Behavioral Patterns of Winning Tenants and Great Landlords
Part One of a Multi Part Series
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.
1. Know Your Banker—and Your Available Funds
This appears to be obvious, but undercapitalization is the number two reason for failure. A good friend who started his business in a competitive center recommends at least six months of working capital with the assumption of no sales or income. I agree, although this capital requirement will throw many prospects off the radar.
“Who is your banker” is the first question I will ask a prospect who has a believable concept, and about 50% do not have a direct answer. The most common sources of funds are home equity, personal savings, and bank or SBA guaranteed loans. Less than 20% of my prospects have written down a sources and uses array; they just “have an idea of what it might take” and somehow feel that someone will invest in their business. WRONG. Who but a very close friend or family member would invest in a small retail start-up?
Do not depend on your business for income generation for self financing your expenses for at least one year. If you do not have the capital to withstand a year of negative cash flow while ramping sales, then keep your day job.
2. Know Your Sales Potential
At the very least, strip mall retailers should understand market potential and store sales potential. These figures are not easy to derive, but must be dredged up before any serious commitments. Market Potential is the sum of dollars spent annually within your trade area for the goods or services you plan to offer. Store potential is your piece of that pie, and it will be smaller than most assume. Even a grocery store who will typically look to a 1.5 mile radius as their primary trade area will assume no more than a 75% share even if there is no grocery store within three miles. Customers will shop elsewhere and no one has a 100% market share.
If your state has a sales tax, quarterly sales data are available for no or minimal charge through the taxing authority. The data may be county or city specific, however some states will provide block census data which allows drilling down to a very tight market trade area. There are several commercial data providers such as Claritas who can provide a ballpark market analysis and sales projections for under $300. The data may not be completely accurate as these services project future data from past census, but it’s better than what most prospects have.
Once you have some reasonable sales estimates, you have the basis for constructing income and expense projections.
3. Know Your Operating Numbers
Reviewing tenant failures since 1998, I found one tenant that had current and accurate sales and expense data to which they could refer and analyze. That anyone can invest $200,000 to $1,000,000 or more of cash and personal debt and remain ignorant of their daily, even hourly, income and expenses is incomprehensible to me but that is the norm for strip mall retailers!
Further, those that do attempt to construct a pro-forma income and expense statement inevitably start with the null question of “how much do I need to break even” and work backwards. Oh! I need to gross $22,000 a week! Well, we can do that! We will make it happen! As much as I love and encourage positive mental attitude, that approach is backward, invites fuzzy math, and tends to ignore the results of market research and sales potential.
The approach should always start with sales potential, derived from market potential. Now that we have the top line sales pro-forma, we work in the expenses, both fixed and variable, to see if we are broaching a business or a hobby. First we start with the easy part, the known expenses which can include rent, advertising, administrative, utilities, taxes and debt service. Then, we drop in the cost of goods sold and fixed and variable labor and have a first look. Does it make sense? Could you take your cash and passively invest in the stock market or real estate for the same or even better return, or are we seeing somewhere around a 15% to 20% profit structure? If you don’t see at least that much after the first year, your margins are too thin to take this risk and you need to walk away. You’ve invested $300 in market research and maybe talked to a lawyer and accountant. Write off your grand spent and consider another venture and venue. That $1000 is the cheapest money you will ever lose.
4. Know What Business You Are REALLY In
While nearly every bank, SBA report, and the small business bean counter will tell you that under-capitalization is the number one cause for business failure, they’re wrong. If that were the case, they by extension if one has a $1,000,000 cash stake and opens a small candle shop and after five years closes because they’ve never broken even and ran out of money, they’re under-capitalized. Do you see the absurdity of this broad brush statement?
The number one reason for small business failure is a lack of understanding of what you are, or should be, providing your target market.
If we ask a restaurant what business they are in, 99% will answer “food service.” In fact, depending on the venue it could be a number of things, but never food service. If you are running a restaurant in an area with low daytime population but with large families, you could easily be providing a home meal substitute operation. In this case, your business is “preserving the customer’s family time and offering a quality home dining experience within their budget.” If you are a fine dining establishment, it’s likely that your business is “enhancing the self image and perceived image of the customer by others.” The word “food” is never mentioned and does not need to be. The golden few who understand their customer and how to satisfy them know the physical product category is secondary to cutomer need satisfaction.
I was contacted recently by a local startup restaurant who was having trouble. They were not tenants, but nice people and I agreed to do an evaluation. What I found was 1) a secondary location that served a very limited trade area that could in no way provide an adequate customer base, 2) a physical food product that was forgettable, 3) a plain, uninviting interior, and 4) pricing that could easily drive one to a competitive venue. In other words, they had not achieved any sort of monopolistic competitive advantage, and could only be viewed as an also-ran. They were not focused on a market; they were just “there.”
The next evening we met over dinner at one of my restaurants. I had assembled my own cost and volume estimates the previous evening, and they confirmed that I was within a few hundred dollars on weekly income and outgo. The rent alone, which was at market and reasonable, was nearly 25% of their sales. If I see a local restaurant paying over 17% while ramping sales and 12% stabilized, I have grave concerns. After reviewing their sales history and discussing the marginal food product and tertiary location, I recommended closing the doors. They closed the next day and subsequently declared bankruptcy. It was not a report that I wanted to give, but it was a reality check that they needed.
The point of the above is that these operators lost everything they had because they did not perform even a modicum of due diligence, nor did they know before they signed a long term lease their reasonable sales potential or expenses. This is the dark side of my job as an at-risk developer, and the sadness never goes away in these situations.
The legendary merchant Marshall Field boiled this last point down to simply “give the lady what she wants.” It’s simple, and it works. Listen, assimilate, and re-focus, even re-purpose if necessary. The customer will reward you by converting your inventory to cash. That’s your goal, remember?
Next In This Series: Five Questions Every Landlord Must Ask A Potential Tenant Before Lease Signing.
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On Dec 5, 2007, SportsCuts said:
Excellent article John. I think you hit the nail on the head with this one.
Thanks for the Claritas link as well. Even though I am two years into my business, I think I will check them out.
On Dec 5, 2007, Jeanne said:
John, very very good article. I got some good learning tips in there and I thank you for sharing that information. I can’t wait for the next article onf the Five Questions… Great job!
Jeanne
J and J Treasures