Northcape

I need a rent reduction or do I….?

One of the most common questions I am asked by retailers is how to negotiate a rental rebate, even though they have a binding lease on foot.

In this blog I thought I would provide my thoughts as to how to approach your landlord for rental assistance, but before I do I think it is important that we first explore why and if a retailer might need a rebate in the first place. Whilst I am a retailer’s advocate, I think it is important that we are honest with ourselves when considering knocking on the door of a landlord to ask for financial assistance. When I say honest, I mean taking a good hard look at your business and asking yourself, “is the level of my rent the real issue or is my business fundamentally lacking in other areas”.

A client once asked for my advice about seeking a rental rebate from his landlord, as he felt that this would significantly improve his bottom line. After drilling down into his financials, I learned that his business’ annual turnover was about $180,000 and that it had made a loss of about $40,000 the previous year. His gross rent was just over $24,000 pa, however he was adamant that his rent needed to decrease as it was far too high and was the root cause of all of his woes.

Whilst I wanted to help my client from a leasing perspective, it was very obvious to me that the real issue wasn’t rent, it was a fundamental problem with the business itself. Annual turnover was way too low, in fact my client later admitted that that sales for this particular retail business should have been around $1-1.2M pa, rather than $180K pa, especially as it was positioned in a good location on a busy high street with lots of passing shoppers and no serious competition.

In my opinion no amount of rent rebate was going to materially improve my client’s financial position. If his landlord agreed on a 50% or even 75% permanent rent reduction, it would still mean that my client would make an annual loss of $22,000 – $28,000 based on the previous year’s performance.

In this particular case I advised him to actually not focus on a rent reduction at all, as this was only scratching the surface and really a distraction. I suggested that he needed to take a much closer look at his operation (after seeing the shop for myself, it was pretty obvious why turnover was so low – I don’t want to be disrespectful, but the state of his fit-out was appalling, I’m talking about cobwebs, blown lights, paint peeling off the walls, worn carpets and very low stock levels. To compound the issue further, his customer service was even worse than the state of the fit-out!  It was very obvious, this was not a rent issue, this was an operational issue, so in the end I recommended that he seek the advice of a very successful ex-retailer associate of mine, who had set up a consultancy business that assist troubled retailers.

In this particular case a rent reduction wasn’t really required, but of course there are situations where securing a rent rebate is appropriate and in fact, should be an expectation;

• In a shopping centre environment, where a landlord is conducting a major re-development and during the course of construction, they impact your business. In these circumstances most states and territories in Australia have legislation in place that permits tenants to claim compensation and that includes rental rebates.

• If your leased premises are unable to be occupied due to some form of natural disaster such as fire, earthquake or flood, many leases allow for rent to abate for a period of time.

• On rare occasions again in a shopping centre environment, if there is a significant change with one of the major tenants, this can have a very serious impact on traffic flow. A loss of a major tenant such as a large supermarket can significantly impact the surrounding specialty shops within the shopping centre.

So what about the situation where you actually have a strong, vibrant business that has a reasonable turnover, however you are struggling to make a profit and are fairly certain that you are paying a much higher rent than many of your neighbouring tenants. Even though you have a lease in place, I do believe it is worth talking to the landlord, however you need to consider the following;

• First of all we need to understand the perspective of the landlord. Whether they are a small private investor or a large listed property trust (REIT), their objective is to make money. We shouldn’t begrudge landlords for this, as they are in business just like you are, so we should never treat them as the enemy.

 

• The second issue to consider is the landlord has no legal obligation to reduce your rent (presuming you have a binding lease and don’t have any extraordinary circumstances such as those noted above).

 

• The next question to ask yourself is “what’s in it for the landlord ?”. If they agree to a short term or permanent rent rebate, what is the impact to their bottom line and why would they accept this. Broadly speaking and depending of the valuation of their property, for every $1 in permanent rent reduction that a landlord gives a tenant will result in $10-$20 decrease in the value of their property. Doesn’t sound like that such impact does it ? Well lets look at an example where a retailer located in a small shopping centre is not trading very well and is seeking a $10,000 pa decrease in rent from their landlord. Using that same multiplier effect as noted above, the impact to the landlord’s valuation in this case is 10 times, so their asset value will be effectively decreased by $100,000 if they agreed to a permanent decrease. In the landlord’s mind the tenant is asking for a rent reduction that results in them losing $10,000 pa in cash flow, but more importantly it also reduces the capital value of their shopping centre by $100,000 ! The landlord is not going think that this is a $10,000pa question, they will think of it as a $100,000 question.

 

To counter resistance from a landlord, I will often recommend to my clients that they start by asking their landlord for a short term rebate (initially) for 3 months as a short term rebate doesn’t normally affect a landlord’s valuation just their cashflow, so they might be more responsive. However when that period expires, I encourage them to go back again for another 3 months and the same again in 3 months and so on. Eventually, we ask the landlord to make it a permanent arrangement, (a bit like cooking the frog so to speak).

Sometimes a landlord will agree to a permanent rent reduction, however you might have to trade off something of value to them. For example the landlord might agree to a major rent reduction but he may want you to take a new long term lease or perhaps they make wish to take back some area from your shop or they may want you to do a full refit of your premises. Of course you have to consider these types of trade offs on their individual merits, but often there can be a win/win outcome.

The key principle to bear in mind when seeking a rent rebate from your landlord is determining what you can trade off, so it is vital that you understand what your landlord is thinking and what is important them.