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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I have a great deal of respect for McDonald’s, and a good bit of that is from my experience as an employee back in the $.15 burger days. They taught me how to work in production.

In grad school we studied their new product introduction cycle; it’s one of the most sparse in the industry. There was a three year void of new products between the existing line and the introduction of the Big Mac, way back when. McDonald’s doesn’t make many mistakes, and they still have the highest margins in the industry. And as we discussed in this recent article, they are still tops with us boomers.Yet, the “how many MBAs did it take to screw this up??” resurfaced yesterday when I bought my first Big Mac in several years, at the drive-thru.

Being a dedicated multi-tasker, as you probably are as well if you’re in this business, I often eat while I drive. I know, I know, that’s a no-no. As a matter of fact, Nation’s Restaurant News in May 2001 cited a study of “vehicular dining.”

According to recent studies conducted by the American Automobile Association and by the Public Health Department in San Francisco, drivers who ate and drank — coffee, milk shakes, colas, juice and other nonalcoholic beverages - behind the wheel were at least as dangerous as those who talked on cell phones.

However, at least 80% of us DO eat or drink while driving occasionally, and that fact is inarguable. A marketer, be them a one off strip mall retailer or a multi-national corporation, must meet the market and customer needs, and McDonald’s didn’t meet mine yesterday.

Driving up Interstate 5, yakking with some broker on the cellphone with the bluetooth, sipping my Coke, I opened one of the two Big Mac boxes (there’s a 2 for $4 deal going, how could I say no), I was horrified to discover the missing ingredient–NO PAPER WRAP! The cardboard box was the packaging and I knew what you see on the left was going to happen.

I ended up with half a head of shreaded lettuce, secret sauce, and burger juice running down my arm, onto my jeans, and the landing spot was the seat of my SUV. It was a damn mess and I blame the Ivy League schools for turning out too many knuckleheads obsessed with saving $0.002 per product delivery while marketing and product delivery get ignored.

I had the same question about the genius boys several years ago when I left KFC with a HALF a drink holder! Instead of the usual four-place cardboard holder, they gave me a half a holder for 2 drinks. How the hell does THAT work? Try balancing two sodas in traffic without a base to hold them. Did the packing managers miss their basic physics class?? Bet they saved a quarter cent though, and got a weekend in Dollyland as a bonus.

When the customer leaves your store, or your drive-thru, the customer experience continues until the product is consumed, stored, or discarded. An omission like this can cost any retailer a customer. Jamba Juice has “customer walks” several times a day, not only to insure the path to the store is free of trash and debris, but the trip out of the store when the customer first tastes the product is equally as pleasant.

What do you do to insure that a positive customer experience continues after you’ve got their money?

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Using the CPI Can Cause Major Problems in Collecting Those Rent Increases!

By Legal Contributor David Durrett, Esquire–Cohen Durrett, LLP

Many commercial lease structures include rent adjustment provisions that rely on changes in the Consumer Price Index (”CPI”) which is assumed to reflect the cost of living increases, if any. Unfortunately, landlords do not appreciate that the U.S. Department of Labor, Bureau of Labor Statistics publishes many indices and does not publish every index every month. Also, the base year for comparison, the year on which the rental increases is to be based, has been changed for some indices. The calculation of the rent increase can be done for the single year just completed or for the period of time back to the original date of the lease.

Ironically, the negotiation of a CPI clause often results in a tenant’s desire for a ceiling (e.g., not to exceed five percent per year) and a landlord’s desire for a floor (e.g., not to be less than two percent per year). In essence, each party desires some certainty concerning the rent adjustment.

Because of the risk of using a CPI provision, landlords may be better served by simply increasing the rent by a fixed percentage each year.

Aside from often not clearly indicating the appropriate index, landlords often forget to enforce the CPI clause and to make the required calculations. If a landlord should fail to make the calculation and advise the tenant of a rent increase, then the landlord may be surprised to learn about Section 2076 of California’s Code of Civil Procedure.

Section 2076 requires a person receiving money, at the time the money is received, to object if the money tendered is insufficient. If no objection is made, then the person receiving the money is considered to have waived any right to additional payment. Based upon this statute, the California Supreme Court held in the case of Julian v. Gold, 214 Cal. 74 (1931), that

a landlord cannot demand payment of rent for past months if he has already accepted partial payment for those months without objection

. A similar result occurred in Bettleheim v. Hagstrom Food Stores, 249 P.2d 301 (1952), where a landlord was entitled to an increase in percentage rent from two percent (2%) to four percent (4%), but who continued to accept two percent (2%) by mistake. The appellate court held that the landlord lost its right to demand the additional two percent (2%).

Too often landlords contact attorneys after they have forgotten to send the tenant a notice of an increase based on the CPI adjustment. Section 2076 poses a problem as to the rent already collected. Landlords would probably be better served by using a rent schedule that shows fixed percentage bumps that require no future calculations by either party over the course of time. Of course, this still does not relieve the landlord of comparing the check with the rent schedule. The underlying theory for such a schedule is to keep it simple. If landlords feel that complexity makes the provision better, then attorneys will profit in resolving the complexity.

Attorney David Durrett has practiced as a shopping center lease specialist for over 25 years in Northern California. David has represented Fortune 500 clients and sole practitioners. He can be reached durrettatcohendurrett.com, or at (916) 927-8797. Neither Cohen Durrett nor Mr. Durrett are offering legal advice with this article, and any legal questions pertaining to this content should be directed toward your legal counsel.

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In our first article in the series, “4 Rules for Strip Mall Tenants Before Lease Signing,” we gave some guidelines for prospective strip mall tenants. This article discusses questions a landlord must ask that tenant before a commitment (lease) is executed in order to more accurately determine the viability and longevity of the proposed tenant.

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Behavioral Patterns of Winning Tenants and Great Landlords

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The actions suggested in this article are a result of back testing failed strip mall retailers and the reasons for their failure. Prospective tenants should use this as a basic but mandatory checklist prior to signing a lease.

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“Slightly down, until we went “red,” smiled the young lady behind the counter, “and since that day we’re up $5,000 a week!” (more…)

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