Lease management 101
Virtually every retailer has one, just about every retailer hates them but wants another one, and most retailers know very little about them.
A retail lease is the fundamental contract that underpins a retailer’s entire revenue. There can be tens, hundreds or even thousands, and without them there is no business, no sales and no profit.
It is also true that in most cases the annual cost of this contract is the second largest expense in a retailer’s gross profit, behind wages, equating to as much as 20 per cent of total sales.
Given the criticality and large expense of retail leases, you might expect it to be a significant operational area in a retail business and that the investment in workforce and systems to manage retail leases would be commensurate.
But in Australia and New Zealand this is rarely the case.
Why? In working with retailers for nearly 19 years across Asia Pacific and North America, the most common reason I see for under investment in the management of real estate is simply not knowing what you don’t know.
As we start a new year with a challenging trading environment, pressure on wages, threats from online and international chain competitors, Australia’s leading retailers are now more than ever seeking productivity gains, strategic advantage and cost reduction.
The answer, at least in part, may well be right at the shopfront.
Here are my top six tips on what to do to manage leases better in 2012.
Fully abstract your leases
Lease abstraction involves reviewing, interpreting, summarising and documenting lease terms and clauses.
It is a highly professional skill and commonly left to inexperienced people who do so very poorly, causing significant problems.
Most retailers will abstract basic lease dates and term, occupancy charges, reviews, guarantees and incentives into a one page, colour coded Excel spreadsheet. A full lease abstraction, however, would include summaries or references to key clauses including make-good, outgoings, notices and those with commercial impact.
The most common errors I see retailers make in abstracting leases involve:
- Incorrect CPI types and calculations.
- Incorrect periods and calculations of percentage rent.
- Notification dates for lease options.
The following are two examples of how profit can leak out of your business through poor lease abstracting:
Using the wrong CPI
In Australia there are generally eight CPI types used in retail leases, in NZ there is one, and in North America there are dozens. There are also numerous calculation methods used including straight CPI, CPI on a base year, CPI + %, CPI x % and CPI average.
It’s a lot to manage, and so when reconciling the latest rent review notice from the landlord and your tenancy spreadsheet review type simply says CPI increase, then you you’ve got some work to do to identify exactly how it’s calculated.
I had one client who had been paying a CPI increase every year based on the local Darwin all groups, but their lease actually said to use the weighted capital city average. On a rental of nearly $200,000 the extra they had paid over the lease term was nearly $10,000. Replicate this mistake across 100 stores and that’s $1 million out the door.
Using the wrong percentage rent calculation within a retail lease it is plausible to have three or four unique lease calculation periods – a lease year for reviewing base rent, a calendar year for reviewing promotions or outgoings, and a financial year for calculating percentage rent charges.
A costly scenario I’ve seen was when a client received a percentage rent invoice for nearly $20,000.
When they compared the landlord’s calculation with their system they found the landlord had used a sales threshold based on the base rent at the beginning of the year not the total rent paid over the year, resulting in an $15,000 over charge for that one year. Ouch!
Desktop audits on outgoings
If you see outgoings (CAMS) as a fixed charge that can’t be negotiated, then think again.
You should consider outgoings more like a tax and know that you have every right to question how the landlord is spending your money. Using a simple desktop audit process you’ll almost always find some savings.
There are three principle areas you should focus on in your audit:
- What types of charges are included in the outgoings budget under your lease?
- Are the expenses incurred by the landlord/agent operational or capital by nature?
- Have the correct areas been used for calculating your pro-rata share?
In your draft lease there will be an outgoings clause trying to cover off every imaginable expense item. Review these items and negotiate out those that your business shouldn’t pay.
An obvious one would be for a fashion retailer not to pay for cleaning grease traps or supplying 3-phase power. Less obvious might be mall cleaning if you are located in an externally facing tenancy.
In your review of landlord outgoings reconciliations, start with the low hanging fruit and choose the stores in centres with the largest budgets or the less sophisticated landlords.
Remember, these budgets are not rental and must, by common law, be justified to all who contribute.
The landlord’s audit statement of outgoings for the previous year will simply confirm the landlord spent what it said it did. Go back three years look for large fluctuations in the annual spend on each line item. That will be a flag to look further.
As an example, security up 30 per cent in one year or repairs and maintenance (R&M) down 20 per cent in another is a flag.
You read the latest centre newsletter which boasts about the new security desk that was opened. Was the build on this new facility listed as a capital expense or was it included in the security line item or R&M and you only noticed when it went back down a year later.
Finally, triple check the landlords calculations of pro-rata share. Even a simple administrative mistake at their end can cost you thousands. Is it the same as last year? Was there new retail space created in the car park? Has all office space been excluded or just the leased component?
In summary, negotiate your outgoings clause, do a desktop audit every three years and check the landlord’s calculations.
Also, be sure to talk to your mall neighbours and check if outgoings are being calculated consistently for all.
Benchmark to compete
One of the greatest business assets you have is the intelligence you have stored within your own business information.
How will your next store perform? What rental should you pay? The questions can be answered most simply by what’s going on right now in your portfolio.
All retailers compare comp sales, unit sales and gross profit/margin. They are basic fundamentals of retailing. Most retailers look at cccupancy cost as a percentage of annual sales and then annual sales on a rate per square metre. Why? Is this enough?
A 25 per cent occupancy cost on $5 million sales generates an entirely different profit to 25 per cent on $500,000, as does sales productivity of $5000/sqm for a 20sqm kiosk versus a 500sqm fashion shop.
A low percentage occupancy cost or a high sales productivity may mean with more floor space you would do more sales.
Doing your internal annual or quarterly portfolio review detailed benchmark analysis can lead you to unlocking organic sales simply by having the right information and intelligence at your fingertips.
When negotiating new lease deals or undertaking portfolio reviews with landlords, if you want to achieve the best deal you need to be able to prove your case objectively.
The landlord will have done their benchmark analysis for their portfolio and if you haven’t done yours negotiating effectively will be a challenge.
Keep information relevant and accessible
Managing a store leasehold portfolio for a retail business involves the administration of a significant volume of information.
Regulations, legislation, contractual obligations, contact details, projects, financials – the list is virtually endless.
Like almost no other department, the real estate team becomes a significant a gatekeeper of information for the business, relied and demanded upon by many from the CEO to the store manager.
Too many times I have seen the volume and depth of information requests create a major bottleneck, causing massive process inefficiencies, stress and leading to painful errors.
Due to the volume, complexity and criticality of information for a store portfolio it must be maintained accurately so people can trust it.
Also important is for information to be accessible when the business needs it. Whether it’s as simple as a contact number or as complex as a financial forecast, even accurate information is worthless if it cannot be accessed on demand.
Ensure that your real estate portfolio information is kept up to date, at least on a weekly basis, that is securely controlled to avoid inadvertent or malicious errors, and that the people in the business who need to access the information can do so whenever they need to.
Systemise and invest
Whether you are national chain retailer or a small franchise group you need to systemise and invest in your real estate team if you want them to deliver you results.
Even the smartest people need the skills, training, tools and applications to do the best job.
Why not do a quick comparison between how much your company is investing in its real estate people, training and systems compared to other departments. Now overlay the total cost and importance of real estate and make the call – are you under investing in this team?
Higher productivity and greater efficiencies are key objectives in a low growth highly competitive market as exists in retail right now.
An experienced and properly resourced real estate team can deliver your business hard cost savings, strategic and decision support as well as the productivity and efficiency gains.
So make sure you employ experienced resources, accurately capture all of the information you need, keep up to date, make it accessible, do your own analysis, negotiate objectively, question the landlord and invest in your real estate team for smarter lease management in 2012.