Can Your Landlord Destroy Your Business?

With rising rents, the "Closing: Lost Our Lease" sign is becoming all too common in small-business windows. Here's what you need to know to avoid one.
Freelance Writer, Self-employed
May 07, 2013

After more than 50 years in business serving deli-style fare on New York City’s Upper West Side, Big Nick’s Burger Joint and Pizza Joint may be closing. The reason isn’t changing menu tastes, the owner’s pending retirement or even economic uncertainty, but an increase in rent. The landlord of the building, located at Broadway and 77th Street, is raising rent on the 1,050-square-foot space—from $40,000 to $60,000 per month.

“We’re struggling to pay $40,000 and we can’t pay $60,000,” says Nick Imirziades, the Greek immigrant who opened the restaurant in 1962 at its original location a few blocks away. Big Nick, as locals universally know him, is still negotiating with the building owner. The last thing he wants is to hang a “Closing—Lost Our Lease” sign in the window.

Imirziades is philosophical about his situation, placing blame on a confluence of events, including rising taxes, the last economic downturn and costly improvements the landlord made to the building. “It’s his property,” he says. “We can’t really fault him for doing what he wants to do.”

This isn't just happening in the big cities. Charlie’s Seafoods in Harahan, Louisiana, served its last shrimp po-boy on April 19. The restaurant, with its quirky trademark sign spelled “Charles Seafoods,” had been a landmark in the New Orleans-area neighborhood since the 1950s.

But “for the last several months, our landlord has been trying to force us into signing a new, more expensive lease,” owner and chef Frank Brightness wrote on Charlie’s Facebook page. “The terms of the lease are totally unacceptable to us. The landlord has chosen to evict us.”

Why So Many Leases are Lost

The possibility of being forced to move or close is built into almost every lease. Some landlords may offer a new tenant a low rate in the expectation that when the lease is up, the landlord will have considerable flexibility in setting new terms.

“That’s their upside,” explains Todd Dorn, a Murrieta, California, re-negotiator who styles himself as “The Lease Doctor.” “When the original lease is up, the landlord hits a home run if the tenant can’t move.”

Businesses particularly susceptible to hardball end-of-lease negotiations are those that typically spend a lot of money on leasehold improvements, such as restaurants, and those dependent on being a specific location. In both cases, it would be too costly to move. If it turns out to be too costly to stay, the landlord can force the business to close.

When You're Most Likely to Lose It

Lost leases are more common when the economy is improving, unemployment is falling, consumers and businesses are buying, and rents and property values are rising. In Big Nick’s case, the most important reason for the pending rent hike is a clause in the lease that says tenants must pay a portion of any increase in property taxes on the building.

In recent years, many landlords also delayed increases because of slack sales during the last economic downturn. Now that the economy is improving, landlords want to make up for the discounts they offered by raising rents.

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Landlords can wait until the last possible moment before announcing a steep rent hike. (That’s why patrons of a business so often hear of a “lost our lease” closure just a week or two before the business’s last day.) As a negotiating ploy, this can be very effective, Dorn notes, because the tenant won’t have time to find and prepare another space without a significant business interruption. Also, most leases have fine print that says if the tenant stays in the location after the expiration of the lease, the landlord can increase the rent by up to 100 percent.

“It’s a game of chicken,” Dorn says. “If the tenant hasn’t made plans, he’s at the landlord’s mercy. There’s nothing he can do.”

The Devil in the Details

Landlord-tenant arrangements are governed by leases, and the clauses in those contracts have been the bane—or the joy—of many a business owner. Unfortunately, tenants’ rights activists, organizations and laws tend to focus almost exclusively on residential renters. Commercial tenants have few protections and, once a lease is up, landlords often have free rein to raise rents to whatever the market will bear.

One way to avoid losing your lease is to get a clause that says you may continue to occupy the premises after the end of the lease at a predetermined rate. However, landlords don’t like these clauses, Dorn says, and it’s rare to get one inserted in a new lease.

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Whether or not you have such an option, you must fully understand what you're signing when you take on a new space. “A lease that looks good for getting the doors open in year one may have a lot of clauses causing the rent to rise dramatically,” says Wade Horigan, founder of Silent Partner Negotiators, a lease renegotiation advisor in Ventura, California. “A small-business owner is doing a hundred things to get the doors open and often overlooks penciling out the lease payments and what they will actually be over the entire term.”

Negotiating Tips

Another way to avoid losing your lease is to start early. Examine the lease 12 to 18 months before it's up. Find out what the landlord’s options are and whether there is an opportunity to maintain your present location at a predetermined rate. If you don’t have an option to stay put at a preset rent, start the negotiations. To a landlord, a tenant in the hand now, even at a lesser rent, may look better than the possibility of having to find a new one who will pay more later.

Before saying anything, however, do your homework. Horigan says to find out whether your local real estate is experiencing an upswing or a downturn. Specifically, find out what similar real estate is renting for in that neighborhood.

A business that's experiencing financial trouble should also be ready to show that higher rent will force a relocation. That may mean opening the books to the landlord to make the case.

Horigan advises opening negotiations with a specific dollar proposal, backed up by whatever facts can be assembled to make the business case. He says tenants should avoid going public or making emotional appeals. Instead, make a bid that's 10 percent or so above what would be acceptable. Then be ready to negotiate.

Ideally, talk to the owner, not a broker or other representative, Horigan says. If your property is owned by a large property firm that has many other properties, that makes it less likely your bid will succeed, he adds.

Horigan suggests that a “blend and extend” proposal often has the best prospects. “Offer them a longer term right now based on them adjusting your current rate to the market right now as well,” he says. “You need to have something to offer that they want in order to try to get what you want.”

Lease renegotiation is something most business owners will do infrequently and possibly only a few times in their careers. For that reason, lease renegotiation experts like Dorn and Horigan offer their services. Negotiators may charge flat fees or percentages of the money saved by the new lease.

Thinking Ahead

In addition to getting the facts in order, a business owner needs to take tangible steps to be in a better position. That includes paying rent on time and in full. Also, being a good tenant, who abides by the rules and doesn’t create problems for other tenants, can only help at lease-renegotiation time.

A business owner should also take a hard look at finances to make sure that getting a favorable lease will really help. Some companies are in such bad shape that losing their leases only accelerates what's inevitable, Horigan says. “Lease renegotiation is really only an option for a company that is fundamentally still strong,” he says.

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If a company is strong, now might also be the time to prepare financially for an eventual lease hike, advises Mitch Roschelle, who leads the U.S. real estate advisory practice at accounting and consulting firm PwC. Roschelle suggests taking a stab at figuring out what your future rent will be, and setting aside funds or building in operational efficiency so you can sustain it.

“A lot of business owners take for granted the fair value of the rent they’re paying and run their businesses based on actual rent as opposed to market rent and don’t provide for reality that someday rents may go up,” Roschelle says. And someday may be soon.

The Rising Tide

Commercial rents in general have been rising more slowly than is normally the case after an economic downturn, according to PwC’s 2013 report, “Emerging Trends in Real Estate.” As property owners work off overbuilding and business vitality gains steam, however, retail space has seen some increases and office space is likely not far behind.

“I’d say in the next 18 months, we’re going to see both retail and office rents grow as the economy recovers and as supply continues to be absorbed,” Roschelle says. Not all markets or types of property will gain equally, of course. High-quality shopping malls may have the upper hand over tenants in many cases, according to a read of PwC’s forecast, while suburban strip centers may be begging for occupants.

The uneven quality of the real estate market suggests one possible solution to a lost-your-lease closing: Move to a better location. If you're currently in a high-traffic, fully occupied retail area where your landlord has lots of leverage, consider a new location in a place like Florida, Arizona, Colorado or Nevada that was hard-hit by the real estate slump but is now rebounding. “There may be some opportunities to look at where that growth is and get in on the ground floor.” Roschelle says.

An Uncertain Future

For Big Nick, the combination of factors that led to his landlord asking for a 50 percent rent increase may spell the end of his 50-year run in business if he can’t find a way out of losing his lease. “We’ve been looking for a new space,” Imirziades says. “But we’ll have to find the right situation. At this point we don’t want to have to build from scratch.”

Read more on small-business financial management.

 Photos from top: iStockphoto (2), Getty Images

Freelance Writer, Self-employed