Expert: Jim Avancena, CPM - 4/3/2008

Question
Hi Jim,
I am looking at renting retail space in northern new york (40,000 pop) in a plaza setting (total plaza 200,000 sf).  Let's say a dozen or so stores, one good anchor, and a stagnat market.  I wish to include renewal options in my initial lease agreement and from  1st to second term (5 years), base rent increased 19.3 ( and the base was on the higher end to begin with)...plaza has 3 empty store fronts.  Common fees are, to my knowledge, not measurable at options exercise or atleast not firm...any idea on industry standards for rent increases (given the little info I have provided)...should it not be based on the change in the CPI?

Answer
Larry-

If the market is "stagnant" as you have described, I would expect that you have great latitude in the terms that will be considered by your landlord - previous "industry standards" are significantly compromised when the landlord is struggling to lease his vacant spaces.  

The first thing you should do is check on the Internet for articles appearing in the last 8 to 10 months that discuss the projections by the experts in your market area for increasing or decreasing vacancy in the retail market for plaza setting retail space.  Is your area expected to increase or decrease its employment in the near future? Is your landlord a large institution that will continue to have vacancies rather than accept lease transactions that are below his pro-forma rental projections?  Do you intend to ask the landlord to spend his money to make improvements to your rental space?  Commercial realtors will likely be marginally more optimistic than the actual market realities.  Considering all types of these lease factors will tell you how to position yourself in the negotiations.

If you have a history of being a strong retail operation and your landlord evaluates your credit strength as high, you should have a strong position.  Evaluate what you have to offer the landlord objectively, and determine how much your landlord will do to do this lease with you.  Does your business develop traffic at the plaza, or will it make other retailers want to lease the other vacant spaces?  Is there another shop that provides a similar product? Etc.

Regardless of what you may have paid overall for rent in the past, you must negotiate rental terms for a future term that reflect the realities of the economy and rental market at the time of renewal.  19.3 percent has nothing to do with rent in the next term.  If the strength of the retail market has weakened do not let the landlord use previous market rent as a base and refuse to discuss a rental base that is lower for the next term.  It is always best to have renewal terms stipulated to be at Fair Market Rental Terms using the three (3) appraiser (or broker) method to establish Fair Market terms no less than one year prior to the termination date of the initial lease term.

Additionally, the base rental rate must be determined in relation to the escalation terms the landlord seeks.  If you will be expected to pay for CAM expenses each year, be certain to consider the economic impact of the CAM expense when combined with your base rental.  I suggest that you request a limit on the amount of increases in real estate tax and CAM cost each year.  The same is applicable if your landlord asks for a CPI basis for an annual base rent escalation. Request a CAP on the amount the CPI increase can be for any single year in the term.   

As our economy continues to weaken, you should try to cap the amount of an increase for any single year of the lease term in the base rent at no more than two (2%) percent, and ask the landlord to consider 1.5%.    I would  accept whatever the real estate tax increase is each year without limitation, but would accept no more than a five (5%) percent increase in CAM expense in any one year.  

I am very concerned about the economy at this time.   Many commercial lenders have refused to honor loan commitments they have made previously with commercial property owners claiming that the changes in the economy and limited available capital make it impossible to honor certain lending commitments.   I doubt however, that your landlord will allow you to include such an escape provision in your lease!

The gravity of the developing economic problems in our country allow you to ignore previous industry standards. It would be wise to start any negotiations early so you have time to identify alternative options if the landlord chooses to be unrealistic.

I hope I have provided you with the kind of information you were seeking.  Send me a follow-up if I can give you an answer that is focused on another aspect of your lease.  Best of luck in your efforts.

-Jim Avancena