Leasing Commercial Property - Basic Tips for First-Time Business Owners

If you're a business owner looking to relocate or expand your operations, you've tuned in to the ideal episode because we're going to speak with an expert in the area of commercial real estate, to give us some guidance and answers to questions that will possibly help you with your property search. That all in itself is a full-time job or can be certainly and it's one that you can't take lightly. My guest named today Fred Encinas, he is the Senior Vice President at NAI Capital, a commercial real estate and property management firm servicing the greater Southern California area.

Questions Answered For You

I'm big on the old saying, plan your work and work your plan. You need to look at, okay, I'm going to do this store today, where am I going tomorrow?

- Fred Encinas

Key Takeaways

  • One of the things the franchisees have really, really brought to me as far as the fact that I like to work with myself and our team over here is that we're not just site-driven. And we'll talk a little bit more later down in the program, but we are market-driven. 
  • Landlords are not as readily accessible to giving you all the options you want. You look at your term, you look at your options, you mention the base rate.
  • So one of the things you always try to negotiate is a win-win situation.
  • You should always work with a broker that knows the market, knows how to negotiate LOI's, and I strongly recommend that any kind of operator has an attorney review that lease at the end.

Read Full Interview


Jeff: Welcome to Deal Talk by Morgan & Westfield, I'm Jeff Allen. If you're a business owner, entrepreneur, or an investor this is the program for you. Our mission is to educate and inform you with the help of some of the most credible, highly-regarded experts in the industry of transacting businesses so you'll be equipped with the knowledge to help you make important decisions when selling your current business or buying one. If you're a business owner looking to relocate or expand your operations, you've tuned in to the ideal episode because we're going to speak with an expert in the area of commercial real estate, to give us some guidance and answers to questions that will possibly help you with your property search. That all in itself is a full-time job or can be certainly and it's one that you can't take lightly.
 

My guest named today Fred Encinas, he is the Senior Vice President at NAI Capital, a commercial real estate and property management firm servicing the greater Southern California area. Fred Encinas, welcome to Deal Talk, good to have you.

Fred: Thank you so much Jeff.

 

Jeff: Fred, let's start talking about it. You've had quite a nice career, and now of course you've kind of moved inland Southern California and you're handling a really, as you say, kind of specialized area of retail real estate and there's so much of that that is swapping hands back and forth. How many of the clients would you say are franchisees versus those that are corporate-owned stores?

Fred: Most of the clients I work with are franchisees, here's what's happening. Companies like Blaze Pizza, Dunkin' Donuts, Five Guys Burgers and Fries, they sell territories and within that territory that they sell to their franchisee, they pretty much all fall in the same model. They sell a territory then it's up to that franchisee, master franchisee in the area to determine where he wants to go, which sites, and how many sites he has to build in a certain build out time period. They want to work with brokers that are knowledgeable in the market, and knowledgeable at build making, and knowledgeable in the LOI, the Letter of Intent part of the process which is very, very instrumental in getting yourself from a letter of intent to a lease on the site that you picked. One of the things the franchisees have really, really brought to me as far as the fact that I like to work with myself and our team over here is that we're not just site-driven. And we'll talk a little bit more later down in the program, but we are market-driven. We do a plan for a franchisee that wants to do multiple stores. And we figure out, "Here's where you want to be today. Where do you want to be tomorrow?" But also we integrate the whole plan and then we cure it. We either cure it or we kind of phase it. So either one, two, or three. And that way we try to go up for high profile locations first. Some people would only want to do one store today. You can do one store today but where do you want to be tomorrow? You're going to assume that you're going to be successful. So with that assumption you need to make sure that you do a market plan of an area knowing where you want to be in the future. 

You're going to assume that you're going to be successful. So with that assumption you need to make sure that you do a market plan of an area knowing where you want to be in the future. 

Jeff: We're talking about commercial real estate with Fred Encinas, my guest today from NAI Capital. You're listening to Deal Talk, my name is Jeff Allen. Fred, it sounds to me like if you have plans for growth later on and you're not simply the type of person who's going to be content with one location that when you start out looking for or scouting out your first location that you're going to want to work with, a broker or someone involved in commercial and real estate property for the long haul to find you these ideal locations in the future. Isn't that correct? Because not everybody is going to do that, is that right?

Fred: That's correct. When I came out becoming a broker in late '07-'08 time the market was really depressed. And myself and my experience level there were people that wanted to have that experience level brought on to their concept, i.e. Five Guys, Dunkin' Donuts, and so forth, that they could feel assured that this person not could just find one site and be a one site hitter and move on, they're committed for the long-term. Here's an example. Just today I submitted a site evaluation package for one of my three Five Guys franchisees on a site that we were working on for six years. Not that we work on every site for six years but we did a master plan of this area, "We're going to do this one today. We're going to do that one maybe a year from now and so forth." We identify where we want to be over time. And even if you're going to be a one store person I'm sure any kind of entrepreneur that wants to do a restaurant or any kind of retail store, they have to look to the future. One of the things that's very, very important is the old adage, location, location, location.

 

Jeff: I know that you kind of specialize in retail and we'll go ahead and we'll stick with that. Maybe I don't have an idea necessarily for growth at least right now. But I am interested in starting my own business. Maybe I've an opportunity to work outside the market a little bit and maybe I'm going to branch out on my own. I've got a business partner and we're going to kind of split up, and I want to grow my business right now. And we'll take the Los Angeles area because that's where you're at, and that's kind of where you have your knowledge base is based in that region. Is this a good time to look at commercial real estate property? And is it a better time for leasing as opposed to buying property?

Fred: The answer to both of your questions, it's a good time for both. Here's an example. Some of the rates on selling properties per square foot out here in the Inland Empire - It's really a value. I'm working with developers coming out of West LA, LA market and they come out here and they see prices that they go, "Oh my gosh, they're so reasonably priced compared to what they see out there in the greater metro LA area." So for purchases, for developers, and end users it's an excellent time. We've seen it's a little bit more challenging right now. When I first started out here in '08 the leasing rates were very attractive. They have consequently gone up. Part of what's happening is there's not enough well located retail sites, A-type sites that are available. There's also some small developments that are coming out of the ground because there's so much demand right now in the retail restaurant category for the well located sites. Those sites tend to be a little bit higher priced per square foot. But one of the things I've seen that a lot of these operators have done, they slide down the concepts so that their overall rent with their rent in the triple-nets, we can talk about that later, we call it the all-in number, is palatable for the P&L. 

One of the things that's very, very important is the old adage, location, location, location.

Jeff: If I'm selling a business, if I'm getting out for whatever reason. I heard you say just a moment ago that this is really a good time to buy. But I would take that to me that if I'm selling a business I'm probably not going to get the best value for my property right now, or am I?

Fred: The land, again I think out in the Inland Empire, I feel it and I see it. It's a really good time to buy that kind of land. But most people that I see that are buying that kind of product are developers. And they're in-turn buying a piece of property and they are kind of like merchant developers. They'll go ahead and buy an acre and a half to 2.75 acres and they will develop a small center and they bring retail tenants into it. It could be a combination of retail... Let's say your kind of wireless phones and so forth. It can get the new QSR's, that are there's Blaze Pizza, there's Nectar Juice, all these categories are looking for space. From that standpoint the buy is a good time to buy. On the brick and mortar which is the leasing part and the buying, that's a little tougher to buy a piece of building where you're a one store operator. I never really got involved where somebody just comes and wants to start a business and buy right out of the bag and because they want to get some experience level and doing whatever they're going to do on the retail side, be it selling phones, or selling hamburgers, or selling pizza. They have to know exactly that business first before they want to buy.

 

Jeff: Let me ask you a question before we go to a break here Fred. If I'm a business owner and I'm just starting out, ideally, what are some of the most important criteria I need to consider maybe in addition to an affordable monthly rate? Again, remember, I'm just starting out and so I want to try to control my costs as best as I possibly can. What are some of the other really important factors that I, as a relatively young start-up company business owner, need to consider in order to find the property that's going to be right for me?

Fred: Okay. Some of the things that I mentioned before, it's called the letter of intent. We typically, all the different retailers that work in the food side, I've even done some large built such sites as well. We issue what's called a letter of intent. In the letter of intent we delineate the really high, important business points. One of the things that anybody that is going to be either leasing a business or they need to think in terms of long-term occupancy. If they want to have more options they need to negotiate a good term, be it 5 years, 10 years with some options. One of the things that I see with franchisees, most want 10 years with 4 or 5-year options. The way options work - options benefit the tenant not the landlord. Landlords are not as readily accessible to giving you all the options you want. You look at your term, you look at your options, you mention the base rate. That's very important because that base rate is what you're paying monthly, plus what's called the triple nets. That base rate, you negotiate it. Typically if you're a one store operator your increases are going to be annually. But when I work for the stronger franchisees that have multiple store kind of program that they're going with and their financial statement is very strong, we're able to get the increases capped to the point where you don't get it until 6th year. And that increase every month, let's say an average of 3% for an independent operator per year increase on the base rent, we usually get between 10%-12% in the sixth year after five years. So in essence for the first 5 years you're not going to see an increase until year six. And then you get another one in year 11, and then you try to do the same thing in your option period wherever they are, two, three, four, or five year options. All the restaurant people I work with out here, they typically want at least two f-year options. And they usually are able to get it if their concept is very strong. 

So that's kind of the two phases we're looking for, plus I mentioned triple nets. It's called triple nets and I don't know if a lot of your client base uses that term. You'll see it in your little document. It's called NNN, that means the nets, and that's your real estate taxes and insurance. And how that operates is that all tenants have to pay those triple nets, and that's for the management in the common area and the outside. The proration of taxes on the property that each tenant has to incur. Plus, it's part of the overall insurance. So that's called the three N's. Most of the tenants I work with they look for what's called the all-in number. They add the base rate, whatever that's going to be. Plus they add the triple nets and then they know that that's the amount of money they have to pay on that space. Back to the triple nets, what you try to do is you try to cap those as well. You don't want to have those triple nets uncapped because what happens can happen. I've seen that, not in deals I work with because we pretty much are able to successfully cap most of those triple nets at a certain percent. And within the triple net itself, there's what's called controllables and incontrollables. And so with the landlord – you tell him, you have to control certain costs and we hold you accountable as a tenant. Then you cap those to make sure that you don't have to see right away triple net increases and your overall what's called all-in rent, but going a little higher than maybe your sales or your other costs that you have to incur on your P&L. So that's the big ones. 

As far as the other thing we try to negotiate is what's called a TI Allowance or Tenant Improvement Allowance, and that's price per square foot. That can range anywhere from I've seen as low as $5 and as high as $45 depending on your term, depending on your financial statement that you're bringing to the table, and depending on how much the landlord wants to have you in the center, and how hard you negotiate. That TI Allowance goes a lot with also delivery of the shell which is another area that you try and negotiate. You negotiate a shell build-out. You're looking for the improvements the landlord put on that space. Be it the size of the sewer, the size of the gas, water, and if you have a grease trap, and so forth. Most of the things you ask, the electrical panel as well. All those items we're trying to make sure the landlord gives you a shell that you can do business with, plus the TI's that he gives you with a tenant improvement. But there's no free lunch with TI dollars he gives you upfront, because he takes that TI dollars he gives you and he amortizes it into the base rent he's charging you. And he amortizes it over the base term if you're in that space. So, those are very, very important. 

One of the other things that I may have to negotiate, and again, it depends on the strength of the person that's getting the space is called termination language. A lot of us have heard of Starbucks. Starbucks was the first one that talked about this. And they used it quite successfully when they pulled back in '06 and '07. And that determination language works in the letter of intent that goes with the lease. Again, it goes over the strength of that person coming to the table. Let's say you don't hit a certain sales level within a certain period of years and your site. Whatever reason, your concept and your site it doesn't gel. Then you have language in there that you negotiate prior to signing the lease in the letter of intent that goes into the lease. And that means that if you don't get a certain sales number you can pay a certain amount of money, and you're not obligated for the remaining period of the lease term which can be tremendous if your concept does not take off. 

These are safeguards you negotiate for your tenants going into the site and somebody like Starbucks gets it all day long – because it's a very strong corporate signature. But I have learned over time, they say we're not a Starbucks. But I've learned too, in negotiation - you don't get unless you ask. And if you don't ask they're not going to give it to you. So one of the things you always try to negotiate is a win-win situation. Landlords understand it. If you're not doing well as well and in the termination language you will want to move on as well. So there needs to be some language that you pre-negotiate, that you're going to pay a certain amount of fees to move on, and typically it has to deal with a certain amount of rent or months of rent. The unamortized value of the broker commission and your unamortized value of TI's that landlord's giving you and amortized over the base term. 

That's very important because that base rate is what you're paying monthly, plus what's called the triple nets. That base rate, you negotiate it.

Jeff: Location, location, location, we talk about triple nets and so many other things, and I still got questions to ask Fred. We're going to talk commercial real estate a little bit more with Fred Encinas, Senior Vice President of NAI Capital. I'm Jeff Allen, we'll back when Deal Talk continues after this.


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Jeff: Welcome back to Deal Talk, Jeff Allen here with my guest Fred Encinas, Senior Vice President at NAI Capital. We're talking about commercial property and what you need to know as you contemplate relocating or expanding your business. Fred, tell us how the site selection process works. We could probably do a show about that all by itself but what are the kinds of things that you look for, for your customers. And I'm sure that you treat them all just as well and with as high regard as you did In-N-Out Burger. Step us through how that process works.

Fred: As I mentioned earlier in the program, I'm big on the old saying, plan your work and work your plan. That came from my training. Particularly I learned that in McDonald's and Ray Kroc was a really big one. He wrote a book called Grinding It Out and that was one of his philosophies, plan your work and work your plan. I take that into real estate and I was trained that way and I've used it over the years and it works every time. Let's say you’re just this one store operator. Let's look at the market. Let's build some wall into ground zero and that's it, and then not look into the future. You need to look at, "Okay, I'm going to do this store today, where am I going tomorrow?" And with that you really need to plan out the area, or else where would I be going? Again, back to the franchises I've worked with, they're multiple store franchisees. We plan a whole County. We go through Counties and we plan them up. What we want to be and what we look for is we look for generators via day time population, residential back-up, major retail shopping hubs, interstates, all those different things that generate people. And what you're trying to find is the best of the best. And the location within the Inland Empire, what we do is we plan out an area then we figure out how they mesh to each other. And then we plan out the phased development of those sites. The high profile sites will be Phase one or Tier one, you go down Tier two, Phase two, Phase three and Tier three. And that way we're really set to work a plan and we're guided by a plan that we all agree on that we need to pursue. It's a little timely, and in consumption of time as far as driving the market and to know the market. But one of the things that I bring to the table is my knowledge in this market. And anybody that hires a broker should really look at the broker's time in that market and how well does he know the market, how well does he know the developers, how well does he know the shopping centers and so forth. And so what you're looking for is long-term position in the market. The only way you can do it is really develop a long-term plan.

But one of the things that I bring to the table is my knowledge in this market. And anybody that hires a broker should really look at the broker's time in that market and how well does he know the market, how well does he know the developers, how well does he know the shopping centers and so forth. And so what you're looking for is long-term position in the market. The only way you can do it is really develop a long-term plan.

Jeff: What is typical? The owner of a property voluntarily take care of a portion of the utilities ever for a new tenant. Is this something that is usually negotiable in the early going, or what's your experience been?

Fred: Most landlords, again, it goes back to your negotiation of your space. Utilities are a straight pass-through. And technically unless there's a sub-meter, the landlord does not pass it on to you. They have people apply for your water, gas, sewer, grease trap and so forth. They don't get involved with it, that's the straight pasture. Where you get credits from the landlord is what we call free rent. That's a good item that we could talk about. Free rent, we call it free rent, it's the time period that you as a tenant are trying to get into the space, you're developing your plans, you're getting the plans approved by the entity, which could be the city or the county. At the same time you’re getting bids by a contractor. That contractor gives you a bid, and you select the contractor. And he in turn once approved by the landlord and whatever entity you're working with, they in turn now take those plans, get a permit, and then they build it out for you. That whole time period, you try to negotiate for a tenant, and they can range anywhere between from after delivery of the space from the landlord, we talked about before, how the landlord would deliver a space with electrical, water, gas, sewer, and so forth. 

After that delivery you typically ask for 120 to as much as 180 days of time period where you will be building out the space, not paying rent. And you might get a few months in there free rent if you finish early and you're still under that time period that should be negotiated yet time period becomes free rent. Or you can also ask for free rent on top of that, but again, that has to be a long-term lease that you're looking at. If you're going for the 5-year deal, those are tough to get from landlords, you’re not giving me enough time to amortize these things you're asking from me because I don’t have enough cash flow coming in during that free rent period. Landlords typically will pay not for utilities and so for forth, especially on the retail side. It's a straight pass through. What you're looking for is for the landlord to give you some of that rent credit along with the TI's and the shell delivery. All of those cost money. All of those things you're looking for if you want to really try to negotiate as best you can so that when you're going to the site you have as much of a shell build about and credits from the landlord to make you successful, to get that store open and operating, so then you can get the current cash flow.

 

Jeff: In other words the free rent is something that will be provided if you negotiate that in and if it is necessary for you to have tenant improvements. Because maybe you've got a company that requires a different kind of footprint in terms of the floor plan, you have departments that have different requirements in terms of space and how they use this space, and they've got their own utility requirements that they need for X number of outlets, lighting, etc. The landlord, just for the most part with rare exceptions, will ever provide those tenant improvements or will ever work with a business owner to pay for a part of those tenant improvements. I'm not talking about utility expenses that are ongoing but I'm talking about the one time only tenant improvements.

Fred: Yes, that's where it comes with the credit you get per square foot. 

 

Jeff: Okay.

Fred: And as I mentioned before you can get $5 and as much as $45. Some of tenants come and they're asking you $50 per square foot because they'll say, "Look, I'm bringing the concept to your shop Mr. Landlord. “You should make sure you give me as many tenant improvement dollars to help develop my space you mentioned before so I can be successful. And guess what, I'm going to draw more customers to your shopping center, then they'll frequent your other businesses within the shopping center." Here's a good example, there's a company out here, a big development company, they're always looking for new concepts, and new shops, and guess what, they're smart enough to know new concepts brings a lot more people. They want to figure out, "This is what it is. This is what they have offering. Let's see what it does here." Guess what, when they're in the center they're going to go up to the other people within the shopping center so that increases the flow to the shopping center. So it goes back to you as a tenant, you try and negotiate a space that's going to give you as much leverage and as much room to build out so you're not paying what I call dead rent. Or you're paying rent and you're not getting any influx on sales because you haven’t opened already. So you're paying all those money out and nothing's coming in. So that's what I help a lot of these tenants do is negotiate that time period. And also we're looking for them to make sure that we get enough money for them that they cannot... It's not going to pay for all of the development because they got equipment that they have to pay for. And the landlords do not pay for equipment, because they know that the TI allowance you're going to use it in the shell, that's the landlord, that's his business. And he's going to include your shell and plus the TI dollars. He'll let you use the TI allowance. And guess what, it improves his real estate as well. So he knows that if you move on, that shell that's going to stay there. So that's one of the things that landlords are very, very savvy about. And that's why they're open to giving you a TI, what you call Tenant Improvement Allowance Dollars.

Again, back to those three things I mentioned before is location, location, location. Because one of the things one store operator or multi-store operator is going to look at - how successful they're going to be at this location.

Jeff: Fred, last question here. We're running out of time and we've got just about another minute or so left. Tell us, what would you urge people to think about, those business owners who are looking at expanding or relocating regardless of where they are? And they're looking at new property for what could be the first time, and maybe even they're expanding, they've taken over a business. And they've never had to acquire a property before but they're looking at expanding their businesses. In this day and age, what are some of the important key things that people have to remember to do and have to keep in mind when they're looking at commercial property?

Fred: Again, back to those three things I mentioned before is location, location, location. Because one of the things one store operator or multi-store operator is going to look at - how successful they're going to be at this location. I got to look at all the factors that make me successful, whatever use I bring to the table be it retail itself, soft goods, food or so forth, what's going to make that site successful number one. And that location now, can I afford to pay for that location for the use of bringing to the table here and then create some kind of success bar so that I can ensure as much as I can that I would be successful. Now one of the things that any single or multi-store owner would have to look at is their lease, making sure that I've mentioned before, those things that they're capping. I just touched really more and more on the economics of the lease. There's a lot of other areas of the lease that you should always have an attorney review your lease. You should always work with a broker that knows the market, knows how to negotiate LOI's, and I strongly recommend that any kind of operator has an attorney review that lease at the end. Because I've seen brokers, even myself, I've done deals for 30 years, I've seen all kinds of language but I'm not an attorney. And I always recommend folks use an attorney to finish up your lease because guess what, that attorney money you're spending up front, there are a lot of fees that you're paying for. Now, the landlord pays his fee, so that's kind of a neat thing. You as a tenant don't get a free lunch because the landlord put that commission into the lease. You're paying on a monthly basis but upfront the landlord pays it for you. So you don't have an additional spending paying for that broker. 

The attorney, guess what, you need to pay for that attorney. A good attorney is going to charge you so much per hour, and I would recommend a transactional attorney, an attorney who specializes in my kind of business, which is retail. And I’ve worked with lots of them over the years. And you see some good ones and you see some not so good ones. But you need an attorney that's going to protect you for ease of entry and ease of exit if you need to exit. And as you get your lease set-up as well you're looking for something that if you want to sell your business down the road you've got something to sell, you got a lease that's a favorable lease. It looks like it's got a lot of things that's going to make somebody who's going to buy your business if he chooses to take off and leave that business and do something else. You have a weighted exit. So you not only have to think about how you get into it, where are you going to exit? It maybe 10 years from now, 20 years from now. You have to think in these terms even though you might not have the answer, but you got to think in broad terms so that your lease are set-up to give you options.

 

Jeff: Fred Encinas, we're going to have to leave it right there because we've run out of time. This has been a great half hour and I want to thank you so much for joining us today on Deal Talk and I hope that we can have you back on again soon because I know that the real estate market changes and I know that things change in your world as far as transacting these types of deals. Again, we appreciate your time. Thanks so much.

Fred: Thank you so much Jeff.

 

Jeff: That's Fred Encinas, Senior Vice President at NAI Capital and he's been our guest today on Deal Talk presented by Morgan & Westfield, a nationwide leader in business sales and appraisals.

If you'd like more information about buying or selling a business call Morgan & Westfield at 888.693.7834 or visit morganandwestfield.com. And make it a point to check in with us again soon for valuable information and insight from our growing list of small business experts here on Deal Talk. My name is Jeff Allen, until next time, I'll see you again.

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