Alicia Miller
With interest rates high and new build/remodel construction costs up, how can you keep your development schedule on track? That sold-not-open funnel is less valuable if big delays put schedules and development agreements at risk. (Or worse, if franchisees drop out altogether in frustration or ask to be released from their multi-unit agreements because they can’t find good locations.)
I met recently with Jonathan Hill, co-founder of full-service real estate firm Morrow Hill and someone with deep franchising experience to explore current real estate trends. What smart actions can growth-minded franchisors can take right now? We discussed exactly that.
Keep franchisees on task in a tight market
Tight inventory continues to be a major factor impacting franchise development schedules and timelines. According to a recent industry report from Costar, retail vacancies are at an all-time low. Only 4.8 percent of all retail space is available for lease as of the end of Q2 2023.
Also, available sites are being leased much faster than new sites are being delivered. The net absorption rate (how much retail space was leased or sold) was 52.4 million square feet over the last 12 months, compared to delivery/new construction completed of 49 million square feet during the same time period. This new retail space delivery is more than 35 percent below the prior 10-year average. With more than 75 percent of new-deliver spaces already having a tenant lined up, there is very little unspoken for new space coming available.
Retail asking rents in this environment have increased by 3.4 percent over the past year, to a new record high of $24 per square foot nationwide. High-cost markets such as New York are seeing $46 per square foot retail asking rates.
All of this means that the search will be longer, moving from 120 days on average from search kick-off to lease execution, to 180 days. This puts landlords and listing agents into the mode of “collecting LOIs.” Asset managers will instruct their agents to collect those letters of intent and play them off each other. Some submissions won’t even get a response, or agents will propose unattractive terms to see if tenants will bite anyway. When lease comments are exchanged, if prospective tenants take too long to respond or make too many mark-ups of the lease, landlords will often just put them on the backburner.
To keep your franchise development on track, franchisors must be prepared to invest effort and time into assisting franchisees in the search and negotiation process. Franchisees should have a sense of urgency about securing sites and need to be held accountable by the development team.
Check in early and often with real estate partners you and your franchisees are working with so you can jump quickly on good opportunities. Make sure you have a buttoned up real estate process that keeps franchisees on task and that your development team is on top of where franchisees are in their negotiations.
Let franchisees know slow response times during the lease negotiation process could kick them out of contention. Landlords routinely have back-up tenants ready to go and will not hesitate to switch gears if they sense foot dragging. Also, get ahead of potential issues with “permitted use” descriptions by being as specific as possible.
Many concepts respond to tighter market conditions by re-thinking the four walls and trying to make do with less space. Be aware that while this will reduce rent, it isn’t likely to help your search efforts because you’re not alone in this idea of looking for 1,600 square feet instead of 2,000 square feet. When you shrink the footprint, make sure to do it thoughtfully to ensure that total unit level economics still create good outcomes for franchisees.
Corporate lease guarantees
Yes, these are becoming more common, as is the case when franchisee liquidity isn’t high enough in a rising cost environment and when the concept would be hard to flip easily to another tenant’s usage. You need an asset manager and a team that buys into that model.
This doesn’t have to be an existential crisis for your franchise expansion plans. First, look at your financial requirements for prospective franchisees. Consider increasing them, especially liquidity requirements if you’re a higher-cost concept. Franchisees may have enough net worth, but underwriters can be concerned if too much of that net worth is tied up in illiquid assets.
Build-to-suit developers have especially tight underwriting requirements. Whereas prior to the pandemic franchisees might have needed $3 million net worth for some of the larger concepts with more expensive buildouts, now underwriters want to see $4- to $6 million net worth with a higher percentage of liquidity.
Increasing franchisee liquidity requirements won’t help franchisees already sitting in your development funnel. Be prepared for landlords to require partial or full-lease corporate guarantees. These can be negotiated with out-clauses after time has passed, but can help get franchisees into the right locations for your concept.
Landlords also need to know your brand and get comfortable with your concept. If you don’t have a nationally known brand, consider putting together a landlord package, complete with your Item 19, a video walk-through, and/or a brief slide deck about your concept. Explain why landlords should have confidence in the brand. Talk about the number of stores you already have open and how your brand resonates with customers.
Tech tools have impact
Powerful data analytics platforms are even more important in a tight market. Concepts can gain the search edge while also ensuring sites selected are set up for franchisee success. Morrow Hill launched a data analytics platform, Vision Map, that improves the ability of franchisors to make data-based decisions to drive growth and maximize market coverage. By utilizing mobility data, location scoring and competitive modeling offered through these analytic platforms, franchisors can identify core customers and strategically choose sites that are proven to have a higher chance of being successful.
The hunt for affordable, great locations is part of today’s arms race to meet growth agendas.
Alicia Miller is the founder and managing director of Emergent Growth Advisors. Her Development Savvy column covers smart ways to market and grow a franchise. She is also the author of the forthcoming book, “Big Money in Franchising: Scaling Your Enterprise in the Era of Private Equity.” Reach her at [email protected].