MRM EXCLUSIVE: ‘Brick & Mortar Franchise Success: Know The Costs or Pay The Price’ Excerpt

Learn how important site selection is for restaurant franchises in this exclusive excerpt from Carolyn Miller”s “Brick & Mortar Franchise Success:  Know The Costs or Pay The Price.” According to the founder of the National Franchise Institute, who was profiled by Modern Restaurant Management (MRM) magazine here, the purpose of the book is to take the guesswork out of the entire development process so franchisees and independent restaurateurs know exactly what it takes to get new locations open in the least amount of time, for the best overall price and, more important than anything else, without making costly mistakes in the process.

A lot of new franchisees and business owners will go online to search for commercial listings or they’ll just jump in their car and start driving around areas where they want their business to be located – like close to their house of their child’s school or daycare center. Because there are so many variables that need to be taken into account, they could ultimately be setting themselves up for failure before they even get started.

Don’t Go It Alone!

Landlords love tenants – and they especially love uneducated or unrepresented ones!  If you think about it, it probably doesn’t surprise you that landlord leases are written by landlords or their attorneys which means the documents are landlord-friendly, not tenant-friendly.

Practically everyone on planet earth is familiar with the term ‘location-location-location’ but not everyone understands just how important it really is.

If you are an independent business owner or a new franchisee and you decide to find a space on your own and negotiate the lease yourself, GOOD LUCK!  First of all, if a landlord sees you coming (unrepresented), you may notice a sparkle on either side of their mouth – it’s drool!  Landlords are busy people.  If they know you’re on your own, they’re probably wise enough to know that a lot of their time is going to be spent on educating you about the finer points of real estate and lease negotiations.  One reason why a landlord may agree to meet with a ‘newbie’ is because there is something in it for them – an unfair advantage!

Most landlords will answer your questions and will be truthful with their responses.  But…what if you don’t ask the right questions?  What if you don’t even know that there are questions to be asked?  By telling you the truth (but not the WHOLE truth and nothing but the truth), they can easily out-position you in any number of ways, starting with the lease.  You know, the lease that they and their attorney drafted together.

We’ll talk a lot more about real estate legal in the next chapter but for the sake of our discussion about site selection and lease negotiations, you should take note that no landlord lease contains all the clauses it should have, and all landlord leases contain clauses that should be removed or at least modified. 

Selecting The Right Broker

Before the right space can be found, you need to find the right commercial real estate partner.  This is really critical.

First, let’s talk about who is NOT the right real estate partner for you.  Besides you yourself, a REALTOR is the next wrong person.  Realtors, which a lot of people don’t realize, specialize in residential real estate, not commercial.  Beware the realtor who tries to convince you (and themselves) that because the real estate license for realtors and brokers is the same, they are perfectly capable of representing you.  They are not!  The lingo for commercial real estate is very different and unique – and so are your potential consequences. 

Now let’s talk about who IS the right real estate partner for you.  For starters, it’s a commercial real estate broker…but not just any commercial broker.  If you need restaurant or retail space, a commercial broker who knows restaurants and retail like the palm of their hand is the person you should be working with, vs. one who spends a lot of time working with clients who lease industrial space or even office space.

Another important qualifier in selecting your commercial real estate broker is to make sure that he or she is a tenant representation broker.  While your broker may also have commercial listings available for lease, when they are working with you they are representing you, not the landlord.  This isn’t just a verbal agreement.  There is a specific document that needs to be executed between you and your broker (in Colorado is an ‘Exclusive Tenant Listing Contract’) that contractually obligates the broker to look out for your best interests, not the landlord’s and not their own.

Ninety nine percent of the time, a commercial broker’s commission is paid by the landlord, even when there is a Tenant Rep Agreement in place.  For this reason alone, you should be partnering with the best commercial broker you can find in order to give your business the best possible chance for success.

Another qualifier in selecting your broker is to ask which other tenants they are currently representing.  While you definitely want to benefit from the expertise they have with locations that are just like the one you will be building (i.e., a restaurant, a fitness concept, a doggie daycare), it’s a good idea to at least ask if they are currently talking to or working with any other concepts that might be a bit too similar to yours, and here’s why.

We all know that restaurants come in all shapes and sizes.  There are QSR’s (quick service restaurants), fast-casual concepts, casual dining options, and even full-service restaurants.  If you are a new franchisee looking for space for your first fast-casual restaurant concept, should you partner with the broker who focuses exclusively on restaurants (since they have the inside track on the market and they have a lot of connections)?  Or are you better off partnering with a broker who does both restaurants and retail? Think about it:  if a desirable restaurant space is available and your broker focuses EXCLUSIVELY on restaurants, who is going to get first dibs on that desirable space?  Maybe you…but maybe not if the broker has other longer-term restaurant clients that they are also looking out for.  If I had to wager a bet, I’d say the chances of you getting first dibs are slim to none.  In fact, I would think that the only way you’re ever going to get a shot at that space is if any of the brokers’ other restaurant clients has already turned it down.

Maybe one of the broker’s other clients said, ‘No’ because their concept already has a location in that trade area and they don’t want to impact themselves.  Maybe there is a menu restriction within that center that won’t allow the other concept to take the space even if they really wanted it.  Or maybe the center has a liquor restriction because of its proximity to a school or a daycare center.  Regardless of the reason, if you align with a broker who only does one thing, your timeline will likely be impacted as you wait for potential locations to come your way.  On the other hand, by partnering with a specialized but diversified broker, you have a better shot at hearing about available  restaurant locations if you are one of only a few of that broker’s go-to restaurant concepts.

Let’s take it a step farther.  This time, let’s say yours is a fast-casual pizza concept.  You might want to reconsider the broker that you partner with if they are also currently representing another fast-casual pizza concept since that would definitely be too close for comfort and could border on conflict of interest.  This type of scenario isn’t isolated to real estate – it can be found with architects and general contractors as well – but if location-location-location is one of the most important ingredients in your recipe, you want to make sure that no one else has better ingredients!

Some brands will prohibit the partners they work with from also working with direct competitors.  That’s great in theory but I’ve seen instances where service providers – who know about the ‘restriction’ – work with both of the direct competitors (in a ‘don’t ask, don’t tell’ mode), hedging to see which one emerges as their top client.   If you don’t ask the right questions, you’ll never know.

Location, Location, Location

When it comes to leasing space and building new locations, there are a lot of critical aspects that can make or break a successful opening.  Practically everyone on planet earth is familiar with the term ‘location-location-location’ but not everyone understands just how important it really is.  Have you ever heard the saying, “High revenue growth forgives many sins”?  Location-location-location fits the bill here.  Even if mistakes are made on the build-out side, a location that is bringing in a lot of customers should eventually be able to recover once the mistakes are paid for.  Obviously that’s not something you can do if no one ever comes through the doors.

There is a tendency to say ‘Yes’ to a location that has the lowest per-square-foot price.  What if that extremely attractive lease rate positions your business in the armpit of the center or around a corner with poor visibility?  Don’t kid yourself that your business is so special that it will be a destination that everyone will be flocking to! 

I read an article recently that said Millennials (who are coming of age as the next generation of franchise professionals) are so technology and social media savvy that they place a lot of faith in Smart Phones guiding customers into their locations.  So much so, in fact, that they are not afraid to take less-desirable spaces because they feel technology will bridge the gap.  I agree and disagree.  Yes, their tech-savvy Millennial peers will use Smart Phones to find them and will probably enjoy the journey.  However, unless the vast majority of their customers are Millennials themselves, the rest of their customer universe may be less enchanted with the treasure hunt and simply opt for an easier-to-find option (perhaps the Millennial’s competition!).  Creating awareness and gaining traction is challenging enough for new businesses when a location is optimal.  If the challenges on the front end prevent early success, it can’t help but have an impact on the chances for long-term success.

If the challenges on the front end prevent early success, it can’t help but have an impact on the chances for long-term success.

Sales and profits should be the top Site Selection Criteria.  When you consider that fifty percent of a dollar is a lot more money than one hundred percent of no dollars, it’s easy to understand that higher sales can often offset a higher base rent.

Even when a site sounds perfect on paper, important site characteristics like visibility, ingress/egress (getting in and out), utilities and space dimensions should be verified before you move forward.  Parking is another consideration.  Although the number of parking spaces within each center has required minimums that are set by the local municipality, neighboring tenants (especially those whose peak customers will be visiting them at the same time that your location will also be its busiest) will impact you.  These are just the very preliminary items that you and your broker should pay attention to.  By themselves, any one of them could be enough for you to immediately decide to look elsewhere.

Among many other things, these are just some of the areas where your real estate broker and your project manager will work together to be sure you get the best location for your new business.

Lease Negotiations & Meeting With Landlords

If you are an independent business owner or a new franchisee looking for your first location, there are things that you and your broker can do to present you and your business in the best possible light with the landlord – and maybe even out-position someone else who is interested in the same space that you’re eyeing.

When you first get together with your broker and sign the Exclusive Tenant Listing Contract (also known as a  Tenant Rep Agreement), the broker will want to get to work immediately to find you the best location for your business.  Some of the preliminary things they will discuss with (and eventually collect from) you are:

• Your Letter of Intent (LOI)
• Your Business Plan
• Your Personal Financial Statements

An LOI spells out details such as the length of the primary term plus any option periods, the base rent amount and any rent escalations, the lease commencement date and the rent   effective date, who pays for renovations, and the timeline that’s involved, etc.

So that you and your broker are ready to immediately move forward when you find the right space, one of the first things you’ll work on together are the details that will be spelled out   in the LOI for you and your new business. 

Having these details figured out in advance allows your broker to simply pull up the form, add address details for the space, and get it in the landlord’s hands as quickly as possible.

By including a copy of your Business Plan and your personal financial statements when you present an LOI to the landlord, you stand a good chance of getting their attention as someone who is professional and SERIOUS!

Triple Net Leases and CAM

Most retail locations have triple net leases, usually shown in documents as (NNN).  What this means is that you (as the tenant) will pay a base rent amount (per square foot) PLUS an additional amount (per square foot) to cover the three components known as CAM (common area maintenance), real estate taxes, and insurance.  Triple net fees, which vary from property to property and from landlord to landlord, are not negotiable.

In a nutshell, CAM is paid to the landlord to cover costs associated with operating and maintaining the common areas of the landlord’s property.  Common areas usually include things such as central restrooms, lobbies and hallways, stairwells and elevators, sidewalks, landscaping, and parking lot striping and lighting.  Some CAM expenses are controllable which means they are fixed amounts that happen monthly.  Others, which vary each month or are seasonal (like utilities and snow removal) are non-controllable.

The per-square-foot amount that the landlord charges for NNN fees is based on your proportionate share (pro-rata share) of the landlord’s total cost for these expenses and services.

I’ve spoken with a number of new business owners and franchisees over the years who admit that they didn’t understand that triple net fees were above and beyond the base rent — until the invoices started coming in!  To say that many of them were unpleasantly surprised would be an understatement.  Here is an example of a triple net lease and how the numbers calculate:

Free Rent

Free rent.  It has a nice ring to it, don’t you think? 

Not every space automatically comes with free rent.  It’s just one of the many things that your broker will help to negotiate on your behalf.  Even if you negotiate free rent, you should know that not all free rent is created equal.  Here’s what I mean:

Free rent can either be a one-time thing or it can be spread out at specified intervals over the course of the lease.  Let’s say you sign a five year lease and the landlord agrees to one free month’s rent for every year.  Great, you will be getting five months of free rent.  But not so fast….the terms of the lease specify that each of the five free months will be recognized after eleven regular monthly payments.  While that will be a nice perk in month twelve, month twenty four, month thirty six, etc., it won’t help your cash flow today.  Not to look a gift horse in the mouth – five months of free rent is great, no matter how you slice it.  It’s just that your cash flow situation could really use the help in the first few months much more so than once you’ve gotten on your feet.  This is where an accurate budget will come into play!

Another important point about free rent – and one that your broker and your real estate legal attorney should both be dialed in on – is the effective date of any free rent that you receive.  Let’s say you didn’t have real estate representation when you met with the landlord to negotiate a lease for your new restaurant.  On your own, you negotiated a three year lease and two months’ worth of free rent.  Most likely you were patting yourself on the back at your savvy negotiation skills because the landlord didn’t have to give you any free rent but you pulled off two whole months’ worth.  Score one for the little guy, right?  Maybe.  It depends on the effective date of the free rent.

If you were so busy doing the happy dance or taking a victory lap in your head that you simply said, ‘Yes’ to anything the landlord proposed, chances are pretty good that the effective date was the day you added your signature to the lease.  While it’s great that you took the bull by the horns and negotiated any amount of free rent, it will take you every single second of those two months (and probably some additional time as well) before you are able to get drawings completed, permits pulled, and construction finalized.  The landlord knew this; you did not.  The landlord’s space would have continued to sit unoccupied for those two months while you got your ducks in a row so he really didn’t give up anything.  In this scenario, you probably burned completely through all of the free rent and actually started paying rent to the landlord before your business ever opened to the public.

We’ll take the same scenario but we’ll change the effective date.  This time, instead of taking effect on ‘lease execution’ date, the lease specifies that the free rent clock won’t start ticking until you have your building permit in hand.  This is cause for a bit of a celebration because even if you aren’t open to the public yet, at least you aren’t putting yourself in the hole while drawings and permits are in the works.

The good news is that there’s a third scenario which is the one that your broker should be working hard to negotiate for you:  a rent effective date that coincides with the date your new business opens to the public!  A lot of factors play a role in negotiating this kind of concession, one of which is the strength of the tenant.  While you may or may not get this, it’s good to know that the possibility is there.

Regardless of which free rent scenario you negotiate, be aware that unless you negotiate otherwise, you could be required to pay CAM charges during your free rent period.

Tenant Improvement Allowance & Work Letters

Tenant improvement (T.I.) allowances are often thought of as ‘free money’ because the landlord is spending his or her own money to make improvements on your behalf to a building that they own.  But think about it.  The landlord isn’t the one who needs the space changed, it’s the tenant.  When you need improvements to the building so that your business operates more efficiently, the landlord’s T.I. allowance is really only front-end help that eventually gets recouped over the term of your lease.  Notice that I said ‘front-end’ help and not ‘upfront’ help.  When a tenant improvement allowance becomes part of your lease during lease negotiations, it’s important to know that you don’t get the money upfront.  When a landlord agrees to an amount (usually a price-per-square-foot calculation), you as the tenant will pay your contractor first.  Once all the invoices are paid and lien releases are in hand, you will submit that paperwork to the landlord who will then cut you a check (hopefully within 30 days).

A Work Letter is a document that becomes an Exhibit within the lease that you sign with the landlord.  As its name implies, the Work Letter spells out the exact work that the landlord (which really means the landlord’s contractor) will complete within the space prior to you taking possession.  Examples include utilities (specific sizes for electrical, plumbing, and HVAC), lighting, finished surfaces like walls, floors, and ceilings, exterior elements, restrooms, etc.  A proper Work Letter contains specific standards and time limits associated with the work that is to be performed.

Work Letters are usually in lieu of tenant improvement dollars.

Your broker’s expertise will play a huge role in successful lease negotiations.  They will know the going rates, which items are negotiable (and to what extent) and which ones are not.  They should also have a pretty good idea about the reputations of landlords and pre-market opportunities (which are spaces that will be coming available in the foreseeable future but have not been announced yet).  A broker is an invaluable resource for you as you take this journey, but they can only look out for your best interests if they’ve been invited to join your team.

A broker is an invaluable resource for you as you take this journey, but they can only look out for your best interests if they’ve been invited to join your team.

Below is an example of what can happen when a broker’s expertise is bypassed.  It’s the story of one naïve mistake and the domino effect that followed:

An independent restaurateur – who was hoping to eventually franchise – was looking for space to open a 2^nd location of his hot dog concept.  He didn’t partner with a commercial tenant rep broker because the landlord already had a broker.  As the tenant, he figured that if the landlord didn’t have to pay an additional commission for a second broker, he would use that as leverage to get a better deal.

After the lease was signed and the space was built out, the restaurateur started getting nervous because traffic counts, in this case pedestrian traffic, were significantly lower than what he was expecting, based on the figures he received from the landlord and the landlord’s broker when the space was originally leased.

Several months in, the restaurateur was baffled that sales were so much lower than he projected (or that he could afford) and decided to confirm pedestrian counts.  Imagine his shock when he learned that the pedestrian traffic counts that he received from the landlord and the landlord’s broker were off by 80%!  How could this be?  It turns out that the reports provided during lease negotiations were older and outdated.  They contained more-favorable figures than what was currently happening in the area.

Remember when I mentioned that, as a business owner, you will get stuck with the business that you allow to happen to you?  This would be one of those instances.  Because the restaurateur didn’t have his own broker and he took the information that was given to him at face value without verifying anything, he really didn’t have a leg to stand on (or any recourse, for that matter).  It’s no surprise that the Landlord and the broker were looking out for themselves – and who could blame them?  Their job was to get the space leased – which they did.  The poor restaurateur was not only losing his shirt on this location, he actually invested a lot of money on the build-out just to get this second location open.  Let’s add insult to injury…the restaurateur’s time and resources were now split between two locations because the profitability on location #2 (or, more likely, the lack thereof) forced him to work IN his business (as a ‘crew person’) vs. ON his business (as its visionary owner) because his revenues were so low that he couldn’t afford the labor costs associated with hiring employees.

After working countless hours for a couple years and struggling to keep the straw above the surface of the water, this restaurateur wound up closing both locations and going back to a desk job.  No matter how excited and optimistic he was in the beginning, this long, drawn-out failure took the wind out of his sails and a lot of money from his retirement account.  In his 50’s, he is now working to replenish his retirement account so that he isn’t forced to work forever.  If I had to wager a bet, I would say that it’s unlikely he will ever make the foray into business ownership again.

Had this restaurateur partnered with an experienced broker, it’s likely that the undated information that was originally presented by the landlord and its broker would have been validated or even researched personally by the broker before the lease was ever signed.

Just like clothes on a rack that look perfect (until you try them on), a space that looks perfect on paper may have flaws at the local level that could – and often should – warrant walking (or maybe even running) away!  While that can be disappointing and will draw out your search for a new space, moving forward with an inferior location could be a fatal mistake.

Educating yourself about commercial real estate and then partnering with the right kind of broker are two key things you can do to be sure that you have the best chance of negotiating a lease that works for you and your new business.  The points talked about in this chapter are really just the tip of the iceberg.  There is a lot more to know and since broker commissions are paid by the landlord, you can’t afford to NOT have a commercial real estate broker on your team!