rent. That means the lessee is responsible for what are commonly called "triple net charges," which include property taxes, building insurance and common-area maintenance fees (called "CAM"). Your real estate broker should be helpful in defining reasonable CAM charges, and a little straw polling in the neighborhood to see what others are paying for CAM charges is wise. The goal is to avoid turning CAM charges into a landlord profit center by negotiating a reasonable contribution to the cause.

Overall, Laube and Shrikian believe total occupancy costs should not exceed 10 percent of projected sales.

Topics: Financial Management , Operations Management

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