A well-negotiated space lease is an important asset, while a poorly negotiated lease could be a liability. Many a budding entrepreneur has signed a lease and then later regretted its terms. Most likely, she failed to evaluate all those clauses and their longterm effects. The watchword: Look before you lease.
Look at the location, the amenities, the neighbors, the covenants, and most importantly the rental in relation to the business you can generate from this location. Do they work for you or only the landlord?
Not every for-rent commercial space, no matter how attractive or economical, is suitable for a nail salon. Before signing, examine your potential market, its source, and whether the location of your salon is better here rather than alternative spots. Consider your neighbors, your effect on them, and if they generate patronage for you. Compare various locations, their estimated drawing power, and your total occupancy cost for each as a percent of the projected gross income.
KNOW YOUR ECONOMIC RENT
A common opinion is that rental agreements are presented with most terms and conditions spelled out offering you two choices — take it or leave it. Not true! Everything is subject to negotiation. The most important factor in the rent is what you can afford and still be profitable, not the asking price. The first price is always what the property owner would like to have. This leaves you to determine what he will settle for.
There are two considerations to be taken into account. The first is “market rent” and the second is “economic rent.” Market rent is based on what similar rental spaces have been recently leased for, the rate adjusted for pros and cons such as location, amenities, condition, lease terms, etc. To determine market rent you need to find similar for rent spaces and make comparisons. Economic rent, the more important criterion, is what you can afford to pay based on your projected income and profitability. Unfortunately, industry statistics are skinny and unreliable. The best procedure is to estimate your income from this location and deduct all expenses (except rent, but including a fair wage for yourself). From the remainder deduct what you feel would be a fair rental amount and compare it with your net profit hurdle rate (this is the minimum acceptable) and the landlord’s asking price. How do they stack up?
Determine how much space you really need. Although you do not wish to be crowded there is no point in paying for excess space. The object is to attract the largest clientele at the minimum cost. It may only be a choice of this or that, but as best you can, project income, expenses (including rent), and profi tability for alternative locations. Include the cost of any improvements you must make. Then compare. Low rental spaces may not be that cheap when you look at the bottom line. Alternatively, the high-priced location may not be that high priced if your revenue and net profit can be increased pro rata. Perform a sensitivity analysis; that is, make your projections at varying levels (optimistic, most probable, and pessimistic) for different locations with differing lease rates. Determine your break-even point for each potential location. The optimistic is hoped for, most probable should support the rental rate, and pessimistic is the worst-case scenario.
TYPES OF LEASES
For nail salons there are usually three types of leases: the gross lease, the net lease, and the parol lease. With the gross lease the only additional occupancy cost is utilities. With the net lease (a.k.a triple net) all property operating costs such as building insurance, taxes, repairs, utilities, etc., are added to the rent. In a multi-tenancy property, it is your share based on your occupancy percent of the whole. Another trap for the unwary is that gross leases often contain escalator clauses, whereby as the cost of taxes, insurance, etc., increase, your rent also increases proportionately. The parol lease is usually a gross lease with a month-to-month tenancy. That is, you could be out at the end of the next month. Percentage leases are rare in salons but a landlord may suggest it. With this kind of lease, after a stated annual revenue is obtained, the landlord receives a percent of all additional income.
Be certain the right to transfer or assign the lease is contained in the agreement. Ensure the clause reads that if the lease is assigned any prepaid rent is credited to you, not retained by the landlord. This is a common trap. Many leases contain a clause by which prepaid rent is theirs to keep.
Most leases contain a clause by which all interior improvements become a part of the building. Although installed at your expense, as title passes to the lessor you can never remove the upgrades, and if selling your salon, cannot expect a purchaser to buy these improvements. Although you may have paid for them, they are not yours to sell. Haggle over this one. As a general rule, if you can’t amortize the cost of the improvements during the first lease term, either their cost or the rent is too high.
Start-up rental holidays, fixture, and move-in allowances are common. Most property owners expect to contribute two or three months’ rent to induce a tenant to occupy a vacant area. So much depends on how badly the owner wants you in and how long it has been vacant. A step up clause that provides for a low initial rent, then periodic increases, may seem benevolent. Most only let the tenant in gently, then soak her later.
The length of lease should be negotiated based on your comfort level. If your salon is a sure winner at a low rental, go for a longer term. If you’re uncertain, go for the shorter term. Either way, as it costs nothing extra and may protect your investment, always include one or two renewal options.
Before signing, inspect and negotiate each clause separately, considering its effect on your salon’s operation and profitability. You must live with the terms of the lease for a long time. If they do not work for your benefit, your troubles may have just begun. Never assume that when first presented all terms and conditions are engraved in stone. So much depends on how badly the owner wants you in and the negotiating skill of the parties.
Whether to have your lawyer negotiate the lease is a personal decision. Proper negotiation requires a full comprehension of your business, and no one, your lawyer included, understands it as well as you do. Still, for all legal and contractual matters employ an attorney. Be sure the one you hire has a good understanding of commercial leases.
Lloyd Manning is a freelance writer specializing in business matters. His most recent book, Winning With Commercial Real Estate, is available from Booklocker Inc., Barnes & Noble, and Amazon.
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