Negotiating a Commercial Lease SCORE Chapter One – Washington DC Metro Area washingtondc.score.org 202-619-1000

Negotiating a Commercial Lease SCORE Services SCORE, a national, non-profit Association with over 10,000 volunteers in 364 chapters, is a resource partner of the US SBA. SCORE Chapter One has 50 Mentors, with diverse business and industry backgrounds, across the D.C. Area. SCORE offers the following services: Low-cost workshops - washingtondc.score.org Individual free one-on-one counseling/mentoring Online workshops, tools, and more at www.score.org SCORE teams provide counseling to assist you to: Increase the value of your business Identify and solve operating problems Recognize and capitalize on new business opportunities Develop business plans Find sources and qualify for financing Here are some of the ways that we at SCORE can help you start and grow your business. All your interactions with SCORE are confidential

Disclaimer SCORE does not provide legal advice. The information contained in this presentation is for general guidance on matters of interest only. It is not a substitute for consultation with professional accounting, tax, legal or other competent advisors. Before making any decision or taking any action you should consult a professional.

Richard Rose – SCORE Mentor 40+ Years in Retail Home Furnishings President & CEO - Town House Furniture 30+ Years as a Commercial Landlord B.S. University of Maryland SCORE Certified Mentor for 10 Years

Negotiating a Commercial Lease Workshop Objectives Develop an understanding of the important Terms & Issues in a commercial lease. Develop an understanding of the Process used in negotiating a commercial lease. Develop an understanding of strategies that can Mitigate Risk in a commercial lease.

What type of space are you looking for? Retail Office Industrial Warehouse

Understanding Commercial Rent

Calculating Rent Rent is calculated per square foot - per year. Example: You’re quoted $50 per sq ft for 2,400 square feet = $50 X 2,400 Sq Ft = $120,000 per year or $10,000 per mo. Is this your Total Rent? Probably Not!

Understanding the Terms

Understanding the Terms Result: Triple Net Rent is Base Rent Only!

Understanding the Terms What happens in a Triple Net Lease?

An Example – Rachel’s Bakery Rachel is planning to open a bakery. She’s Looking at 1,200 sq ft in a 32,000 sq ft Center She’s been quoted $40 per sq ft Triple Net – NNN Real Estate Taxes are estimated at $4.00 per sq ft CAM and Insurance are estimated at $7.50 per sq ft What is Rachel’s Total Rent?

Doing the Numbers Triple Net Rent: Real Estate Taxes: 40 per square foot X 1,200 sq ft = $48,000 per year or $4,000 per month Real Estate Taxes: $4.00 estimated per square foot X 1,200 sq ft = $4,800 per year or $400 per month Insurance and CAM Charges: $7.50 estimated per square foot X 1,200 sq ft = $9,000 per year or $750 per month Total Rent = $61,800 per year or $5,150 per mo. What is Rachel’s Potential Risk?

Rachel’s Potential Risk Five (5) Year Lease - $309,000 Ten (10) Year Lease - $618,000 Startup Costs - $238,598 Potential Risk - 5 years $547,598 10 years $856,598 The Take-a-Way! Executing a Commercial Lease is a big deal. There could be serious consequences if you fail.

Estimating Taxes, Insurance & CAM Why are Taxes, Insurance and CAM Estimated? Real Estate Taxes: $4.00 estimated per square foot X 1,200 sq ft = $4,800 per year or $400 per month Insurance and CAM Charges: $7.50 estimated per square foot X 1,200 sq ft = $9,000 per year or $750 per month How is the Exact Amount Calculated?

Pro-Rata Share Tenants Pay Their Pro-Rata Share of Taxes, Insurance and CAM. Calculating Pro-Rata Share - Divide Tenant’s Premises in Square Feet by the Total Square Feet in the Building.

Rachel’s Pro-Rata Share Rachel is looking at a 1,200 square foot space in a 32,000 square foot shopping center. 1,200 32,000 .0375 Rachel’s Pro-Rata Share = 3.75%

Negotiating a Commercial Lease Understanding Taxes & CAM Will the Tenant see the actual Real Estate Tax Bill? Will the Tenant be told what’s included in CAM? Will the Landlord be accountable? Will the Landlord Negotiate these charges? PASS OUT REAL ESTATE TAX AND CAM SCHEDULES

Let’s Look at Rachel’s Taxes and CAM * * * * * * * * * * * * * * * Let’s Look at Rachel’s Taxes and CAM

Common Area Maintenance Summary Clarendon Real Estate Investment Trust Year: 2015 Tenant: Rachel’s Bakery Common Area Maintenance Pro-Rata Share - 3.75% CAM Charges 187,585.39 Administration Fees 15% 28,137.81 Total 215,723.20 Pro-Rata Share-Rachel’s Bakery 3.75% 8,089.62 Amount Paid -9,000.00 Overpaid – Take Credit Next Month 910.38

Tax Summary Real Estate Taxes 142,000.00 Clarendon Real Estate Investment Trust Year: 2015 Tenant: Rachel’s Bakery Real Estate Tax Summary Pro-Rata Share - 3.75% Real Estate Taxes 142,000.00 Legal Fees – Tax Appeals 646.00 Refunds: 2014 Tax Year -735.60 Total 141,910.40 Pro-Rata Share-Rachel’s Bakery 3.75% 5,321.64 Amount Paid -4,800.00 Balance Due – Net 30 521.64

The Leasing Process

Step 1 - Prepare Yourself Engage a SCORE Mentor or Advisor for Help Prepare a Quality Business Plan. Don’t be generic. Write the Business Plan yourself. Identify your value proposition, differentiation, sales goals and projections. Explain your assumptions and your marketing plans for success. Include a detailed schedule of start-up costs. Identify your Source of Funds. Prepare a Personal Financial Statement

Step 2 – Retain a Leasing Agent Your Leasing Agent will: Review your Criteria. Assist in finding a space. Arrange for you to visit spaces. Present your Offer. Negotiate your deal. (The LOI) Be paid by the Landlord.

Step 3 – Retain an Architect & General Contractor Negotiating a Commercial Lease Step 3 – Retain an Architect & General Contractor Before or during the LOI process, you need to consult with an Architect and/or General Contractor. Prepare a preliminary plan drawing. Check out existing systems. Your General Contractor should provide an estimate for build-out costs. Be sure you understand the process and time line for obtaining Building Permits and the Occupancy Permit. What is a reasonable Time Line?

Understanding the Time Line Finding the Right Space 1.0 Month Obtaining Contractor’s Estimate 0.5 Month Negotiating the Deal – the LOI 1.5 Months Negotiating & Executing the Lease 1.0 Months Pre-Lease Execution 4.0 Months - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - Obtaining Architectural Plans 1.0 Month Obtaining Building Permits 2.0 Months Construction Time 2.0 Months Construction Time Line 5.0 Months

Step 4 – Negotiate the Deal Now that you understand the Issues, you’re ready to make an offer. Offers are typically in the form of a non-binding Letter of Intent – LOI - prepared by your Leasing Agent. The Landlord will ask for your Business Plan and Financials. If interested, the Landlord will negotiate the terms of your offer. Your Leasing Agent will negotiate on your behalf.

* * * * * * * * * * * * * * Let’s Look at Rachel’s Letter of Intent

Negotiating a Commercial Lease Letter of Intent 1. The Tenant is a legal entity. 2. Location and size of premises. 3. Use of the Premises. 4. The Non-Compete Clause

Letter of Intent 5. The Lease Term – 3, 5 or 10 years? 6. Base Rent 7. Lease Commencement 8. Rent Commencement Is there a Free Rent Period?

Letter of Intent 9. 3% Rent Increases – What’s the Impact? Year Annual NNN Rent Monthly 1 48,000 4,000 2 49,440 4,120 3 50,923 4,244 4 52,451 4,371 5 54,024 4,502 6 55,645 4,637 7 57,315 4,776 8 59,034 4,919 9 60,805 5,067 10 62,629 5,219

Letter of Intent Percentage Rent 6% Applied to Sales above a Normal Break Point. Monthly Rent divided by 6% = $4,000/.06 = $66,667 in Sales Rachel pays 6% of sales in excess of $66,667 monthly.

Rachel’s Monthly Percentage Rent Rachel’s 2016 Total Sales 6% Rent Over $66,667 Break January 25,000 February 25,000 March 25,000 April 25,000 May 25,000 June 166,667 $6,000 July 25,000 August 25,000 September 25,000 October 25,000 November 25,000 December 166,667 $6,000 Total Sales $583,334 6% Monthly Percentage Rent Total $12,000

Understanding Percentage Rent What if we calculate the Normal Break Point Quarterly? Quarterly Rent divided by 6% - $12,000 / .06 = $200,000 in Sales – The Quarterly Break Point Rachel pays 6% of sales in excess of $200,000 per quarter.

Rachel’s Quarterly Percentage Rent Rachel’s 2016 Total Sales 6% Rent Over $200,000 Break January 25,000 February 25,000 March 25,000 April 25,000 May 25,000 June 166,667 $1,000 July 25,000 August 25,000 September 25,000 October 25,000 November 25,000 December 166,667 $1,000 Total Sales $583,334 6% Quarterly Percentage Rent Total $2,000

Letter of Intent 11. Real Estate Taxes & CAM. 12. Option to Extend. 13. Utilities – separately metered. 14. The Condition of the Premises. Tenant’s Work. 16. Tenant Improvement Allowance. How is it paid?

Letter of Intent 17. Exterior Signage The Initial Deposit 19. The Security Deposit 20. The Personal Guaranty 21. Radius Restriction

Negotiating a Commercial Lease Letter of Intent Lease Preparation Brokerage LOI Disclaimer - The LOI is a Non-Binding Agreement only when it includes a Disclaimer. If the parties agree to the terms of the Letter of Intent, the Landlord will instruct his Attorney to prepare a Lease Agreement.

Step 5 – Lease Execution . . . Engage a Lawyer The Lease Agreement is prepared by the Landlord’s attorney in favor of the Landlord. The terms of the LOI will be incorporated into the Lease. Your attorney will review the Lease. Your responsibility is to read the Lease completely, understand it, and ask for changes in your favor. Prepare for Success and Failure.

Additional Lease Issues The Assignment & Sub-Let Clause The Transfer of an Interest in your business is an Assignment. An Assignment or Sub-Let will almost always require Landlord’s Permission. This clause is particularly important if you plan to bring others into your business. The Assignment Clause is even more important if your business is in financial distress.

Additional Lease Issues

Questions?

Richard Rose, SCORE Mentor Resource Listing Richard Rose, SCORE Mentor richard.rose@scorevolunteer.org Score National: www.score.org Score Local: www.washingtondc.score.org SBA: www.sba.gov