LFTL: RENT!
If you’re a Gen Z kid who loves showtunes, you know Revolutionary War history courtesy of Hamilton. If you’re a millennial kid who loves a good belter, you know that rent sucks (and there are 525,600 minutes in a year).
For those paying attention, this is our second mention of Rent (the musical) in LFTL. It’s partially because we ship Roger and Mimi but primarily because rent is something on our client’s minds frequently. And with good reason. It’s a restaurant's largest truly fixed cost and outsized rent burdens can make profitability very challenging.
So let’s dive into rent, specifically the NNN or Triple-Net leases common in the modern retail world. A “triple-net” lease means the base rent is net (accounting speaking for doesn’t include) maintenance, real estate taxes and insurance. Gross rent is a rent calculation that encompasses all charges.
1. Base Rent: The Foundation of Your Lease
Base rent is the starting point of your lease agreement. Typically calculated on a per square foot basis, this cost is your primary rental fee. It's straightforward: the price per square foot times the total square footage of your space equals your base rent. Location, demand, and the property's value significantly influence this rate. It's vital to balance the location benefits with the cost per square foot to find a space that meets your needs without overstretching your budget and remember base rent is not the entirety of your rent charges – too many operators lose valuable potential profit by calculating pro-forma rent on base rent alone.
2. Percentage Rent: Success Has Many Fathers
Percentage rent is an additional cost often included in retail leases, which started in high traffic A+ spaces but has drifted to a point where it’s pretty much ubiquitous (although definitely push back). It's based on a percentage of your monthly sales, kicking in after you reach a certain threshold – which can be a negotiated number or frequently based on a 'natural breakpoint.' The natural breakpoint is typically calculated by dividing the annual base rent by the agreed-upon percentage. For example, if your annual base rent is $50,000 and your percentage rent is set at 7%, your sales threshold (natural breakpoint) would be approximately $714,286 ($50,000 / .07). Sales beyond this point will be subject to the additional percentage rent.
3. NNN Costs: Beyond the Base Rent
NNN costs, or triple nets, encompass three main expenses: Common Area Maintenance (CAM) or operating expenses, real estate taxes, and insurance. These costs are above and beyond your base rent and are shared among the tenants of a property and are frequently calculated on a pro-rata share, meaning if you occupy 10% of the space you pay 10% of the costs. They are charged on a per square foot basis.
CAM or Operating Expenses: This includes the costs of maintaining shared spaces like parking lots, hallways, amenities and (sometimes) building staffing costs.
Real Estate Taxes: Your share of the property's annual tax burden.
Insurance: Your portion of the insurance the landlord carries on the property.
These costs can fluctuate based on external factors and property expenses, so it's crucial to ask for historical data and estimates to better plan.
4. Tips Surrounding Rent Decisions:
Understand Your Lease: Ensure you clearly understand how your base rent and NNN costs are calculated and what's included.
Budget Wisely: Your pro-forma needs to account for NNN costs. If your rent budget is $100,000 you cannot afford a base rent of $100,000 because you will be off by 15%+ due to the NNN charges. Additionally plan for potential increases in NNN costs, and don't forget to factor in the percentage rent if it applies.
Negotiate Terms: Don't hesitate to negotiate terms. You can sometimes cap NNN increases or negotiate more favorable percentage rent terms.
Seek Professional Advice: Consider consulting a real estate attorney or a commercial real estate broker specializing in retail to guide you through the process.
Don’t Discount How Big NNN Can Be: According to Jason Kastner, managing director at Dochter & Alexander, NNN fees can range from 5% to 25% of gross rent. He cautions that’s a huge spread and can make a big difference on pro-formas. Mixed-used town centers, and newer buildings tend to have higher NNN fees.
NNNot Going to Get Relief: In distressed sales situations, landlords may be willing to provide some base rent relief but they are much less willing to provide a break on NNN costs. So if a restaurant has a monthly $20,000 rent and $4,000 in triple net negotiations (total rent $24,000) and they negotiate a “half-rent” deal the tenant frequently believes they will be paying $12,000 while the landlord believes the tenant will be paying $14,000. The higher NNN costs are relative to base rent the more important this point is to negotiate because when a tenant asks for a full abatement of rent the landlord understands this to mean only abating base rent in most cases.
Last Bites
November 2023
Tax Changes For the Coming Year
For the tax year 2024, the IRS, responding to inflation, has announced several adjustments benefiting taxpayers. The standard deduction is set to increase: $29,200 for married couples filing jointly (a $1,500 rise) and $14,600 for single taxpayers and married individuals filing separately (a $750 increase). This adjustment allows more taxpayers to keep a larger portion of their annual income. IRS spokesman Anthony Burke explains that these changes, mandated by law for about 60 tax items, are intended to align with inflation and maintain fairness. The majority of taxpayers, nearly 90%, opt for the standard deduction. Additionally, income thresholds for various tax brackets will also rise, affecting rates from 10% to 37%. Other adjustments include a $400 increase in the earned income tax credit and a rise in the annual exclusion for gifts. There's also an increase in the contribution limit for retirement plans like 401Ks and IRAs. These changes, applicable to 2024 earnings, will be reflected in tax forms prepared in 2025.
Your Mortgage Loan May Be An Asset
After 15 years of low interest rates, homeowners are faced with a sudden paradigm shift: those fixed-rate mortgages that they took out at ultra low rates may look like liabilities, but, seen through a mark-to-market lens, they're valuable assets...to illustrate this consider that a $500,000 30 year mortgage at 7% would carry an interest charge of $697,544.49 while the same mortgage at 3% would carry an interest charge of $258,887.26, a difference of $438,657 (or $1,218 a month). If you were to invest that money at a 4% yearly yield (very realistic) you would have $819,737 dollars at the end of your mortgage!
The _____ Might Be Less Damn High (Part XXIV)
Three economists go duck hunting. A duck flies out. The first economist shoots well in front of the duck. The second economist shoots well behind the duck. The third economist triumphantly screams “WE GOT IT.” Why the fowl joke? Well after calling a recession imminent for almost three years, there seems to be a consensus growing among economists that we are heading for a soft landing with inflation cooling although consumer spending remains a concern heading into the oh-so vital Q4. Our advice – recognize that we are in uncharted territory, remember to be earning interest on idle cash and a long time horizon balanced approach never goes out of style because no one knows.