From Kathy in Athens, GA
Q: I have been approved for [xx] franchise, and have found a strip mall in a good location. The landlord is not moving on the rent. How do I know how much rent I can pay?
A. Kathy, I’m deleting the franchise name and will send you a complete percentage rent table, and I will explain how to use it. For this discussion, I found a short version of a percentage rent table here.
Here are some steps to take which aren’t a substitute for a sophisticated income model (which this franchisor doesn’t typically use), but will give you an estimate that’s fairly close to the maximum sustainable rent you can pay.
1. Shop around in comparable locations. Yours is a common use so you won’t be able to get in to some places as the use will be taken, but ask the leasing agents and even the shop owners what they are paying. You should be able to determine if your landlord’s rent is in the right range.
a. Don’t forget to ask the triple net rents, or CAM. They can vary widely between centers, especially if the property has been reassessed upon a sale. Here in California the CAM can increase dramatically after a sale is closed, from the property tax increase.
2. Look at the percentage rent tables; in your case the typical percentage rent is 7%. Although most strip mall leases do not require percentage rent clauses or the landlord often will waive them, we should understand what they mean. Let’s say the minimum base rent is $24.00 or $2.00 per square foot per month. Divide the annual base rent by the stipulated percentage rent figure, and we arrive at $343.00($24/.07). Remember, we’re discussing square footage, not absolute rents. Multiply your space square footage, let’s assume 1,2000 s.f., by $343.00 and our product is $411,600. When you have a percentage rent clause, that figure of $411,600 is known as the “break point.” If your annual sales are above that figure, you will pay the greater of 7% of your gross sales, or the minimum base rent of $24.00 psf. So, if you did $40,000 per month, or $480,000 per year, your adjusted rent would be (7% x$480,000)= $33,600, whereas as if you did less than your breakpoint of $411,600, your rent would be $28,800.
The significance of hitting a break point is that your rent has dropped to a highly favorable( read low) percentage of gross sales. In the past two decades CPI increases (which our legal contributor Dave Durrett does not recommend) or fixed annual increases have all but replaced percentage rents in strip mall leases, but the calculation is significant for calculating commercially reasonable rent levels for each category of business.
3. Take the table percentage and double it. In your case, that means you can pay around 14% of your sales volume in base rent and sustain operations. This is a very rough estimate, but sometimes close enough for a go/no-go decision.
4. Divide the quoted minimum base rent ($24) by the doubled percentage figure (14%) and we arrive at $171. Multiply by the square footage of 1,200 and we arrive at the lowest volume needed to keep the base rent at 14% of gross sales, or $205,200 annual sales volume. If your sales volumes are at that level or better you should be fine (in your business; rent levels differ for each category) but with volumes below that figure you might have trouble breaking even as your rent would exceed 14% of your sales.
5. Divide and Conquer. $205,000/ 12 months = $17,083/4 weeks = $4,271 per week volume to pay the bills.
Can you do that, Kathy? Looking at a recent aerial photo, your location in Athens doesn’t appear to be in the newest growth area, but if it’s stable I think you can do those volumes with that franchise.
Capsule Notes-Estimating Maximum Base Rent Payable
- Ascertain average vicinity rent levels
- Find the appropriate percentage rent factor
- Double that factor
- Divide the annual base rent by the doubled factor
- Reduce to monthly or weekly as needed
- Your decision is now can you produce the minimum sales volumes to sustain operations?
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What is the average percentage of total common area expenses to total minimimum rental income in Southern California strip centers?