Northcape

Annual Rent Reviews….. which mechanism should I seek ?

If your retail business is located in a leased premises, your lease would contain a provision that allows the rent to be reviewed on an annual basis. Rent can be reviewed according to a number of different methods including Fixed Percentage /Stepped Increase,  Consumer Price Index (CPI), by a special Formula or it could be reviewed to Market.

Each one of these methods has pros and cons depending upon a number of factors, so I will explain how each method operates and outline their advantages and disadvantages.

Fixed Percentage/Stepped Increase: This is where Base Rent is increased by a specific percentage, commonly around 2% to 5%. For example, let’s say your current rent is $70,000pa + GST and it is increased by say, 3.5% in Year 2 of your lease, the new rent is simply calculated as follows; 1.035 x $70,000pa + GST = $72,450pa + GST. Sometimes this method of review is expressed in dollar terms whereby the actual annual rent is simply stated as $72,450pa in Year 2, rather any mention of a percentage.

The advantages of this type of review is that you know exactly how much rent you are going to pay over the entire duration of your lease term. From an accounting and financial management perspective, this is invaluable. Also, in times of high inflation (such as what we are currently experiencing right now), having fixed increases protects you, as the level of increase is limited.

The downside is when inflation is very low and by extension the CPI growth rate is also very low, you might slightly overpay on your rent. It’s not likely that you will pay a lot more than the prevailing CPI growth rate, but it is a bit of negative in such circumstances.

Formula Review: A Formula Review is not a common method of rent review, however some rents are calculated according to an agreed formula of some description, often involving Turnover Rent. For example, I have seen a lease where the base rent was reviewed according to the average of the last 2 years base rent and turnover rent – in this particular case the retailer actually paid turnover rent during the 2 years leading up to the review, so the retailer had quite a large rent increase.

Generally speaking landlords don’t subscribe to this method and most retailers don’t like them either as they can become too complex. Having said that, during times of slow economic growth where sales are weak or declining, having rent tied to a formula as noted above could actually be advantageous, however in times of prosperity where sales are growing strongly and turnover rent is likely to be paid, well then this would be a distinct disadvantage. 

Consumer Price Index: Gearing rent to movement in the Consumer Price Index (CPI) is quite common. In most cases it is calculated by comparing the most recent quarterly CPI figures to the quarterly CPI figures immediately 12 months prior. As noted above in times of low inflation, this method favours retailers, as the CPI is usually very low or in some cases, even negative. This means rents will increase marginally or actually decrease.

Of course the inverse is true in situations where there is runaway inflation like we are experiencing right now. Some retailers have leases geared to CPI and some even have a formula that includes CPI, such as CPI + 1% or CPI + 2%. I am afraid there maybe many retailers in this exact situation right now and will be expected to pay ridiculously high CPI rent increases. As I am writing this article, the All Groups CPI figures for each of the eight Capital Cities for the September 22 Qtr has just been published and the results are absolutely horrifying. Comparing the Sep 22 Qtr to Sept 21 Qtr, Year on Year growth ranges from 6% in Perth to 8.4% in Adelaide !  What this means is, if your rent is geared to CPI and is due to be reviewed during the Sept 22 Qtr, it will increase between 6% and 8.4%, depending upon which area of Australia your business is located. Some retailers might have even have heftier increases if their lease contained a combination formula such as CPI + 1% or CPI + 2%. For example if you are based in Adelaide and your lease is geared to CPI + 2%, your rent will actually increase by over 10%!

Market Rent Reviews: A Market Review is where the Landlord and Lessee attempt to agree on what they believe to be a fair rent for the premises. The definition of Market Review is marginally different depending on which state or territory your business is located, however the principles are pretty well the same. In essence a Market Review seeks to establish how much rent could be obtained by the Landlord for your premises if it were vacant and on the open market. Generally speaking the Landlord is to assume that the Permitted Use is similar or the same as is present, but they should not have any regard to Goodwill that your business has.

A Market Review allows the rent to remain the same, to go up or to go down, depending upon market conditions prevailing at the time of the rent review date. Retail lease legislation in most states and territories also forbids “Ratchet” clauses that attempt to hold rents at the same level and only movement in one direction (usually upward). In principle this is probably the fairest method of rent review, however they can be risky for retailers in certain circumstances. If the local market where your business is located in is very hot with low vacancy rates and experiencing high rental growth, then a Market Rent Review could see your rent skyrocket upwardly – remember there are no limits on how high (or low) your rent can move. 

As a Market Review is a process that involves the Landlord and the Lessee to negotiate, sometimes the parties disagree as to what they believe fair Market Rent is. Funnily enough Landlords tend to believe that rents should be higher and Lessees tend to believe that rents should lower. In such circumstances most leases have a clause that allows the matter to be referred to a third party, usually a professional Valuer who will determine what the rent will be. If it gets to this, the Determining Valuer is usually the final arbiter, so whatever they assess the rent to be, will be the final binding new rent, irrespective of whether this represents an increase, a decrease or remains the same.

So…. after considering all the above methods of Rent Review, which one should you press for when negotiating your new lease ?  The answer to that is, it depends on your individual  circumstances and what your outlook is economically – honestly it’s a very tricky question as you need to have a crystal ball to predict the future.

Personally, I like certainty, so for the past several years I have been recommending Fixed Annual Rent Increases to my clients wherever possible and Market Reviews where appropriate (such as during an exercise of a Lease Option). Of course some landlords do not always agree to fixed increases and insist on CPI Reviews, so some of my clients have reluctantly agreed to CPI reviews, however for the most part we have been pressing for Fixed or Stepped Increases.

As everyone who is reading this article knows, we are currently in a high inflationary environment the likes of which we have not experienced in over 30years. Unfortunately no one knows how much longer this will last for or how high inflation will go, so my preference for the immediate future is to continue to try and lock in fixed annual increases wherever possible, at least you know exactly how much rent you are going to pay in future, no matter what happens.

Sales Reporting and Turnover Rent

If you are located in a shopping centre, it’s highly likely that you have a lease that requires you to report gross sales, usually on a monthly basis, but sometimes annually and in many cases, both monthly and annually.

Retailers who own their premises need not be concerned about this, together with those retailers who lease a single holding building, as most landlords who own these types of assets are generally not that interested in their tenant’s sales.

Of course many retailers do have their businesses located in a shopping centre, so this article will be very relevant to them.

Why do shopping centre landlords want your sales figures? Well, it’s important to understand that landlords collect sales from most tenants in shopping centres for three main reasons. Firstly to gauge the performance of the shopping centre as a whole, in terms of how the asset is performing – they use this data for the purposes of Marketing, Asset Valuation and Annual Reporting (where a shopping centre is owned by a public company). 

Secondly they use this information for leasing purposes by segmenting sales into the various retail categories such as Mens Apparel, Ladies Apparel, Unisex Apparel, Fresh Food, Eat In/Takeaway Food, Household, Services etc…so that they can determine how specific categories are trading. This helps them decide on whether or not they should increase the number of retailers in a particular category or perhaps create a new category or even reduce the number of tenants in a certain category. 

Leasing Managers also review sales figures on a regular basis to assess individual retailer’s performance to determine if they are likely to pose a risk in term of default (in cases where sales are declining at an alarming rate). Strong sales growth could actually indicate that a retailer is overtrading, so the Leasing Manager knows that there could be potential to increase the size of the premises, so in either case, sales reporting is critical for the purposes of leasing. 

The third reason why sales reporting is so important is to determine whether or not a retailer should pay turnover rent. What is turnover rent? Essentially turnover rent is paid when a retailer’s sales exceed a specific threshold or “Overage Point” during a designated period. In most cases this is easily calculated by simply taking your annual base rent and dividing it by the agreed turnover rent percentage. For example, let’s say a retailer has an 8% turnover rent clause in their lease and their base rent for the year was $100,000  – we simply take $100,000 and divide it by 8% to give an Overage Point of $1,250,000. What this means is, if this particular retailer exceeded $1,250,000 in the given year, then the landlord would be entitled to 8% of sales which exceed this level.

On the surface this may seem reasonable, but what if you are a retailer such as a Lottery Agent and operate on low profit margins? Let’s say lottery sales for the year where say $2,000,000 – that would mean our agent would need to pay the landlord 8% of the difference between his annual turnover ($2,000,000) and the Overage Point ($1,250,000) – the calculation is as follows: $2,000,000 less $1,250,000 x 8% = $60,000. Turnover Rent of $60,000 is now payable in addition to the base rent of $100,000 already paid, so all up $160,000. This is seriously problematic as the commission paid on lottery sales is only 8-10% (depending on which state or territory you are located in), so this would mean that you would literally have very little or nothing to pay all of your other operating expenses such as wages, insurances, electricity etc…

Guess what, I have encountered many situations where this exact situation has occurred. The numbers were different, but in each case the retailer should have paid the landlord turnover rent in addition to their base rent. Luckily in most cases the landlords in question had no idea how the turnover rent clause operated and those who did understand, realised that it was very unfair and did not charge the tenant additional turnover rent.

Unfortunately in some cases the retailers did have to cough up the additional turnover rent, which placed a massive financial burden on them.

So… how do you avoid something like this happening to you? In this particular case I would only ever report commissions on lottery products and any other commission based revenue, not the actual raw sales, as this artificially inflates your turnover.

Also when negotiating your lease, I would insist on a special clause that states that if turnover rent applies, it is to be calculated only on commissions based income, not on gross sales relating to those sources of income. 

If possible, I’d try to dissuade your landlord from having a turnover rent clause at all, particularly given the slim margins certain industries have to work with. However if your landlord insists on you reporting all gross sales and not just commissions and they also want a turnover rent provision, then I would only agree to a nominal turnover rent percentage, say 1% (or preferably less depending on how high your base rent is). What this does is significantly increase your Overage Point to the level where you would not likely exceed it. Using the same example above where our Lottery Agent is paying $100,000pa in base rent, but now adopting a new turnover percentage of say 1% instead of 8%, this would alter the Overage Point significantly up to $10,000,000 (ie. $100,000 divided by 1% = $10,000,000). Given our Lottery Agent is turning over $2,000,000, they are now well below the new Overage Point of $10,000,000 and will never pay any additional turnover rent, unless of course they experience a massive increase in turnover in excess of $10,000,000pa, in which case I suspect that our Lottery Agent might actually be more than happy to pay some additional rent.

Seriously though, given the implications I urge all retailers to carefully check the commercial terms and fine print of their proposed new lease to make sure that they understand the impact of reporting sales and the effect this has on turnover rent. 

When should I upgrade my store?

In today’s super competitive retail environment, we have to be on top of our game if we wish to remain in business. As a retailer, there are so many aspects that we need to get right, including store location, store presentation, merchandising, buying, customer service, advertising/marketing, human resources, financial management and the list goes on. 

I wanted to discuss one aspect insofar as it affects your retail lease, that of store presentation or to be more precise, your fit-out.

Irrespective of whether or not you purchased an existing business or started a new business from scratch, it is imperative that the presentation of your fit-out always appears fresh. Remember the old adage “A picture is worth a thousand words”. Obviously a tired antiquated fit-out will not be appealing to customers and this also sends a strong message to your landlord, suppliers and the wider community that you really don’t care. In fact there is empirical evidence to suggest that a retail business that is rundown and dilapidated will generally not perform as well as a retail business that has a modern vibrant fit-out. 

So, when is the right time to upgrade your store? Well, the answer is it depends upon a number of factors, not the least being when your lease expires. As a tenant, the first question you should always ask yourself is, do I have enough tenure in order for me to heavily re-invest in my business? In other words, do I have enough time remaining on my lease to risk outlaying a large amount of capital? This is a very important question to ask yourself, as a re-fit could easily cost $100,000-$300,000 (maybe a lot more depending upon the type of retail business). 

For example, let’s say you have been operating a newsagency in the same shop for 6 years and have a 7 year lease. During this time, you made a few minor improvements to your fit-out such as the odd lick of paint and perhaps installed a few LED lights but nothing too major. Intuitively you know that the store really needs an upgrade and your respective Lottery authority also insists that you need to upgrade your Lotto counter and screen within the next 6 months. What should you do? 

You only have 1 year’s guaranteed tenure, but you decide to move forward with the refit now, however what happens if the landlord decides to not renew your lease in 12 months time? Obviously, you would have to vacate the premises meaning more than likely you would still owe a lot of money to your financier and if you had to find new premises, you would also have to fit-out these premises, which could be an additional $100-300K. On top of this you would have to outlay a significant cost to de-fit and make good your old premises. As this example demonstrates, the financial consequences of not planning ahead could be quite painful. You might think that no-one would be that silly to invest such a large sum of money without the benefit of guaranteed tenure. I’d like to say that is true, but during my career, I have witnessed many cases exactly like this example.

A far more prudent approach would be to try and renegotiate a new lease before you made such a large financial commitment. If you approached your landlord and explained that you wanted to bring forward your lease renewal slightly on the basis of you doing a major store upgrade, most landlords would oblige. Presuming that you are successful and managed to secure a new lease term (and perhaps even an option to renew), you now have peace of mind that whatever you spend on your upgrade will not be wasted.

In my opinion the best approach for keeping your store looking fresh all the time, is to re-invest more frequently during the term of your lease, but not necessarily with large lumps of capital. Successful retailers often budget for small cosmetic makeovers every 2-3 years, so when it comes to doing a major upgrade (usually 5-7 years), the cost is not near as severe, as much of the fit-out has already been modernised over the period. This approach also benefits your trading performance as customers will be more attracted to a retail business that always looks modern and tidy as opposed to a store that is deteriorating. 

Of course there is a cashflow advantage to this approach too. Investing modest amounts of capital and spreading these costs over the term of your lease, is far more pragmatic than having to outlay large sums of capital every 5-7 years.

I guess if there is one guiding principle that I recommend, it is to have a long term Business Plan and an accompanying Capital Budget that allows for small regular injections of capital to ensure that your business always looks fresh and inviting to customers.

Inflation…. how it’s likely to affect your retail lease

No doubt you would have seen the recent headlines about how Inflation is growing at an alarming rate and now impacting the everyday cost of living. Anyone who has been to the supermarket recently or filled the tank of their vehicle, can attest to how high prices have been climbing recently.

So, what exactly is Inflation and how does it affect a retail business?

Inflation is where an economy experiences sustained high price increases that effectively reduce the purchasing power of a currency. What this means is you need more dollars to pay for the same goods and services that previously cost a lot less. Of course this puts immense pressure on consumers, unless they are receiving corresponding increases in wages and salaries. Unfortunately wages/salary growth has historically not kept pace with the rate of Inflation, so many households are really starting to feel the pinch. 

Rising Inflation is generally not good for anyone (despite what some economic commentators say) particularly retailers who rely on the health of the consumer. The more a consumer has to spend on basic everyday needs such as electricity, fuel, gas, water, telecommunications and food, the less they have to spend on discretionary purchases, thereby impacting overall retail sales.

Aside from the obvious affect of weakening consumer demand, the average Cost Of Goods Sold (COGS) is increasing meaning the retailer will need to raise their sale price to try and maintain profit margins. This makes business even more challenging, as consumers are already pulling back on spending, so price increases will only  exacerbate the problem. 

Of course as a business owner, you will have your own operational expenses that will also be impacting your bottom line – costs such as Insurances, Electricity, Rent, Loan Repayments etc… will all be increasing, thus further eroding your profit. Eventually Inflation will find it’s way into wages/salaries, thus pushing up your operating expenses even more.

What about your lease, how will Inflation affect it?  In most cases where a retailer is leasing commercial premises, they pay outgoings – these are effectively the combined statutory and running costs of maintaining the common areas of the building that your business sits in. These expenses encompass items such as council rates, land tax, water rates, insurances, air conditioning cleaning, security, repairs & maintenance and a bunch of other items. As Inflation continues to bite, most if not all of these costs will increase significantly, meaning that your proportion of Outgoings will also increase.There is another major impact of Inflation that may now start to seriously impact you as a  retailer. If the base rent in your lease is geared to CPI (Consumer Price Index), it will increase significantly for the foreseeable future as any increases in Inflation are reflected in the CPI. As I am writing this article, the March 22 Quarter CPI All Groups Index for Australian Capital Cities has been released – compared to the March 21 Quarter, the increases are utterly staggering. The rises range from 4.4% for Sydney all the way up to 7.6% for Perth, so if your rent is based on movement of the CPI, you are facing massive increases depending upon which state/territory your business is located.

Some leases will be even more problematic as they are increased by CPI + 1%, 2% or 2.5% (or even higher). The result of this means that if for example you are based in WA and your lease states that your rent is to increase by CPI + 2% (based on the Perth All Groups Index – March 22 Qtr compared to March 21 Qtr) then, your rent will actually increase by 9.6% ! 

If you take into consideration all the increases in operating expenses and now outgoings and rent, total expenditure for your business is likely to rise dramatically. When you factor in weaker consumer demand (likely to result in lower sales), we are entering are a perfect storm.

So what can you do to combat this situation ? 

Wages/salaries and rent are likely to be the two largest expenses of your business, so it’s important to really focus on these two areas. In terms of rent, if you have a lease on foot and it is geared to CPI, I would immediately talk to your landlord about not passing on the full extent of the increase, at least this year. I would try to negotiate perhaps halving the increase or maybe agreeing on a lower percentage.

If your lease is about to expire and you are starting to negotiate a new lease, I would try to fix the annual increases to say 2%, 3% or perhaps even 4% or 5% and avoid agreeing to any type of CPI increase. Your landlord might not agree to this, so maybe try for fixed percentage increases just for the first few years of the new lease term and CPI thereafter. We don’t how long this Inflation is going to last for – Central Banks in most developed economies maintain that Inflation is only transitory (ie. shouldn’t last too long), but I don’t believe they know for sure one way or another. I suspect Inflation is only going to get worse before it gets better and maybe protracted for some time yet.

Of course negotiating your new rent to the lowest possible level is going to be really critical, particularly if you want to remain in the same location and your landlord insists on CPI increases. 

Try to think laterally – as with any new lease negotiation, I highly recommend that you look at considering alternate locations to relocate to (if possible), as a new landlord might be much more flexible with their asking rent and rent review mechanism.

I strongly believe that the months and years ahead are going to be very challenging from an Inflation standpoint, so it will be important to simply not accept the status quo. Regardless of what your lease states, if you are struggling with high rents and ballooning outgoings costs, I would try to negotiate some type of arrangement with your landlord. It will not be easy, however it is worth trying as the alternative could be much worse.

If you need assistance you should consider appointing a professional lease negotiator or solicitor to act on your behalf, as this will give you the best chance at improving your situation.

Leasing…..get good advice !

Unless you own your premises, you would have a lease with a landlord so the value of your retail business is very much dependant on the quality of your lease.

If you purchased an existing business, it’s likely that you would have assigned (transferred) a lease from the original business owner to yourself. Before deciding on whether or not you should go forward with the purchase of the business, you would have undertaken some Due Diligence to determine if the business was viable and had potential – if you didn’t purchase an existing business, but started a new enterprise, you would have followed a very similar process, however in the absence of any historical data, you would have undertaken a financial viability instead.

Irrespective of whether you purchased an existing retail business or opened a brand new business, you would need to consider a myriad of issues such as;

• Trade Area
• Adjacent Retailers/Competition 
• Car Parking
• Location of Premises
• Premises Size/Layout
• Authority Approvals 
• Shop Design/Fit-Out
• Projected Turnover
• Projected Profitability
• Gross Annual Rent
• Lease and other Legals 
• Human Resources
• Finance 

Of course the above list is only a small sample of the many issues to consider when establishing or purchasing a retail business. Needless to say though, they all require a specialised knowledge, so unless you have a lot of experience in these areas, I highly recommend that you engage with professionals who can help you.

Regardless of whether or not you already own a retail business or are about to open a new business, I recommend that you seek the services of the following professionals as a minimum;

1. Lease Negotiator – if you are experienced and feel confident to negotiate a lease yourself, then you won’t need a Lease Negotiator. However if you don’t have the experience, time, inclination or just feel uncomfortable dealing with a landlord, then I recommend you engage a good Lease Negotiator. A negotiator will work with you and all your professional partners (ie. Accountant, Solicitor, Designer/Shopfitter etc…) to achieve optimal commercial lease terms.

2. Accountant – a good accountant is worth their weight in gold, so it’s important that you seek sound financial advice in terms setting up and operating your business. I am not just talking about someone who simply puts together your BAS and handles  your tax returns, I am talking about partnering with a commercial business person who is able to provide prudent financial advice and help you with all manner of financial matters including dealing with financiers, minimising costs, driving efficiencies, improving profit margins etc…

3. Solicitor – after you or your Lease Negotiator have agreed on commercial lease terms, it’s of paramount importance that your solicitor review the lease in detail before you execute it. Likewise if you are buying or selling a retail business, your solicitor should handle the entire purchase process including the lease assignment (or new lease if applicable) together with any other issues such as authority approvals, industrial relations issues etc.

4. Designer and Shopfitter – store design is very important, irrespective of whether you are just doing a cosmetic upgrade or brand new fit-out, you need to keep your business looking fresh and vibrant. I thoroughly recommend that you engage a good shop-fitter and designer, however some shop-fitters have designers within their team which makes the process a little easier – they should be able to deliver a fit-out that meets with your landlord’s design requirements and at the same time is functional, robust and stylish. Even after your fit-out is complete, having an ongoing relationship with your shop-fitter is a good idea, as there are often maintenance issues that need attention from time to time.

When it comes to running a retail business, it’s important to surround yourself with professionals who know what they are doing and do it well. You know the old adage “You are only as good as the company you keep”!

Don’t accept the Status Quo….

So here we are, approaching the end of 2020 and it seems like so much has changed since the beginning of the year. A global pandemic has gripped the world and we now have a new language that includes such terms as “social distancing”, “Covid-Safe” and “Contact Tracing”.

Aside from the very real health impacts of this emergency, the economic fallout from Covid-19 has been felt in every corner of the planet, in fact according to the World Bank, global GDP is expected to contract by 5.2% this year, with major industrialised economies such as the United States contracting by over 30% just in the second quarter alone. There is now little debate amongst leading experts that the economic downturn could well be as bad or even worse than the Great Depression.

Australia has managed to avoid a major loss of life so far, however the economic consequences are being felt, especially in the state of Victoria where the Stage 4 lockdown has decimated thousands of businesses and causing deep social unrest. At the time of writing this article there is a debate raging as to whether or not the Andrews government’s response to the Covid-19 emergency was well managed – irrespective of one’s views, the fact is the economic downturn in this state is probably going to be the most severe of all the federation and likely to contribute to the Australian recession lasting longer than initially thought.

Whilst most other states and territories are experiencing lower rates of Covid-19 infections and are not in a Stage 4 lockdown like Victoria, the national economy and more specifically the retail sector is still very sick (pardon the pun). Having visited a number of shopping centres and high streets in NSW recently, it is clearly evident that there are still many retailers not re-open with more and more shops becoming vacant every day.

It is true that some retail channels have actually benefited from the lockdowns ie. “stay at home retailers” such as hardware stores, building suppliers, landscape/gardeners, electrical/electronic homeware retailers and supermarkets have all experienced a significant lift in sales due to many people spending a lot more time at home. However department stores, apparel, footwear, restaurants, cafes, lottery agents and newsagents have all been detrimentally affected – whilst the “stay at home” retail sector is currently enjoying their time in the sun, it’s not likely that this trend will continue in the medium to long term. Eventually government subsidies such as JobKeeper and JobSeeker are going to be cut off, as will allowing employees to dip into their superannuation funds. These factors together with rising unemployment, stagnant wages growth, a slowing property market and banks tightening up on lending, is likely to result in less retail spending across all sectors as we enter 2021.

Landlords are feeling the pinch too, in fact several large Real Estate Investment Trust (REITs), particularly those with substantial shopping centre assets recently sustained massive hits to their balance sheets and profits in FY20. Some of these landlords are endeavouring to navigate their way through this situation with common sense and are genuinely trying to work with retailers, however some on the other hand are putting their heads in the sand. Over the past 6 months or so I have dealt with a multitude of different landlords in connection with Covid-19 rental assistance – fortunately we were able to work collaboratively with most landlords, however some continue to be belligerent and wish to continue on as if everything is just fine – they want to maintain the status quo and do not wish to adjust their expectations according to what is unfolding in the market. However this is not the time for accepting the status quo, not by any stretch.

Unfortunately, I am still seeing offers from landlords with all manner of unrealistic commercial terms that are just not reflective of current market conditions. I have noted below some of the common requests and also detailed how I think you should respond to each of them;

• High Asking Rents: Some landlords are still seeking major increases in rent, however rents in general should at the very least be frozen, if not be going backwards (however this is dependant of course on the specifics of your individual circumstances). Generally speaking though, I would not be accepting large rent increases at this time.

• Rent Reviews: Many landlords are still seeking annual increases of base rent of 5%, however this is way too high. I would try to negotiate 2% or 3%

• Turnover Rent: Most large shopping centre landlords are still asking for Percentage Rent or Turnover Rent, however I’d try to push back on this or at the very least, reduce the percentage.

•  Bank Guarantees: I have noticed a real upsurge of landlords wanting 6 month bank guarantees, however this is overkill and ties up too much working capital. I suggest providing the equivalent of 2-3 months gross rent + GST only.

•  Personal Guarantees: Very few landlords will accept no personal guarantees, however this is something that you should talk to your solicitor about. If possible I’d try to push back on this.

•  Leasing Incentives: There is still a lingering perception from some landlords that they shouldn’t need to provide any leasing incentives (such as rent free and or capital) to sitting tenants who wish to renew their leases.The theory being the landlord has you on the hook as you have a business at risk, so they don’t need to incentivise you to stay. WRONG….in this market you should have other options, so I would endeavour to seek incentives when negotiating a new lease or renewal.

• Rent Rebates: Very topical at present especially given the Covid-19 situation. Whilst the federal government and the states/territories did introduce mandatory rental assistance for retailers who sustained a specific decrease in sales in 2020 compared to 2019, the assistance while helpful was not  all that meaningful. Irrespective of the level of impact you have sustained from Covid-19 there are other underlying economic issues that were occurring before Covi-19 and will continue after the pandemic finishes. If you are in financial strife, I would press your landlord for assistance and be persistent, don’t take no for an answer.

For the most part I believe the majority of landlords are trying to do the right thing and are willing to help their tenants, however there are some landlords that still haven’t woken up to the “new normal”. They maintain that everything is ok, the economy is bouncing back quickly, so they shouldn’t be expected to suffer much if anything – they think everything is returning to the stauts quo. Unfortunately they are wrong, so don’t accept your landlord brushing you off in the current economic climate.

Leasing… A Brave New World After COVID-19 Coronavirus

No, I am not talking about Aldous Huxley’s 1932 dystopian novel about the future, I am referring to what is looking like the “new normal” for retail business in Australia. I don’t really like that term, as a lot of the main stream media use it far too often, however as I am writing this blog, the COVID-19 Coronavirus crisis has resulted in the forced closure of tens of thousands of retail business all over the country, so things have changed.

Of course this is not unique to Australia, the COVID-19 emergency has affected the entire globe and being handled by governments in a similar manner, however this has resulted in the world’s economy to grind to a halt.

In Australia, this couldn’t come at a worse time, as our retail industry was already in serious trouble, evidenced by the plethora of retailers who had gone to the wall recently. You know the names –  Bardot, Dimmeys, Ed Harry, Forever 21, Napoleon Perdis, Harris Scarfe and many more.

Of course much of the country was also experiencing a crippling drought, then we had an awful bushfire season over the 2019/20 summer and this was followed by major storms and floods that played havoc with electricity and telecommunications to large areas of the east coast. The last thing our industry needed was a world wide flu pandemic, I mean seriously, what are the odds of that happening?

So, here we are in April 2020 in the midst of the largest health emergency the world has seen in a century and our retail industry has been smashed for six. An optimist would say, ok the health emergency is very bad, but we’ll get through it and everything will go back to normal, right ?

Well, I am not too sure about that. Before the COVID-19 shut down of most of the developed world, the financial system was already deteriorating, so now that equity markets are in free fall, tens of thousands of companies have closed and millions of people have lost their jobs, the world is unquestionably heading towards tough times. In fact the International Monetary Fund (IMF) recently advised that the global economy has now entered a recession that could be as bad or worse than the global financial crisis of 2008/09.

So, what should you do as a retailer? Well every situation is different, however the first action I would take is to immediately investigate what financial assistance you can claim from the Federal Government and your respective State/Territory Government. There are a number of grants, subsidies and other forms of financial assistance that may help keep your business afloat.

Secondly I’d check with your insurer to investigate if your policies allows for any type of business interruption coverage.

After understanding where you sit with these matters, you’ll need to discuss your financial position with your accountant, hopefully you have some cash reserves that might buffer the impact of the downturn.

Of course your staff will be one of you main priorities, so you will need to think carefully about what you do in this area – putting off staff maybe required, but if you believe they are strong employees, I’d do whatever you can to try and retain them for as long as possible. When the COVID-19 crisis passes, you’ll need the best staff you can find to re-build your newsagency business.

Lastly you really need to consider your lease (assuming you don’t already own your shop). Now I realise that you may be tied to a long term lease and are legally bound to it, however to quote our Treasurer Josh Frydenberg, “extraordinary times call for extraordinary measures”.

If you are a tenant in a shopping centre or other commercial property and have a legally binding lease on foot, generally speaking you are not entitled to unilaterally adjust the rent down permanently to a level that you think is acceptable. That said, if you have had to close your business or only been partially trading due to the restrictions imposed by the authorities, your turnover has probably decreased substantially. The Federal Government has recently introduced a new Code of Conduct for commercial tenancies and the various states & territories are in the process of introducing legislation that rides on the back of the Code – they will provide a framework for short term rental assistance that can be sought from the landlord.

Given the extraordinary circumstances we are dealing with, I believe most landlords will consider helping you with some form of rental discount in accordance with the new Code, however it was only ever designed as a short term measure. It is highly probable that the economy for the remainder of 2020 and beyond will be very tough, so it is time to seriously  think about how sustainable your lease is in the long term.

Putting aside any short term assistance that you may receive, I strongly recommend that you critically review your rent and if you believe it is just not sustainable in the long run, you should talk to your landlord about possibly re-negotiating your lease. In most cases this will be very difficult, however this is not the time to be blindly accepting the status quo of anything – when the Coronavirus emergency passes (and it will pass), we are more than likely going to experience a deep recession, so I think you should have a frank conversation with your landlord.

It’s a brave new world….

How is customer service relevant to your lease ?

How important is customer service to your retail business? Most owners would say that good customer service and strong relationships are fundamentals of running a successful business. Seems obvious, right? Well in theory yes, but in practice there are plenty of shoppers who have encountered poor customer service at some point in their lives. As a retailer this should be abhorrent to you – of course retailers are human, we all have off days when things just don’t seem to be going our way. There are myriad of reasons for this, including personal issues such as financial stress, relationship problems, health challenges etc…however we must try to shield our own personal issues from customers.

The reality is your customers have their own personal issues to deal with, so the last thing they want to hear is you grizzle about how quiet trading has been during the past few days or how your landlord is unreasonable. Whilst some of your customers may sympathise with you on the surface, they really aren’t that interested and are probably just being polite.

With nearly 30 years in the retail industry having worked on the landlord side of the equation for most of that period, I encountered many retailers who would otherwise have had strong businesses, had their customer service skills been up to scratch. During my daily walks around my shopping centre as a Centre Manager, I would often chat to retailers about how business was – whilst most retailers were even handed with their feedback, some negative retailers blamed all their woes including falling sales and declining profits on everyone else (including their customers) – they did not think for one moment that the source of their problems may have lied with themselves!

Imagine blaming your financial performance of your business on your customers – I remember hearing all manner of crazy explanations such as “old people just don’t buy enough product” and “my customers are very price conscious and don’t like paying a lot” and “customers these days just don’t have any loyalty”. Instead of blaming the very people who they relied on to generate sales and by definition, their livelihood, these retailers should have taken a good hard look in the mirror and asked themselves – I am the problem, does my negative attitude and that of my staff stink ? Are we providing poor service?

In the shopping centre industry we would often gauge customer attitudes towards individual retailers, through research that included exit surveys and focus groups carried out by independent third parties – funnily enough the vast majority of those retailers with the lowest customer feedback scores were the same retailers who’s sales were declining and often corelated with their rent payments falling behind.

In each of these cases I believe the retailer had simply missed the mark in terms of meeting the wants and needs of their customer – they weren’t focused on looking after the very people that they needed to satisfy.

From a landlord perspective, especially within a shopping centre environment, it is fairly obvious which retailers have good customer service and those who do not. As mentioned there are plenty of indicators such as poor sales, climbing rental arrears and badly maintained stores. In many cases landlords also receive direct customer feedback from shoppers who simply walk into the Centre Management office and complain about how poorly they have been treated.

When it comes to renewing a lease, most landlords will not look favourably upon a retailer who exhibits poor customer service, as more often than not this same retailer is not likely be meeting their obligations under their lease. If the landlord has an opportunity to replace this retailer, they may not offer a new lease to the incumbent operator meaning their business would be impacted significantly.

So remember, good customer service is integral for so many reasons, including the security of your leased premises….

Negotiating a lease….know your business

During the course of negotiating leases on behalf of my clients, I am often asked all manner of questions such as where is the best location for my business, what size premises are ideal, how much rent should I pay etc…?

I am always happy to provide recommendations about such matters, however it really is up to my clients to understand their own business model and have clear views on these types of issues.

Successful retailers usually have a very strong understanding of what works and what doesn’t work in terms of trade area, shop location, size of premises, orientation/shape of premises and acceptable gross rent. They are able to accurately assess a given trade area to determine how their product/service will be accepted and will often have a specific formula for determining how many transactions are likely to occur and the average sale per transaction.

Once a retailer has determined the level of annual sales that can be achieved, they will work backwards to calculate how much gross rent they can afford. This will be determined by the level of gross profit the business is likely to generate – a low gross profit business such as a newsagency can only sustain a low rent to turnover ratio of around 5-8%. Of course the inverse is true for a high gross profit business such as a jeweller, as they can sustain much higher rents.

It is not uncommon for successful retailers to own more than one retail business, so these operators are easily able to draw upon their experience and historical trading data to create a system that works for them. Over a period of time these owners develop an intimate understanding of all aspects of their business, so when it comes to negotiating a new lease, they intrinsically know their metrics and limitations. Being intimate with the metrics of your retail business is therefore imperative, otherwise you can fall into the trap of signing a new lease that just doesn’t work for you.

Over the past 5-10 years the retail sector has been under attack from a myriad of factors such as on-line retailing, increased competition from new players in the marketplace, low  wages growth and high household debt. As a result, many retailers have fallen over which has resulted in increased shop vacancy rates, so landlords have struggled to grow rents and keep a lid on vacancy rates, especially in regional areas.

Of recent time I have noticed a trend emerging with many landlords pressing retailers to  take on larger spaces, no doubt due to the difficult leasing market. On many occasions I have had to persuade landlords not to push my clients into taking unnecessary space, when they clearly have no need for it. Generally speaking the larger the space, the greater the rent (not to mention additional cost of fitting out and stocking these premises), so it’s not necessarily in your interest to take space in excess of your requirements.

Landlords often offer leasing incentives such as rent free and/or capital to encourage retailers to take more area, however this can be perilous. If the shop area is much larger than what you require, you are may end up paying a higher long term rent that is not sustainable, as well as possibly creating major stock issues, both of which can lead to severe financial distress.

If you are planning to enter into a new lease, I highly recommend that you thoroughly analyse your business, know your metrics and develop a clear set of leasing parameters and try not to deviate from them.

Location, location, location …

I was recently appointed to act on behalf of a retailer who had been having difficulty negotiating a new lease with his landlord on a potential new site within his shopping centre.

Up until my appointment, communications between the two parties had completely broken down. Whist both sides were keen in principle to relocate this particular retail business to a better location within the centre, they just couldn’t come together on the commercial lease terms.

On reviewing all of the facts surrounding the situation, I learned that this retailer had quite a strong business, but it was currently located at the far end of the shopping centre, with no major tenants nearby. This section of the mall was about to be redeveloped and the retail tenancy mix altered to the point where I thought staying in the existing location would have been detrimental to my client.

By contrast, the alternate location proposed by the landlord was very close to a strong supermarket trading at over $50M pa – the surrounding precinct was also going to be refurbished and would soon include a second supermarket which would undoubtedly generate a huge amount of foot traffic.

Whilst my client agreed that the proposed new site was a better location, he was very agitated about the fact that the landlord wanted 50% more rent for the new site. The interesting fact was that this retailer still had about 2 years remaining on his existing lease, so the landlord was quite content to leave my client in his existing shop, unless he was more realistic about paying a market rent for the new site. Importantly this was not a forced relocation, the landlord just thought that offering the new site to my client was the right thing to do – it was good for him, good for my client and right for the centre’s tenancy mix (something which I completely agreed with).

Before I commenced negotiations with the landlord, my client and I had a robust debate about what we thought was a fair market rent. My client cited lower rents that other retailers where paying throughout the centre, so he could not accept that the landlord wanted to charge more rent just because he was making improvements to the centre.

Of course my objective is to always achieve the best possible commercial deal for my client, but the best deal doesn’t always mean securing the cheapest rent, it means securing the best possible location on the best commercial lease terms.

I did think that the landlord’s asking rent for the new site was on the high side, but not to the same extent as my client. The other important fact that my client kept glossing over, was that this was not a market review, nor was it a forced relocation, so the landlord had absolutely no obligation whatsoever to offer the new site or negotiate the rent. In fact the landlord could ask for whatever rent he desired as my client was already bound to a legally binding exisiting lease for a number of years.

I had to confront my client and be honest with him, so I asked him a few simple questions;

• Which was the better location in terms of adjacent major retailers, the existing shop or the proposed new site?

• Which location would have the highest foot traffic?

• Which location was likely to generate incremental sales and profit growth ?

• Which location was going to increase the profile of his business medium to long term?

• If you don’t embrace this opportunity and be more realistic on the rent, what is the long term future of your business in the current location?

I am sure that you can guess what my client’s response was, of course the new location was superior in every way, so my client started to realise that he should be more realistic about how much rent he could pay. Remember, the landlord didn’t actually have to offer the new site to my client, so I reminded him of this fact and the alternate future if he stayed in the old location.

In the end we agreed on revised leasing parameters and I successfully negotiated what we both thought was a good lease deal on the new site. I managed to reduce the asking rent by 20% (in addition to gaining some leasing incentives) but yes, the new rent was higher than the current shop’s rent, but in our opinion it was worth it. We had secured one of the best locations in the shopping centre and my client was confident that increased profits that he would generate from this new site, would more than cover the new rent, many times over in fact.

We secured the future of his business by observing an old real estate maxim, “always go for the best location !  Location, location, location……” !