Signing Your First Retail Lease - Cautions and Tips

After reviewing over 250 retail and warehousing leases around the world and opening 120 retail stores in 22 countries, I learned these invaluable lessons.

The Story

At age 23 I was hired as a sales director for a young, 12-employee retail company that opened carts and kiosks in malls around the US and had just begun opening full inline stores in the Caribbean - starting in St. Thomas, St. Maarten and Cozumel. 

My job was to evaluate the increasing number of requests being received from interested entrepreneurs around the world that wanted to open retail stores that sold our product. 

Over the next 12 years I would review over 250 leases and work with local entrepreneurs to build a business plan that considered the pros and cons of opening a store.

An important part of the plan was a detailed pro-forma of expenses to develop a break-even analysis. Once we knew how much revenue the store would have to generate to break-even, we would work with the entrepreneur to evaluate their level of confidence in generating the required break-even revenue based on the location of their lease, considering their marketing strategy, fixed and variable overhead, seasonality and more. 

When I left that company after 12 years, I was hired by Crocs, Porsche Design, Seafolly, Margaritaville and other retailers (large and small) to evaluate their expansion goals and develop sound business plans to determine retail store expansion, same store sales growth initiatives and larger market expansion initiatives. I have negotiated leases in some of the most premier shopping destinations in the world including Whaler's Village on Maui, the most popular casinos on The Vegas Strip, Fashion Island in Newport CA, Time Square NY, Mykonos Greece, Alaska cruise ship ports, every major island in the Caribbean and in nearly all 50 states. 

The Lesson

Working with hundreds of entrepreneurs, reviewing hundreds of leases and opening over 100 retail stores and warehouses, I learned countless lessons including the following 10 items that I find exceptionally critical: 

1. Landlords know retail as well as you do...and likely better. Their job is to maximize the lease to the highest level possible - taking as much profit from you as they can, without putting you out of business. 
2. An optimized lease is usually 8%-15% of sales. Your marketing/advertising expenses are usually a similar 8%-15% of sales.
3. A great retail location that provides substantial shopping traffic means that you should spend less on marketing. So a savvy landlord will ask for lease rates that are 15%-20% of sales, and tell you that because their location is so great you will be able to cut your marketing expense substantially. 
4. Landlords will use terms like "natural break points" to establish a blend of fixed and variable lease rates that generally work to their benefit - even on marketing that you pay for independently.
5. There is a major difference between food traffic and shopping traffic. Malls and shopping centers will give significant lease discounts to major restaurants to drive traffic and increase perceived traffic counts to boost retail lease costs. Food traffic doesn't convert to retail traffic. Caution should be given to traffic counts provided by landlords.
6. Malls and shopping centers will also give favorable lease rates to "anchor" retailers like Nordstrom that generate significant traffic, so those traffic numbers can be used to boost retail lease rates. Anchor traffic does not convert as much as retail traffic. 
7. The 5-year rule: New malls and new shopping centers and destinations are almost always high risk. Leases will be artificially inflated to meet the needs of the developer, because there is no history yet. You might get lucky and land a great location in a new mall or shopping center that becomes a smash hit. But the risk is higher. We learned to almost never sign leases in locations that didn't have at least 5 years of history. And in 5 years if they have had more than 1 tenant in each location...beware. If you can, find and speak with the tenants that have left. 
8. Second-level locations are always higher risk. There are few exceptions to this rule. Ground level locations almost always have better traffic. 
9. At the small, startup level, warehouse leases should always have a possible retail element. A small retailer that is opening their first warehouse to produce, package, bake and/or ship their product should find a small warehouse that has the potential for a retail store front to sell products directly. Maybe an inexpensive retail location with some walk by traffic that can be a store in the front and your warehouse in the back. You're signing a lease anyway...open it up and let your customers help pay for your lease with a simple retail store that can be as small as 50-100 square feet. 
10. The best research you can do is to speak with neighboring store owners about the landlord, build an accurate expense pro-forma so you know exactly what you're getting into financially and then do people counts: Sit in front of your location for 7 days - count traffic with two different counters. In 1 hand, a people counter that counts all bodies that walk in front of your store. In the other hand, a people counter that counts only bodies carrying shopping bags from other retailers. This will give you a basis to calculate conversion rate which will help to build a revenue forecast.

Signing your first lease is committing to an extended relationship with the landlord. In addition, it is committing to build out costs that can be expensive. (TI) Tenant Improvements can also be negotiated with the landlord, usually in the form of a few months of free rent so you don't begin paying until you open. 

During the time that you have the lease, you will likely experience larger economic surprises that help or hurt your business. There will be "acts of God" (as leases call it) that could affect your business. It's important to nurture a great relationship with your landlord so that as things happen in the world that are out of your control, you are able to work with your landlord on creative solutions that keep your business open and keep the landlord satisfied as well. Relationship with the landlord are critical. 

You aren't alone and we can help. Fulton365 is able to help build a pro-forma for your lease, help with lease negotiations and even conduct on-site visits to evaluate locations and build a business plan that will help you decide to proceed.

Don't be scared of the prospect of signing a lease - but respect the process. Take it seriously. It's OK to say no to your first possible location. The numbers, forecasts, pro-forma, etc. are not a crystal ball that guarantee any single outcome. But they can shine a light a risks that you will need to consider, which increases your likelihood of success. 

You've got this. Enjoy the journey!