MRM EXCLUSIVE: Credit Remains King in Multi-Unit Franchise Lease Negotiations

Thanks to the strengthening U.S. economy, both rents and occupancies are on the rise at better shopping centers around the country. Does this mean multi-unit franchisees are losing leverage in lease negotiations?

Not necessarily.

To be sure, landlords today can be a bit more aggressive provided their centers are well located and enjoy strong foot traffic. Personal guarantees, in which tenants agree to be liable for the landlord’s losses in the event of a default on the lease, are one expression of this. Back during the recession and its aftermath, some landlords reluctantly agreed to shorter guarantees than they would have preferred (in some cases, the guarantees were for just one year). Today, most landlords in my home state of New Jersey are seeking longer guarantees than before, sometimes substantially so.

Multi-unit franchisees have good reasons to continue to feel emboldened at the negotiating table.

Guarantees vary from state to state, depending on what is customary among the parties involved. In New York, for example, many landlords ask for so-called “Good Guy Guarantees,” which require tenants to provide several months’ notice and not be in default in order to limit the landlord’s financial exposure should the tenant close its store prior to the end of the lease. In addition, many savvy landlords around the country often require tenants to agree to pay back the unamortized costs that they have incurred, such as brokerage commissions and tenant improvement allowances. These negotiating points can make a big difference, which is why it is so important for tenants to be represented by experienced retail brokers and lawyers.

While it is true that today’s landlords are being a bit more aggressive in negotiations, the tables have by no means turned with respect to leverage. Simply put, multi-unit franchisees have good reasons to continue to feel emboldened at the negotiating table.

For starters, the first criterion of every shopping center owner—particularly those embarking on new projects—is finding tenants with solid credit. Multi-unit franchisees tend to be in high demand precisely because their credit tends to be so strong. This is especially true of those operators with locations numbering in the hundreds.

Another important consideration is the slogan that is now on the lips of so many of today’s retail landlords: “Food is the new anchor.” Amid competitive pressures such as the rapid growth of ecommerce, many brick-and-mortar chains are shrinking their store sizes, closing selected underperforming locations, or using the bankruptcy process to shutter large numbers of units or close down altogether.  By contrast, restaurants continue to generate foot traffic. They are both Internet resistant and experience-oriented—precisely what landlords are looking for as they seek to fill vacancies and make their properties relevant to shoppers who can order just about anything they want from their smartphones.

The biggest challenge for the restaurant franchisee is to overcome competition from rivals.

Savvy restaurant operators with strong credit are well aware of these dynamics. They are unafraid to bring a sharp pencil to the table and might, for example, ask to see the landlord’s development pro forma in order to understand what kind of returns the landlord is actually making (with a view toward holding that landlord to a low return). The economic rebound has not been so strong that restaurant chains are being forced to, say, pay for their own build-outs or forego receiving tenant improvement allowances (in New Jersey, landlords tend to pay TI of between $10 and $20 per square foot).

Typically, given the proliferation of restaurant brands in today’s marketplace, the biggest challenge for the restaurant franchisee is to overcome competition from rivals. Indeed, if a landlord has a desirable restaurant location available for lease, you can bet there will be at least five different competitors seeking to land the deal. That means landlords can in many cases “have their pick” among these competitors. And so you have to be able to win the landlord’s confidence that, in fact, your particular concept rises above the competition and is the one with the longest staying power, most compelling brand and strongest financial statement. Communication and selling skills are critical here.

In retailing, of course, it is always tricky to make sweeping generalizations: The dynamics in a class-“A” shopping center in an urban area will be different from those of a “C” property near a failed housing development. Fortunes vary at individual centers, too, because one center might be thriving even as another one across the street struggles to survive, perhaps because of dated design, the wrong tenant mix or lack of easy ingress and egress. Generally speaking, however, multi-unit restaurant franchisees, far from being hamstrung by the economic recovery, are still going strong. They can and should be unafraid to defend their interests aggressively as they sit down to negotiate new leases or renewals.