Understanding Restaurant Real Estate
How to navigate the complex leases and more
Restaurant closures, these days, are a dime a dozen. From newer spots to longstanding establishments, it seems like no one is immune to the financial pressures that come with being a part of one of the most competitive industries in the country. Why is this happening? More often than not, the reason behind a restaurant closure has to do less with a bad concept or the high cost of ingredients, and more to do with real estate, including confusion about the intricacies of renting or owning a space.
“For a lot of restaurant owners, this is their first or second time in business, and they just don’t know what they are doing,” says Colby Swartz, a Senior Managing Director at Suzuki Capital, a company that invests in restaurants. “People think they can open a restaurant and people will show up and they will always make money, and that’s just so far from the truth.”
Remember, before building, it all starts with the lease terms.
It all starts with the lease. Most restaurateurs end up renting their space, and according to Nate Adler, Managing Partner of Huertas (and the founder of the Eastville Restaurant Collective, a community group for East Village restaurateurs), they don’t take the time to read the fine print and understand all of the associated costs that come with renting a place. A common tactic employed by landlords is the triple net lease, in which all common area maintenance charges and real estate tax increases are pushed onto the tenant. “That can definitely lead to future difficulties, as those costs then escalate year over year,” Adler says, leading to additional thousands of dollars in necessary payments on top of the monthly rent, which in most cities, is already sky-high. Renters are also at the mercy of the landlord when it comes to renewals and changes in rent cost, which can lead to further financial stress.
These are hidden costs that are hard to foresee, but end up being big expenses.
And the costs don’t end there. Swartz says there a number of ways that both cities and landlords can get restaurateurs to pony up, including demanding up to six months’ security deposit, unexpected fines from the Department of Health (“even for small stuff, like not having a light covered,” he adds), and hiked-up insurance umbrellas. “These are hidden costs that are hard to foresee, but end up being big expenses,” he says.
There’s a reason, ultimately, that so many restaurateurs end up opening up shop in a hotel: “It’s one of the only ways a restaurateur can succeed and grow your brand,” Alder says, “because you are having someone build out the restaurant for you, and you just take a management fee.” The downside is that if you’re not a celebrity chef, those opportunities can be tough to come by. For the everyday restaurateur, Swartz and Adler offered up their best advice from the real-estate side for sustaining your restaurant’s lifespan:
Know your neighborhood.
Nate Adler outside of Huertas located in the East Village, NYC.
This seems obvious, but Swartz says that many restaurateurs become so overly invested in a concept, they don’t ever think about whether that type of food is a fit for the neighborhood where they’re looking. “Understand your local demographics,” he says. “Am I going to put a Michelin-rated restaurant on Avenue B in the East Village? Probably not. That’s not within that neighborhood’s price point and expectation.”
Understand that compromises will likely have to be made.
“When you are getting into a commercial deal, you can’t fall in love with a space,” Swartz says. “It’s not residential real estate. You’re not building your perfect home. There are going to be things that you have to overcome. You just have to figure out: is this something I can live with or deal with?”
Read the fine print on the lease, and then read it again.
It's really important to pay attention to every detail on a lease.
Adler has seen many restaurants that fail because they didn’t take the time at the beginning to read through a lease that included unexpected fees and stipulations. “Lease renegotiations don’t happen very often,” he adds. “It’s important not to dig yourself into a hole from day one, because it will only get worse.”
Try to negotiate a percent rent deal.
Because success in a restaurant is never guaranteed, Adler recommends a percent rent deal, which means that you pay a base rent, and then if you make a certain amount of money, you give a percentage to the landlord. It’s a win-win situation because it means both you and the landlord are rooting for you to have a successful year, so everyone gets paid. And that way, if you have a bad year, you are limiting your excess costs.
Use your neighbors as resources.
One of the upsides of the restaurant industry, Adler says, is that restaurateurs “are usually pretty transparent about their numbers. They’ll tell you exactly how much money they make every year.” Knowing these numbers, or even just getting tips from those who have already gone through the process, will give you reference points when you are making financial projections and negotiating your lease.
Always set aside excess capital.
“You are probably going to have unexpected expenses or overruns on capital. Very rarely do you set a budget and stand by it,” Swartz notes. “A lot of people feel like if they don’t open by a certain time they are bleeding money, but those 6 to 8 weeks are vital for your business. If you have extra money set aside, you are protecting yourself from having to rush.”
Look beyond the brick-and-mortar and find other revenue opportunities.
Yes, your brick-and-mortar space is important, but in this day and age, Adler says, it’s vital to think beyond your four walls. Figure out all the ways you can monetize—from large catering orders to mobile delivery—and make sure you are setting up the proper infrastructure in each area.