Wednesday, October 24, 2012

Entropy and the Commercial Lease (Tradecraft)

When you rent a house or apartment, you pay a monthly fee and if something goes wrong, a grumpy guy comes over and fixes it. This is nice, because this way you are not the grumpy guy, as you would be if you owned a house or condo. Also, if that grumpy guy decides to raise your rent, you can simply leave at the end of your relatively short lease.

A commercial lease is a combination of the bad parts from home ownership with the bad parts from renting. You still pay a monthly fee, but it include an additional fee for what they call common area maintenance. Our CAM is roughly an additional 20% beyond the rent. So besides rent, you also pay a fee to fix the roof, pave the parking lot and keep it lighted at night, taxes, insurance and all the other things that would normally be included in residential renting, or would normally be a part of home ownership. You also pay additional fees to manage this. Sometimes your CAM charges cover all those things, and sometimes you get a bill once a year, possibly for thousands of dollars, because the roof or parking lot, or dry rot remediation or some crazy new ADA requirement went over budget.

In addition to that common area maintenance, you are also responsible for the interior of your space. For example, yesterday, I replaced the water heater in one of the bathrooms. Eventually, if you stay long enough, you'll replace everything as it breaks down, which is another drag on the business that most small business owners forget to calculate. In addition to that water heater, we've replaced toilets, most of the bathroom fixtures, repaired doors and windows, fixed electrical problems, and replaced every light fixture. The worst case scenario is always an air conditioning unit (we have two), which can cost around $10,000.  If it's inside or in some way connected to my space, it's my responsibility to maintain and repair.

So the obvious answer to such a racket is why not buy a building? Many small business owners will consider this, if they're in an area of the country with a lower cost of living. I've heard it referred to as the retail store retirement plan. You're paying rent anyway, why not make it a mortgage? There are a couple problems with this.

Commercial mortgages never went nuts with crazy NINJA loans (No income, No Job, No Assets). When you buy a commercial building, you put 20% down, cash money. There are some current government programs right now at 10%, but lets work with that 20% number. How much cash is that? Well, our space, if if were free standing, would cost about a million dollars to own. So that means we would need $200,000 cash money, smacked down on the barrel-head.

Most game stores start on far less than that, usually in the $50,000-$100,000 range. Having $200,000 cash to buy your building is not really feasible. That's two more stores or a maybe the lower range of a profitable franchise (the yogurt business I recently looked at required $400,000). That $200k is a tale wagging the dog kind of thing. I recall at one point realizing I could make almost as much money managing my own property as running my business. Still, with 10% down, I could imagine doing it.

However, now you've got two businesses. You're now a commercial real-estate mogul as well as a store owner. It's true that you're probably well suited to the task, considering you've been doing most of the work already, but there are potential problems. Your real-estate venture may last longer than your business and you may get stuck with an empty property.

You may notice that commercial real-estate companies seem to have enough cushion with their properties to sit on empty ones for years. I know I couldn't personally pay a single month of my commercial rent, even at the height of my IT career. That was my biggest fear in my current location. In the old, smaller location, I could keep my day job and support it remotely with my personal income, if necessary. That doesn't work in the big leagues.

What happens if the neighborhood goes bad? I'm told Concord used to be a much nicer place than it is now. Imagine that change happening for the worse again over the next few decades. So now you've got a place that's not so hot with two businesses located in it.

The area could get better, and you may even be pressured to kick yourself out! A company like Starbucks can move in next door and suddenly you can charge twice the rent. That's what happened behind us in the Park N Shop shopping center. Suddenly it had delusions of gentrification and rents in the dirt mall skyrocketed.

Then there are eminent domain issues, problems with drive-by lawyers (one has sued my property management company 17 times), and difficult and indifferent local governments. Still, I can't help noticing the cars in my property management's parking lot are much nicer than mine.

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