How do you approach requests from a national tenant that can hurt your property value? What do retail landlords care more about? How do you balance TI with free rent and how much to give of each?? Bethany Babcock, Founder and Principal at Foresite Commercial Real Estate, reviews major points for landlords to negotiate with their prospective tenants.

There's a lot of pushbacks that we need to give tenants, how do you approach that because when you're talking to a national tenant, they have a lot of the upper hand. How would you recommend a landlord walking through that?
I like to explain to them how it impacts the value of the property, because sometimes, especially if it's a national tenant, they're working from a real estate department, they've never had to think about it from a landlord's perspective. I like to show them how it's going to impact the landlord, and how do you propose we solve that? And put the burden back on them to come up with the solution. Once they understand that what they're asking for is a $100,000 ask, but they feel like it's a $10,000 ask, they start to weight their priorities a little bit differently because their goal is to get a deal done. Putting the weight back on them to be able to come up with solutions is important, but it's something that some of these things are more important than others.

1. Vague or generous assignment language tenants are priced based on their risk in retail, and so, when you have a tenant that can assign their lease to another guarantor, if it's not clear that the guarantor is of equal or greater strength, it can impact the value of the building. That's been happening a lot. You see that in single-tenant properties where a large operator will set up all of these locations, guarantee the lease, but have the ability to assign the lease to another operator. And so, someone will buy it at a lower cap rate with this really strong credit and then later have it assigned to a tenant with a lower credit, that's an immediate reduction on the value of the building. Tenants need to know what they're asking for and understand that their credit is the value of that building.

It has to be of equal or greater strength as far as a guarantor goes. I try to avoid putting an exact dollar amount like some of the leases will say that they have to have a net worth of x or x number of locations, the problem is that the guarantor that you're signing with might start with X locations and then grow exponentially. The value of your property has also improved as the credit of your tenant has improved, but if their ability is to sublease it to a tenant of lesser quality, now you'll see the value go back down.

 2. TI and landlord work letter: I got an LOI recently where they said, we're only asking for $20 a square foot, but then they sent a work letter that was worth the equivalent of $150 a square foot. Tenants need to understand what their work letter covers, and how much it costs a landlord to get there. National tenants are really bad at doing that because they will send a default work letter with all of their LOIs without actually taking a look at each location and adjusting it so that the work letter doesn't look so overwhelming. A landlord is going to get it and immediately think I have to do all of this, and they're going to go price it out, and it will kill the deal. Tenants need to look at each specific location, and think, Okay, this one already has the grease trap, this one already has the vent, and adjust their work letter if they're going to send a work letter. Or it's better just to send a request for TI, but the work letter gets confusing when tenants haven't visited the property or had a contractor visit the property. Those default templates really can mess things up.

You're negotiating the lease on a national level, however, the TI is at a local level, who within the organization do you ask to work with at that point?
I ask them to bring out the person that they do their build-outs with and have them visit the property with the work letter, and then come back and highlight the sections that still need to be done based on what they see, or have them do it with an architect because a lot of times, they don't mean to be asking for as much as they normally do, it's just a default that gets slipped in. And sometimes they don't realize, oh, that area has already been trenched in the back, or that one already has an opening, but the landlords get it and immediately pass it off to their architect or their contractor and say price this.

3. RFP (request for proposal): That's common when office tenant reps come over and bring tenants to a retail property. You see that a lot in medical because they're used to working with a medical office tenant and trying to bring them to a retail center. In-office RFPs work well because you send out your criterion to all these office buildings and say, this is what I need, who can give me the best price? And everyone submits it back, you put it in a neat little spreadsheet, it comes back and you select the best option. That doesn't work in retail, because there are no two centers that are truly alike. How far are they from a light? How far are they from the curb cut orientation? How far back does the space go? All of those things are differentiations that don't really get expressed clearly on an RFP and so when you get it and submit all those responses, it doesn't give a clear picture of the property. A lot of retail landlords won't respond to those, because they're thinking that the tenant hasn't even visited the space, how do I know they're going to like it? That's one thing that doesn't translate well from office tenant representation to retail.

What do you recommend the landlord do at this point?
A landlord should ask them if have they visited the property. And if they haven't, then it's a pretty good indication that they're not that serious. They also say, I'm happy to submit the letter of intent, and I can send it responding to the RFPs, they're these 20-page things with questions about the HVAC system. Usually they'll use the same RFP that they've used in preparation for an office building and they'll ask questions about the elevator. But that just doesn't apply. And it becomes very frustrating for both sides.

Why would a retail tenant use an office template?
If it's someone that they've used before for their office space, and they're comfortable with that broker, that broker will take them over to retail centers even if they don't have a whole lot of experience working with retail centers. They might think that they're the same and just try to apply the same process without accommodating for differentiations in the market.

4. Retail landlords care more about the use than they do about the rent brokers will sometimes get frustrated when the first question the landlord asks, or the landlord rep asks is, what use? And they'll think, just tell me the price! No, it depends on what use, they want to know who are they, and how many locations they have, you can't just say I can't disclose. It wastes everyone's time because there might be an exclusive that prevents that use from being at that property. And that might keep them from doing a lease or waste everyone's time, but also, they might not like the use, or it might not fit with the overall feel of the center. There's a lot more psychology that goes into leasing out a shopping center than leasing an office building, for example.

You have to make sure there's a lot of chemistry between the tenants, and that they complement each other. If you do it right, and you merchandise the center well, all the tenants sales improve. It's an art, it's not just a matter of leasing the space on a price, like an office lease.

How would you encourage the tenant to disclose? Is it a grocery store or a clothing store?
I say, hey, if you can't disclose it to me, I'm not going to be able to give you a whole lot more information, because I have a list of 15 or 16 exclusives that this property has, and I need to make sure that we even have an option, can you tell me the category and the credit profile? And they'll say, Okay, it's a bakery, and they have 30 locations. Okay, great. And then we can continue the conversation.

5. Not every landlord wants the longest lease term possible: Brokers are very much incentivized to do a very long-term lease and sometimes the landlord doesn't want that, and sometimes the tenant doesn't either, so it's important to make sure that everyone's asking the right questions. A landlord is assumed to want the longest lease term possible and that's not always the case. One of the reasons is because they might want to stagger the expirations so that you don't have more than 30% rolling over in a year. Or sometimes the conditions might throw off the deal and that's one way to get it back on track by shortening it a little bit, or they might have a different long-term plan for the property. Longer isn't always better.

How do you balance TI with rent and timing as well, because some of these things can take a long time to get leased. From a landlord's perspective, you need to pay your mortgage and your taxes and everything else, how to balance this with a very solid tenant?
That's a tough question because every landlord is going to be a little bit different, it's going to be different based on whether or not they had just paid out a bunch of TI to another tenant, or they have another big event coming up like a refinance. Their motivation is going to be a little different and so the way they structure things is going to be different based on each property and each landlord. I will say that some of the more creative landlords will try to set it up in such a way that they can offer free rent that matches it, maybe 1.2 dollars in free rent for every dollar in TI to incentivize people to do it more than free rent if they're cash-constrained. They might have a little metric like that that they'll use, but it really depends on each landlord and property and also tenant because, depending on the quality, and if they want them there, a landlord can go out and get financing for that TI or something.

A lot of people know that lawyers can kill deals and you are not an attorney; however, if I were to buy a center, I would prefer that you review the leases first. Is this something that you provide as a service to look at the leases and letting us know which items you like and/or don't like about the leases of this center that we're looking at purchasing?
That's something we do when we're representing buyers, it's part of the due diligence process, and we'll advise them on the economic impact of those leases, we don't get into the liability portion of it, that's where the attorneys step in. When we look at how that particular lease impacts the value of the property and the performance and operations of the property, that's something we get involved in.

Do you take a look at each lease?
Yes. We'll go through and abstract each lease, especially if we're going to be taking over the property management. It's pretty common when someone buys a property, that we'll do the property management as well. They get abstracted in two different ways:

1. From the purchasing side, for those that we'll help put that together when they're going to get debt. And those abstracts look a little bit different, it's based on the financial terms.

2, Then the property management team does it again, based on the rules and processes of the shopping center, as well as the rents and the schedules before they enter into their accounting.

They get pretty scrutinized.

Do you provide services outside of Texas?
We do but not as much as we do a lot in Texas, but we have some properties out of state that, in conjunction with local brokers, that we will manage and lease.

Is there anything else that we haven't covered about leases that you think is important for our audience to know?
There's one thing that I'm seeing a lot of right now when you're looking at the leases, a lot of times you'll see tenants that will try to change out the language in the CAM. That's one thing I think is really important for tenants to realize: when you're doing that you're not really asking for huge economic change, but you're asking for an administrative burden on the property management staff and so that's why a lot of owners are reluctant to give in on those terms. It has little to do with economics, and a whole lot to do with keeping the leases consistent and being able to operate that center effectively. Sometimes they might give up somewhere else on the negotiations just to keep that language the same.

Bethany Babcock