Who Should Pay the Impact Fees?

In a sellers’ market, like the one we’re in now, negotiation for leased space gets tough. Landlords grant far less concessions on a deal than they did just a few years ago. Inventory for well positioned space is low, demand is high. In the race for space, prospective Tenants sometimes agree to pay for items that they normally would not, such as items that are traditionally supplied by the Landlord.

There’s a catchy adage attached to what items Tenants’ believe are the Landlords responsibility to tender. It goes ‘If it stays, the Landlord pays’. Utilities, structural improvements, and necessary ancillary services (parking lots, etc) are among these items – they ‘stay’ with the space after the Tenant leaves. BUT there is another, sometimes large ticket item, one that rarely gets brought up at the initiation of a deal – impact fees.

Impact fees are imposed by the city or county; as such the rates vary from county to county, from city to city. They are called many things. They are hidden under names like, reservation fees, sewer capacity fees, meter fees, connection charges, tapping or tap-in fees, EDU fees, availability fees, the list continues.

In some cases these fees are zero or negligible. Sometimes there is a moratorium, but in many cases impact fees are an unforeseen cost that blindsides the Tenant when they go to pull their building permit. Some building departments will hold your permit hostage until these fees are paid in full. I’ve personally seen impact fees across the board. I’ve seen some impact fees as high as $300,000 in parts of Maryland attached to the use of a patio. I’ve seen some in Florida that we’re $5,000. I’ve seen some that were $300. It really depends on the location of your project.

If you’re interested in a space, especially if you’re going from one use to a more intense use (for example going from retail to restaurant) inquire about impact fees. Ask your broker to vet this for you. Since these ‘impact fee credits’ (they become credit as soon as they are purchased) stay with the property, they are assets to the Landlord. Get language into your LOI that makes any payment of impact fees or like charges, the responsibility of the Landlord. If this item becomes a negotiation point, be sure that you know the valuation, that your broker or architect has inquired about the dollar amount due and when that amount is due. 

Tenant Improvement Allowance – A Shell Game?

I have many franchisees ask about Tenant Improvement Allowance. It almost sounds too good to be true to those that are just stepping into the world of Real Estate. “You mean the Landlord is going to give me money to help me physically build out my space? Wow! What a good guy!”

The concept of Tenant Improvement Allowance, sometimes called TA or TIA, isn’t about the Landlord doing you any favors. Many call it a ‘shell game’ because it can be used as a way to raise the base rent. In which case, you are essentially financing these ‘free’ improvements through, not only the initial term of your lease, but any future options you exercise.

That being said, TIA can help out those entrepreneurs that start out with only a small amount of capital. It’s a real balancing act. Too much TIA and your base rent is inflated. Watch out for this scenario when a Developer is about to flip the property. To make his or her balance sheet look better with large rent numbers, they’ll flood you with cash up front. Be smart about it. You’ll be paying the inflated rent for 5 or 10 years; this time period can be long enough for you to have paid the original TIA amount back 3 fold.

Percentage Rent and Breakpoints

Sometimes Landlords ask for percentage rent. I often get asked what is percentage rent, immediately followed by the question how to calculate a natural breakpoint. 

Basically, percentage rent is a way for the Landlord to share in the success of your business. The idea is that they receive a negotiated amount of additional rent if you hit a negotiated milestone in sales. Lots of use of the word ‘negotiated’ here because there are several variables. 

There are two ways that Landlords establish the threshold above which they receive ‘percentage rent’. One way is a natural break calculation. Here, the amount that you’ll pay in additional rent is a function of your base rent. I’ll work through an example below. The second way to establish the threshold is an unnatural break. Here, the Landlord an you just agree on a sales volume. 

Lets work through an example of a natural break and an unnatural break. 

Natural Breakpoint Example: Lets say your paying a base rent of $25 psf on a 4,000-sf space. You annual rent in this scenario is $100,000.  The Landlord has proposed percentage rent at 5% above natural break. So $100,000/0.05 = $2M. This means your natural breakpoint is $2M in sales. The Landlord will reap 5% of anything you make above that $2M mark. If you make $2,200,000 in annual sales, the Landlord will be owned $10,000 from you in additional rent. Heres how I calculated that: $2,200,000(your sales) – $2,000,000 (natural break) = $200,000 (0.05) = $10,000.

Unnatural Breakpoint Example: Using the same example $25 psf on a 4,000-sf space. In this example the Landlord want 5% over an unnatural breakpoint of $1.8M. Here, the Landlord has set a breakpoint that is not tied to the base rent – he can set it as high or as low as he needs to make his ROI work for him.  Lets say you made the same $2,200,000 in annual sales. The Landlord would get $20,000 in additional rent. Here’s how I calculated that: $2,200,000(your sales) – $1,800,000 (unnatural break) = $400,000 (0.05) = $20,000.

The concept of percentage rent is usually in the favor of the Landlord. I’ve seen it used by an experienced broker to reduce the base rent. The key to percentage rent is to put that ‘carrot’ of a breakpoint as high as you can so that when you do hit it, your sales are so strong the additional payout doesn’t have an impact on your operation.

How Much Should I Be Paying In Rent?

I often get asked ‘How much should I be paying in rent?’. The rule of thumb for a restaurant is based on your projected sales. Your all in rent ceiling should be no more than 6% to 8% of your gross sales. 

An example of this is as follows:

Lets say you have a 3,500-sf space at an all in rent of $20 psf. Your annual rent for this space is $70,000. Lets also say that your restaurant is projected to do $1,000,000 in annual sales. Your rent ceiling would be equal to $1,000,000 (8%) or $80,000 per year. In this example, the proposed rent is lower than the rule of thumb, so judging by industry standards and assuming your operating your restaurant efficiently, this rent rate is manageable.

Annual CAM Increases

Recently, I received a call from a franchisee who was upset about his CAM (Common Area Maintenance) increases. For a 4200-sf restaurant endcap on the edge of town, the franchisee was paying around $6 psf in CAM charges. The $6 psf CAM charge reflected a recent 5% increase. His question: “What can I do to get my CAM charge down?”

“Yikes”, I said. Not because of the CAM rate (this is actually a very decent CAM rate), or the CAM increase,  but the fact that he wanted a reprieve in CAM costs. CAM is notoriously difficult to negotiate down, especially once you’ve signed the lease. “You’ll have better luck negotiating a lower base rent”, I told him. I needed more information about his situation. 

The franchisee told me that the property had just been flipped. “What are your neighbors paying in base rent and in CAM?” I asked. He wasn’t sure, but he made an effort to go find out. In the meantime, I called a broker I knew in the community and asked her what the comparables were for his area. “Even in an endcap, he’s paying about $1.50 psf over market”, the broker told me. 

With this information and the intel from the adjacent tenants in the shopping center, the franchisee was able to negotiate a lower base rent rate. How is it possible to lower your rent rate after you’ve signed a lease? You need to communicate with the Landlord. If you’re feeling a pinch for whatever reason, communicate that to their team. You don’t get anything if you don’t ask!