How much to cancel store lease

[Dan Nad]

How much would it cost a retailer to cancel $100M of lease obligations with a length of 0-5 years? These leases are usually about 1000 sqft in malls and some on streets. I've tried to look at public companies but typically the lease cancellation expense isn't broken out separately. Is it done as a fee or a percentage of remaining lease? 

[James Storey]

@Dan Nad in my experience, there has never been a set in place cancellation standard unless it is specifically written out in the lease. Some tenants will negotiate a lease cancellation clause up front to limit their expenses if something were to go wrong and they were to buy out their lease.

If there is nothing in the lease that states how the lease is to be paid in the event of a cancellation, then it's up to the landlord and the tenant to negotiate how much the tenant should pay for the landlord to remove the lease obligation. This can be costly in legal fees to write up a lease cancellation agreement and negotiating it back and forth, especially if you are dealing with a large corporation as a tenant.

In my experience, the best and most reasonable way of calculating the fee the tenant should pay to buy out their lease is to run a Present Value calculation on the remaining lease obligation at a specified discount rate. You would do this by running out the remaining lease obligation (rent, CAM, reimbursed expenses, etc), and discount it back at a specified discount rate. The discount rate is determined by the landlord based on his/hers expected return on the lease. The higher the discount rate (higher expected return), the lower the buy out fee is, the lower the discount rate (lower expected return), the higher the buy out fee. This is similar to the way a bank will determine the prepayment penalty if you pay your mortgage off prior to the end of maturity. Keep in mind, this is very simplified.

EXAMPLE:

Lets assume a tenant has $100M in lease obligation left over 5 years, like in your question. And that leaves the tenant paying $20M a year on their lease. Let's also assume that the landlord determines that he can make a 9% return (discount rate) on his money today. Plugging this into a discounted cash flow calculator would determine the lease buyout would be about $77M in Net Present Value. 

This is not set in stone in the way to negotiate this but it's a great starting point. The tenant get's a discount on their lease liability and the landlord can take the $77M and recoup their investment and reinvest at 9% to replace their lease value. However, I will be up front, if you are dealing with a large corporation that has a ton of legal backing, expect to get thrown around in the ring because it can be a tough and costly negotiation.

Hope this helps.

James Storey, CCIM