Leasing Commercial Property in Today’s Economic Climate

This article appeared in Issue 3#4 (May/June 2009) of Business Franchise Australia & New Zealand

One of the most important business decisions you will make while you are a franchisee, apart from purchasing a franchise in the first place, is whether to buy or lease a property from which to run your business. 

After salaries, the cost of your business lease is likely to be the biggest overhead you have. Franchisees across all industries choose to lease rather than buy for a variety of different reasons.

Firstly, the franchisee may not have enough equity to secure a loan, or is not entirely convinced about the location of the premises and wants the freedom to move to another premises once the term of the lease is up.  More commonly, it may be that their ideal commercial premises is not on the market at the moment, and is only offered for lease. Desirable commercial property is very difficult to source at the moment, so leasing may be the only option on the table for many franchisees right now.

Franchisees and business owners need to be aware that entering a commercial tenancy agreement or lease is a very significant business decision. It is a legally binding contract that will affect the value of your business and should not be taken lightly. I would advise every franchisee to seek legal advice before signing a lease to ensure they are fully aware of the terms and conditions, and how the contract may affect their business. There are a number of other important considerations, including:

• whether you have received sufficient information about the premises (a disclosure statement);
• whether the space is available for your and your customers exclusive use;
• the duration of the lease;
• whether there is an option to renew the lease;
• who is responsible for any repairs and maintenance?
• whether the lease can be assigned to someone else;
• whether you can vary your type of business during the terms of the lease; and
• whether you need to contribute to the payment of common areas, general property insurance, rates and levies.

The agreement will be written taking into consideration the interests of the landlord, or lessor. Consider whether it also meets your needs, or if there are any additional terms and conditions you would like to add to the contract. This is why you need to take the time to properly read the terms and conditions of the contract and discuss it in its entirety with your lawyer.

In many retail franchise systems, for example, the franchisor holds the head lease and grants a ‘sub-lease’ or ‘licence to occupy’ to their franchisees.  There are advantages to this approach, one of which is that the franchisor retains control of the property should there be a future problem with the franchise relationship. Other franchisors are not parties to the property lease; however, they are involved in approving a site and assisting the franchisee through the lease-execution process. In both cases, the franchisee should take the same care in reviewing the contract and making themselves completely aware of their obligations. They should be aware of the terms of the head lease and ensure that they are reflected in their occupation agreement. 

If there are additional or more onerous terms in the occupation agreement, the franchisee should re-negotiate with the franchisor.  In this arrangement, the length of the lease term should, as far as possible, mirror the term of the franchise agreement.  In the event that the term of the franchise agreement exceeds the term of the lease, the franchisee and franchisor are both potentially left in a difficult position. 

The current economic climate has resulted in a number of significant changes in the real estate and property sector.  Both residential and commercial property is becoming more affordable, so more franchisees, management personnel and business owners are choosing to use this great opportunity to purchase property, particularly while interest rates are so low!  The bad news for lessors right now is a higher vacancy rate due to many businesses deciding to rather purchase a premises at the conclusion of their lease term. The retail sector is being hit particularly hard though, because of many businesses suffering financially, due to depressed retailer sentiment and decreased consumer spending. 

Because this is the case, at the present moment, there will certainly be more room for franchisees and business owners to negotiate with their lessor. The lessor’s main objective in the current economic climate will be to secure a good quality, reliable and long-term tenant, so, provided you are one, the lessor would most certainly be more open to negotiation on certain terms on the contract, such as rent increases. 

Franchisors that hold a number of leases with the same organisation will certainly have the upper hand in bargaining power, and will be able to negotiate better lease terms on behalf of their franchisees. I would suggest all franchisees with a sub-lease certainly question this issue with the franchisor.  In the current economic situation, any assistance to small businesses, such as more lenient lease conditions, could go a long way in ensuring the overall health of a franchise or business.

The franchisor may offer to assist the franchisee with lease negotiation, depending upon the circumstances. After offering suggestions and tips, some franchisors let the franchisee take the lead in negotiations. If the franchisee is not comfortable leading negotiations, it may be appropriate for the franchisor to step in. If the franchisor takes on this role, it is important to constantly communicate with the franchisee on what is being proposed. 

Looking at the commercial leasing market overall, there are more instances of short term or casual leasing, which provide tenants with greater flexibility allowing them to adapt to the changing climate more quickly. Short leases are often called tenancy agreements, but there is no difference in law. You can fix your contract for any period you like. If your landlord wants you as a tenant, he will ask for a long term. Start negotiating with the term that you would like, not the one that is presented to you. 

Lessors are accepting reduced rents for vacant space, particularly in the retail sector, with some reductions reportedly as high as 50%. Current tenants are also in a much more favourable position to re-negotiate lower rents than they were just over a year ago. As the economy becomes stronger, property values will rise again, and tenants will no doubt find themselves paying more rent. It is therefore advisable to negotiate a ceiling on the contract over the lease term, so that the rent cannot rise above a certain value. 

I recommend that all franchisees currently in leases or searching for a suitable property to lease to negotiate conditions, lease terms and prices with the lessor.  You just never know what type of agreement you could arrive at with the lessor! 

However, I would like to put a word of warning out there to all franchisees and business owners, particularly those not in the retail sector. Now that commercial investors and property developers have tightened their belts, there is less commercial construction on the cards, and therefore, fewer future opportunities to lease in the office market.  A shortage of office space is likely to become a concern across Australia at the end of the year and into 2010 – once all the commercial development currently in construction is completed and released to the market later this year.  When this happens, it will be very difficult for franchisees and businesses to source property, and when they do, competition will be fierce. At this point in time, there will be virtually no opportunity to negotiate very favourable terms (for the tenant) on the contract. 

Having said that, franchisees and business owners who are keen to negotiate the best terms and conditions on their lease should do so within the next few months, while lessors are still searching for good quality tenants and trying to avoid long-term vacancies.  While it may appear on the surface that there are few sliver linings in the cloud when it comes to the Global Financial Crisis (as it has now become known),  in actual fact it presents enormous opportunities to astute buyers and renters. In other words, instead of worrying about what impact it may have on your business; rather look at ways in which you can score some real, definitive cost savings. Saving money on rent is certainly one of those.  

There are no rules when it comes to negotiating a lease. That is between yourself and the lessor. Every lessor is different, and what is not acceptable to one, may certainly be acceptable to another. Therefore, do not be afraid to lay out your needs on the table. They may be quite straightforward, such as a ceiling on the rent, or they may be more unusual, like the landlord being responsible for the maintenance of external signage of your business. Basically, you will never know what they will agree to unless you ask the question. Happy negotiating! 

Mike Green has over 20 years of experience in the real estate industry. He is the former owner of Harcourts franchise, Mike Green Real Estate Ltd (Auckland).  As Managing Director of Harcourts International since December 1999, Mike is responsible for the overall operation and direction of Harcourts’ group of companies, and with Paul Wright, is one of two owners of Harcourts International Ltd.