First-time tenants looking for retail space are often astonished by the demands of a retail landlord. Unlike upper floor tenants, they are often asked to do their own improvements and sometimes to do basic code work, which they believe the landlord should provide. Retail tenants are expected to pay their own utilities and garbage and do their own janitorial; and sometimes, in addition to their base rent, will pay the landlord a percentage of their gross income. There are often limitations on to whom they can sell the business or to whom they can sublease their space. Two initial areas to understand are the lease structure, and tenant improvements.
How leases are structured
Most commonly, retail leases are NNN, or “triple net.” This means that in addition to the base rent for the space, the retailer pays all the expenses of operating their own space except the mortgage on the building. (These charges are also called “common area charges” or CAM.)
The NNN charges will include the space's pro-rata share (usually based on square footage) of the building's taxes, insurance, management expenses, exterior ground maintenance, security services and all other costs of operating the building from which the retailer benefits. The NNN costs are usually estimated at the beginning of the year and then are divided by 12. The monthly NNN charges are then added to the monthly rent and are adjusted to the actual costs at year's end.
One important thing to do when negotiating a retail lease is to get a list of all the items for which the retailer will be charged, and the costs of these items in the previous year, in order to build them into the rent budget. In addition to the NNN costs, a ground floor tenant usually pays their own utilities, garbage collection and janitorial. These costs must also be built into the rent budget, and usually must be estimated by the tenant, as the landlord won't have records of those costs.
Making tenant improvements
Most improvements put into a space by a retailer bring no value to the landlord. When the retailer leaves, the incoming tenant normally demolishes all of the custom improvements made by the previous tenant. Hence the landlord will usually only contribute to the cost of the tenant's build-out as an incentive when it is absolutely necessary to do so to lease the space. If the space is in demand, the landlord may be able to demand that the tenant also do basic building code work. The situation on tenant improvements may vary dramatically from space to space.
Financing for tenant improvements may also take several forms. The landlord may agree to subsidize some of the improvements through free rent. The landlord may also pay a lump sum when the improvements are finished and the tenant moves in. The landlord may also loan funds to the tenant by increasing the rent over the lease term to amortize the cost of the tenant improvements. Or, the landlord may do some of the improvements himself. Or, the tenant may pay the landlord to do some of the tenant's improvements. Receiving approval from the landlord for improvements, ascertaining who will pay whom when, and documenting all the agreements around tenant improvements is an important part of retail lease negotiations.
Retail leases usually contain many other specialized terms and conditions. Brokers specializing in this area can be invaluable in helping any tenant negotiate a lease under which they can operate successfully.
Marti Christoffer specializes in retail and ground floor leasing for Starboard Commercial Real Estate in the San Francisco area. She also sits on the Board of Commercial Real Estate Women (CREW).