Expert: Jim Avancena, CPM - 2/3/2009

Question
Hi,
We just bought a small retail shopping center with 4 commercial units.  The lease on one of the units is expiring in May 2009.  The tenant has been there for long time (20 yrs) and we would like him to continue.  However he's not sure if he wants to sign another lease, sell his business or just close shop.  We want to work him, however we would like him to make his decision sooner than later.  So my questions are
1. How long should we give him to make his mind. (his current lease expires in May 2009).
2. Should we offer him short term lease? If he decides to sell his business, a longer term lease may be more attractive for the new buyer.
3. In the new lease, should we have any specific clauses in case he sells his business?
4. And lastly, we would want to base our rent increases on CPI, can we add a percentage on top of CPI? is this prevalent in the leases? and how much is standard?

Thanks for taking the questions.

Answer
Dan-

The answer to your questions depends heavily upon how strong the retail leasing market is for the space your tenant occupies.  Given the economy, I would make a decision based on the strength of the market for you to release the vacant space.  

My understanding is that retail space is in critical condition everywhere.   However, a difficult economy is not well suited to a worn out retailer.   It will take hard work to hustle and sell in the near future.

I would tell your tenant that you have no choice but to start marketing his retail space immediately.   Tell your tenant that your door is open, and that he/she should contact you if they make a decision on renewing, closing, selling, etc.

Be open and honest with your tenant, but you cannot wait a day longer to start marketing the space!  Put up, or order a "Lease" sign TODAY.

Again, base the term you will offer your existing tenant on the strength of the demand for the retail space.  The most important thing is to assure the next tenant has a good credit history, they know how to market what they sell, and to have someone in that space paying you rent so you can pay your mortgage until you pass by the coming recession/depression.

If you do enter into another lease with your current tenant, include language that gives you complete control over the type of use that can occupy the space, the buyer must have good financial standing and that you must be given accurate, bona fide accounting information on the intended business buyer, and as many reasonable clauses as possible to give you control over them going dark, hours of operation, etc.  You cannot risk having your center look disreputable to the community.

Rental escalations must be made carefully with your eye on the economic horizon.  A percentage of the CPI is very common, but any escalation must be made with a feel for all of the terms of the lease that effect the increase in rent.  

In difficult times, it is wise to have a strong relationship with your tenants and keep communications open.  Although a CPI might reflect the strength of the overall economy and seem reasonable, I would be certain to get a reimbursement for your real CAM and RE Tax cost, and then think about escalations.  I would consider a CPI of 25% to 50% of the Labor Departments determinations; but be prepared to back of if you client struggles for reasons other than their inability to sell.

I am very concerned that retail tenants will struggle in the next five (5) years, regardless of how hard they work or how skilled their abilities.  Keep tenants in your retail space and paying you what is necessary to cover your mortgage and operating costs.

Good Luck,

-Jim