Making Real Estate a Core Value of Your Franchise System, Part 4 of 4
Hopefully, you are adopting a standardized real estate process that encompasses a clearly defined all-in-one strategy for site selection, lease negotiation, and legal review. I realize that, as a franchise executive, you may not have the time, resources, or capabilities to put this process in place. This four-part series highlights 11 key points for standardizing your real estate process. Click to read or review Part 1, here for Part 2, and here for Part 3.
VIII. Building a Successful Real Estate Strategy
Site selection, lease negotiation, & legal review
Up to this point, we've focused on the importance of having a standardized real estate process in place to support franchisee success. Now let's take a look at the central components of this process, as well as the potential costs of not having a process in place.
Franchisors spend much of their time and resources developing strategies and systems for marketing, sales, training, operations, distribution, and supply chains. What they often neglect to develop is a standardized approach to location, leasing, and legal processes.
Franchisors should absolutely have a highly detailed real estate operations manual that clearly defines the specifications and guidelines for each of the following areas: 1) site selection, 2) lease negotiation, and 3) legal review. Sharing this manual with the key participants in the lease transaction (the franchisee, area representative, site selection specialist, franchisee's leasing agent, landlord's asset manager, landlord's listing agent, and two attorneys) will help prevent inconsistencies, frustration, loss of time, and a guaranteed sharp increase in start-up costs that cripple working capital.
IX. The Cost of Do-it-Yourself Site Selection
Let's take a look at a sample franchisee lease assignment where the absence of a standardized process directly and substantially affects the profitability of your franchisee's business.
Presented with the option to rent a 2,200 sq. ft. space, a franchisee opted instead for a 3,000 sq. ft. space based on the leasing agent's recommendation (after seeing the franchisee's excited reaction to the extra square footage). The additional 800 sq. ft. will have minimum effect on the franchisee's gross sales, and it falls outside the low and high allowable (1,700-2,500 sq. ft.) for the business to maximize profitability. What's more, the franchisee must now pay an extra $2.00 at 800 sq. ft., or $1,600 per month, for a total of $19,200 per year. Over a five-year lease term, the franchisee stands to lose $96,000 of profitability.
All this could have been avoided by having a franchise real estate professional on staff or representing the franchisor, who is experienced and has mastered the franchisor's site selection process, and is there to guide the franchisee to the right location and square footage.
This real estate expert will know the common mistakes in selecting a site - and how to avoid them. They'll know if a potential location is one intersection too far, on the wrong side of the street, or in the wrong location within the shopping center. They'll know that intangible factors such as visibility, convenience, traffic patterns, and tenant mix - not just demographics and lifestyle behaviors - are the key factors that make or break a franchisee's store volume.
Only an experienced, approved, trained professional - one who exclusively represents the franchisor, whether internally or outsourced - understands these intangibles on behalf of the franchisee. And only by repeatedly representing the same franchise concept in each new market will that professional know the right questions to ask, and the right time to ask them. Your franchisee deserves to have a professional with this knowledge, experience, and insight gleaned through previous location and site selection experiences working to protect their best interests.
X. The Financial Impact of a Poorly Negotiated Lease
A standardized all-in-one site selection, lease negotiation, and legal review real estate process will reduce start-up costs and protect the working capital of your franchisees.
Let's take another look at what a lack of a standardized process can cost your franchisee, particularly when it comes to lease negotiation. In this scenario, the franchisor outsources a real estate agent to provide services for a franchisee in the agent's local market (the old, "We have someone in your area who does our real estate" tactic).
This agent has not been expertly trained on your lease negotiation strategy or unit-level economics, and will be used on a limited basis only when a franchise is sold in that area. This agent has a low vested interest in, and little loyalty to, either the franchisor or the franchisee; their main interest lies in closing the transaction and collecting their commission as quickly as possible.
With no expert guidance from a professional vested in the franchisee's success, the franchisee should expect to:
- pay $1,600 per month in additional rent ($2.00 x 800 sq. ft.);
- pay $2,000 to $10,000 in demolition costs to return the property to a vanilla shell;
- pay the entire cost of converting a raw or gray space to a clean vanilla shell (four walls, drop ceiling/standard lighting, HVAC, and ADA bathroom);
- lose up to 50% of the available/potential landlord-tenant improvement allowance; and
- see a significant reduction in savings related to rent abatement.
To offset these kinds of costs - generated by inadequate lease negotiation enacted by an untrained, inexperienced outsourced agent - franchisees end up investing a significantly larger amount of their allocated start-up budget, which substantially reduces their available working capital. This could represent $50,000 to $100,000 of unnecessary expenditures before the doors even open. Add to that these excess monthly rental costs, and you're looking at $19,200 less per year in the franchisee's net profit.
XI. Finding the Hidden Profits During Legal Review
Last but certainly not least, it's critical to make sure your legal review process is as standardized as your site selection and lease negotiation processes. Once a Letter of Intent has been fully negotiated between the leasing agent and the listing agent, franchisors typically offer inexperienced franchisees several options: review the lease themselves; hire a local attorney to review the lease; or ask their leasing agent or broker to review the lease.
We have found none of these options preferable. Instead, as part of your high-quality real estate services, use your approved real estate attorney - ideally, a professional who is trained in all aspects of your real estate process - to carefully review the lease. Your attorney will be able to identify opportunities to improve the contractual terms and flexibility of the final lease. While there are no guarantees, landlords often will agree to more flexible terms related to the following:
- Corporate signatures
- Early termination or kick-out clauses
- Good guy clause
- Expiring personal guaranty
- Refundable deposits
- Improved signage provisions
- Negotiated CAM/NNN costs
- Sublease, assignment, and relocation clauses
Without this expert legal resource available, your franchisees will often feel forced to accept the lease as is, unfavorable terms and all.
Finally, consider this: If you were investing in a corporate location, you can be certain you would ask your attorney to thoroughly review the lease for missed opportunities. Your franchisees deserve this same scrutiny from a legal expert familiar with your legal strategy.
Scott J. Simcik is President and CEO of FGP Commercial Leasing in Westlake Village, Calif. FGP provides an all-in-one real estate service that includes site selection, lease negotiation, and legal review in all 50 states. The company offers a complimentary, 5-week program to assist in standardizing your real estate process. Contact him at 800-471-1682 or email@example.com.
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