Overcoming the Commercial Property Challenge

In view of the turbulence on the high street and the level of recent insolvencies in the retail sector, one would imagine that, when it comes to tenants acquiring new leases, there is a strong buyers’ market.

According to the Office of National Statistics (ONS), UK commercial property rental growth is expected to stagnate in 2019. There is some small growth expected in retail parks, but otherwise the market is broadly flat and the outlook does not look rosy for commercial property investors.

Retail vacant property rates stand at above 10%, according to the British Retail Consortium, which is their highest level in 4 years. Furthermore, the Financial Times has predicted that retail property portfolio values are set to drop by 20% in 2019.

Despite this, it comes as something of a surprise to find that many UK landlords appear oblivious to this economic backdrop, rather as though they believe they are still in the golden age of long leases, high rents and regular rent increases across the whole sector. Whilst it is not fair to generalise, landlords and their agents and lawyers tend often to be reactive, un-co-operative, slow, and to have an unrealistic view of their bargaining position.

This means that franchisors and franchisees looking for commercial premises in the UK often have a tougher time than expected, and that store/restaurant roll-outs take longer than anticipated. Franchisees who have signed a franchise agreement with an exclusive territory often struggle to secure the right premises or the right terms. In a worst case scenario, someone who has given up a stable and well-paid career to become a franchisee, and who has paid their franchisee fee upfront, has no property and therefore no income, even 18 months or more into their franchise term.

In fairness, landlord attitudes are not the only issue creating pressure on the commercial property market. Despite the high vacancy rates on UK high streets, the UK remains a fairly crowded land-mass.

The UK does not have the same scale of large out-of-town shopping malls, and our town centres are tightly packed.

In addition, the pressure for more residential property is considerable. So much commercial space has been converted to residential, or mixed-use, in recent years, that finding suitable available commercial premises in many towns has become hugely difficult. Furthermore, the increased presence of residential premises in town centres means that getting planning permission becomes harder. The extent of the problem varies depending on industry sector. But planning restrictions can be particularly burdensome if you need 24 hour opening, or if some level of noise will be present at your site, and authorities will often turn down planning applications because there is a lack of parking.

It is all too easy to fall into traps when seeking commercial premises. Some of the most common scenarios, together with tips on how franchisees can avoid the pitfalls, are as follows:

1. The franchisor sets unrealistic roll-out targets

It is easy to under-estimate how long it takes to secure the right premises in any given location, and to get a lease signed. Ambitious development targets lead either to poor choices of locations, or to unhappy franchisees.

As a franchisee, you are well advised to take a very conservative approach to your development expectations. Do your research on how long it has taken other franchisees in the system, and franchisees and developers of other similar systems to find sites.

2. Agents over-promise and under-deliver

There are some excellent agents, including some with a genuine national and international reach. However, not everyone who says that they have this, actually does. With poor or inadequate advice, many franchisees make the wrong decisions on property.

A dose of cynicism does you good here. Agents you speak to may give the impression that they have your best interests at heart. In truth, they may not have, as their paymaster is the landlord, not you. Do not believe agents’ advice as to local going rates per square foot, for example. Do your own research.

3. The franchisee lacks support

Unless the franchisee is already a multi-unit operator, with plenty of experience securing and negotiating their own leases, a franchisee left to their own devices to find their own site and do their own deal has a high chance of failure.

One solution is to consult multiple agents, and to draw significantly on the support that the franchisor, or their other franchisees, can offer. Remember also to start taking legal advice before you sign or commit to any Heads of Terms document with the landlord or agent. Your lawyer will be able to spot if you are signing up to something that is unreasonable. If you don’t find this out until after the Heads of Terms are agreed, it is difficult, or even impossible, to change your position.

4. Signing a new franchise agreement before a site is identified

This is a high-risk strategy. It means that you are handing over your franchise fee, and committing yourself financially to the operation of the business, without being sure that you can perform the agreement from suitable premises. The franchisor might push hard to receive initial fees from as many franchisees as they can, as quickly as they can. This gives the franchisor a healthy cash flow in the short term. But all too often it shores up a cohort of unhappy, resentful franchisees, and the franchisor’s reputation suffers.

We always advise franchisees against signing a franchise agreement, and signing over their until they have identified at least one site which is available in the territory and that would suit their needs. If you can’t do this, then you run a commercial risk. But the risk is lower when you buy into a franchise which has invested in a strong support system for franchisees. The most professionally run franchises have teams of people (either in-house or external or both) who use a large network of sources to find properties well in advance of those properties being listed by local agents.

5. There is no site in the territory…

Sometimes the problem is not that it takes too long to find a suitable site, but rather that there is no suitable site at all in the territory. Small towns can be risky here, particularly if you need premises of a certain square footage, with a fair amount of footfall. It might not actually exist in your patch. It is a catastrophe if you don’t find this out until after you have signed.

To avoid this trap, you need a heavy dose of realism. Do not take your franchisor’s enthusiasm on face value. Buy a map of your area, study it, mark it up, and literally walk – or drive – the streets, so that you know pretty much every inch of it.

6. Poor choice of location

Many, if not most, franchise systems are highly susceptible to variances between one site and another. In the F&B sector, for example, overheads are high and margins are typically quite thin. It only needs footfall to be a few percent lower than expected, or for staff costs to be a few percent higher than planned, for a site that looks profitable on paper to be significantly loss-making.

Fortunately, there is a solution here. There are various types of software available for territory mapping and site analysis that will do quite a sophisticated forecasting, in terms of footfall, and local population demographics. You no longer need to rely on guess-work or opinion.

One other point worth understanding in advance: when you take on a franchise that requires a site, your franchisor will have one of two potential ways of managing this:

1. The franchisee does their deal directly with the landlord:

In this arrangement, the lease is between the landlord and you. The franchisor does not get involved.

2. Headlease:

In other systems, the franchisor takes the headlease on all the properties. This means that they have a lease between themselves and the landlord. There is then a sub-lease from the franchisor to you. Effectively, then, your landlord is the franchisor, and you pay your rent directly to them.

There are pros and cons of either of these routes, and the decision is generally governed by the strategic direction that the franchisor has chosen for the network.

The direct lease is, on the face of it, cheaper. This is because if the franchisor is your landlord, they may well want to be charging you some sort of uplift on the rent to cover their administration costs. On the other hand, if the franchisor is doing the deal with the landlord, they might be able to leverage their financial strength (known as their “covenant”) to get you a better deal.

You need to understand clearly which route your franchisor will want to go, and why. If they are taking the headlease, then ask them if they charge you fees for it. Ask them also whether or not you will be able to participate in negotiations with the landlord when it comes to rent reviews. Remember also that even if the franchisor has taken their own legal advice on the headlease, you still need your own independent legal advice on your sub-lease. Just because something is acceptable to your franchisor, does not mean it is acceptable to you.

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Roz Goldstein is the founder of Goldstein Legal, specialist franchising and commercial lawyers. Roz has extensive experience of franchising, having spent almost 20 years working in the industry before setting up Goldstein Legal, which is now one of the leading franchise legal specialists in the UK. 

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