Here’s an example of an age-old arm wrestle – the Landlord and the Tenant. On one hand, the Landlords objective is to generate as much income from the property to increase the asset value (typically measured as a capitalization rate). On the other hand, the Tenants objective is to minimize the cost of the lease to leave more capital available to grow the business, so that the business increases in value.
At least we’ve established one common factor here; both parties have the same objective – to increase value.
So rather than go head to head like rutting elk, there are other ways that both parties can increase value. Partnership.
While your mind is still spinning about the thought of being a partner with your Tenant or Landlord, consider these key elements to value creation;
Landlord
- Long Term Lease (long can be defined in various ways depending upon the type of asset and the location, long by definition in its respective market);
- Continuity of Payments – reliable, timely receipt of lease payments by the Tenant;
- Reputable Business – another market specific factor, though generally speaking businesses which; a) deliver regular, busy clientele to the property;b) sit within the boundaries of the City/Town/County’s designated Use for the property; and c) are providing for the sales and service of legal products (i.e. not prostitution, not stolen property, not illicit drugs etc.)
Tenant
- Revenue Growth – delivered via an increasing stream of new and repeat customers who are willing and able to purchase goods or services at an agreed price;
- Predictable Cost Base – delivered by good fiscal control of fixed and variable costs including cost of goods sold, labor, utilities and rent.
Without a venue to conduct business, the Tenant has no business. Without a Tenant, the Landlord has no income. Neither have the ability to create value.
How does the Partnership work? There are several ways to structure a Partnership, here are some examples;
Revenue based Rent (aka Percentage Rent). The Landlord and Tenant agree on a minimum base rent which may be as low as zero. The Tenant then pays rent based on an agreed percentage of gross sales. This type of Partnership is often seen in large retail malls.
Profit Share. In this case, the Tenant pays rent based on an agreed percentage of net sales. Minimum base rent may also apply.
Part Ownership. The Landlord and Tenant agree on a minimum base rent which may be as low as zero. The Tenant then provides the Landlord with a part ownership in the growing business, in exchange for rent. While non-traditional, this type of structure can benefit young start-up businesses looking for venture capital or initial equity to get a start.
These non-traditional approaches to leasing commercial property can benefit both parties, particularly at times such as these. Consider, the benefits;
Landlord
- Retains the Tenant, leaving the lights on rather that having a dark space/dark property, which drives value down, immediately.
- Creates Opportunity to increase income when good times prevail.
Tenant
- Provides predictability to the cost of the lease, costs only increase if revenue increases. With good fiscal control, these increases can be accommodated.
- Ties the lease to business growth in a way that encourages the Landlord to be a willing participant (i.e. encourages Landlord to take more interest in maintaining the property, the landscaping, the potholes in the parking lot, lighting etc.)
Not to be overlooked, there are risks in any type of partnerships. Triggers need to be drafted into any lease to provide for performance and give each party the appropriate protection. Also, your Business Plan should be up to date, complete with a thorough risk analysis to outline how to approach and how to deal with the challenges presented in a partnership, and in all facets of the business.
Let one thing be certain, there are many Landlords with vacant dark spaces and many unemployed ex-Tenants out there right now who could have benefited from these types of Partnerships.
Meagan Hill is a Commercial Real Estate Investments Specialist and Principal of NAI Jackson Hole servicing the Jackson Hole WY and Teton Valley ID markets.
For further information, contact Meagan at (307) 734-8700 or meagan@naijacksonhole.com
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