Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
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39 March | April | 2016 CCIM.com fees, regulations, and standards imposed by the franchisor. Upon taking possession of a leased premises, a franchisee will likely have invested significant sums of money that an independent startup tenant would not, such as a franchise fee, legal fees for the franchise agreement, and accountants' fees for the preparation of budgets and projec- tion reports for review by the franchisor. T e franchisee will then invest additional funds in building out the premises and purchas- ing inventory, equipment, and signage, all in accordance with the franchisor's require- ments. Thus, a franchisee-tenant is often more invested in the success of the location than a corporate or independent tenants. Franchisor Cure. Finally, most franchi- sors have the right to cure lease defaults, step into the franchisee's shoes as tenant, or f nd a replacement franchisee. It is costly for a fran- chisor to de-brand a location. Especially if a location is successful but a franchisee is oth- erwise in default of its obligations under its lease, franchisors will of en exercise this right. T is is advantageous in that the landlord does not have to expend money on eviction proceedings or enforce the provisions of the lease or guaranty. Also, there is no time between tenancies, so the landlord does not lose rental income and the continuous opera- tion of the business maintains foot traf c at the landlord's center. Before Negotiating Managing timing is crucial in franchisee lease negotiations. A landlord will not want to remove a property from the market, undertake due diligence to approve a tenant or guarantor, and pay lawyers to negotiate and draf a lease agreement before a fran- chisor fully approves the franchisee and its chosen location. However, prior to issuing approvals, a franchisor may require a fully executed lease. So, ideally, a landlord should delay incurring the bulk of the costs associated with the lease until the only outstanding contingency to the tenant obtaining a franchise agreement is the franchisor's approval of the lease. Loan Document Compliance. In negoti- ating any lease, but particularly a franchisee lease that may be subject to certain franchisor requirements, a landlord should look back at any applicable loan documents, such as deed of trust or mortgage, loan agreement, and security agreement, to ensure that the lease and the franchisor rider do not conf ict with the landlord's obligations as borrower. Spe- cif c areas of concern are casualty provisions, such as who retains insurance proceeds and whether there is an obligation to rebuild af er a casualty; any conf ict with a fran- chisor requirement in which the landlord waives its interest or subordinates its rights to place a lien on the franchisee-tenant's bank accounts, furniture, f xtures, or equip- ment af er a lease default; and whether the lender has the right to review and approve any assignments or amendments of the lease. T e Franchisor Lease Rider. Too of en, extensive negotiations, draf s, and redraf s of a franchisee lease are completed, the lease is ready to be executed, and only then does the franchisor lease rider or addendum f rst surface. Upon review, a landlord will some- times f nd those provisions conf ict with the fully negotiated and agreed upon lease provi- sions. Some franchisors are more f exible in the negotiation of their riders, while others' riders are not negotiable. T us, a landlord should review and attempt to resolve any unacceptable provisions in advance of engag- ing in the lease draf ing or review process. Franchisor Rider Provisions Franchisor's Consent. When a franchisor requires that the landlord and franchisee- tenant obtain franchisor's prior consent to any lease modif cation or amendment, it is in the landlord's best interest to add that only material modif cations or amendments require consent and that consent may not be unreasonably withheld, conditioned, or delayed by the franchisor. To avoid unneces- sary delays, a landlord may propose a time period within which the franchisor must either provide consent or notice of denial, and if no response is provided within that time frame, the franchisor is deemed to have consented. Default Notices and Cure Periods. Commonly, franchisors require copies of default notices. T ey also may require addi- tional time beyond the cure or grace period provided to the franchisee before a default becomes actionable. A landlord may agree T e year 2015 saw more than 795,000 fran- chise outlets throughout the U.S., according to the Franchise Business Economic Outlook 2016. T at number is expected to increase by 1.7 percent this year, adding approximately 13,500 new units across 10 business lines. While retail and restaurant franchises are likely to lease space in shopping centers, a growing number of franchises in business, personal, and educational services are also locating in other types of commercial cen- ters and small of ce parks. T us, landlords of multi-tenant properties are increasingly likely to encounter franchisees as potential tenants. Having a franchisee-tenant can prove a very lucrative and benef cial arrangement. However, it does come with a unique set of risks, many of which are addressed below. With one in 12 businesses in the United States now being a franchise, landlords should famil- iarize themselves with ways to minimize the risks and ef ectively navigate the pre-approval and franchisee-lease negotiation process. Landlord Benefi ts Probably the most signif cant benef t of hav- ing retail and restaurant franchisee-tenants is that they bring a familiar trade name, other franchise locations, and as a result, an exist- ing customer base to a property. Nationally recognized tenants also draw other potential tenants with an interest in occupying space in the same center. Sometimes they are even willing to pay increased rentals, if the per- ceived draw of the franchise is large enough. In addition, there are several other benef ts to leasing to a franchise tenant. Qualif cation of Tenant. Prior to granting approval to purchase a franchise, a franchi- sor generally reviews the franchisee's experi- ence, f nances, and other pertinent factors to determine whether the franchisee will be able to maintain a successful business. Because failure of a franchisee's business is a direct ref ection on the brand, and patrons' perception thereof, a franchisor has a par- ticularly strong interest in the franchisee's success. As such, by the time the franchisee approaches the landlord, the franchisor has of en undertaken extensive due diligence and pre-qualif ed the franchisee. Franchisee Investment. While each franchisee runs its own business, there are cnythzl/Getty Images