On the Future of Restaurants
Happy Holidays!
I hope that your work year is rapidly drawing to a close. I’m trying to end mine sooner than later, but as I’ve made clear from time to time I am a terrible vacationer. Hopefully there will be some time away from the phone and computer, maybe some cooking. Lots of Ray Conniff Singers.
“The Trendy Elitist.” is on break this month, because it turns out to be very difficult to build a new brand extension at the holidays. Until January!
I’ve been a bit of a Debbie Downer these last two notes, walking through the many problems facing small restaurants. Labor. Technology. Grumpy patrons. Inflating food costs. Inflating rents. The long slow decline of the workday lunch. The good (?) news is that at least the VC ghost kitchens have decided to start serving medium rare chicken.
But it’s the end of the year and a time for hope, and a new start and— yada yada yada — let’s end this short series on independent restaurants on a (truthfully) high note. All is far from lost. Commercial real estate is here to help!
How often do we get to say that?
But in order to help, CRE has to rewrite some of its old rules. I’ve written many times about what I consider to be the flawed premise of the retail “credit lease” regime. No offense to bankers but this is a banker mentality: the landlord “loans” space to the tenant who guarantees repayment in the form of rent. This is all well and fine and good for Amazon warehouses and Citibank offices, the AAA investment-grade bonds of this real estate-as-banking story. Apartments and hotels are the mortgage-backed securities: aggregating lots of little leases to make a collateralized pool. Restaurant leases somehow got slotted into the former category. In reality they belong in the latter.
If all you want for Christmas is bond-like NOI, then restaurants are not for you. If you are in the business of financially engineering the agglomeration lots and lots of longterm leases; if your idea of a bad time is being involved in any way in your tenants’ business then you should not have any restaurants in your real estate portfolio! Okay maybe a Subway franchisee or a McDonald’s outparcel or two. But that’s it! Get out of the restaurant landlording business. It will not spark joy.
But. . .
If you’re trying to place-make; if you’re trying to create a vibe; if you want a destination; if you need a place that people choose to go to, then I have the answer to your prayers. You definitely need restaurants. Probably a lot of them. But you can’t lease space to independent restaurants the way you do Walmart.
Place making
You can’t, because as restaurateur Brady Wood likes to say, a lease is built for perfection and a restaurant is not. Yes a restaurant is a challenging business but many challenges have to do with the lease structure. If you own the building and the restaurant, then you have a lot of room to be flexible on those economics. You can take more profit in good months and less in bad ones. The reality is that most restaurants are profitable. Many times they just aren’t profitable enough to pay the landlord the full sticker price.
As a landlord, what do you hope to get in ROI on a restaurant lease? An eight? A restaurant investor typically expect 30%+. In fairness they expect this because so many restaurants close, but also because most restaurants have short-term leases. With no terminal value to the lease you need high cash flows.
So why not get a better return on your investment? Invest 100% of the cost of the restaurant and get the exact restaurant you want. Hire a management company to run it and if it goes to plan you’ll make at least twice what you would in rent. If it doesn’t, tweak it until it does. Fire the manager and hire another one. Change the menu. Change the decor. But you don’t have to worry about re-leasing it, with butcher paper slowly sliding off the dark storefront for months at a time. Because you own it.
Yes you may have some bad months. Hell you may have some negative ones that require you to float a small loan to the business. But this happens in development! Think of it like you’re developing a tiny project inside a larger project and the restaurateur is the 0% GP.
This isn’t rocket surgery. This is already a thing in our world. I bet you’ve been a 0% GP at some point in your life. Hotels have been run on management contracts for decades. I can’t believe it has come to this, but you KNOW I’m serious when I actually resort to making charts to prove a point.
See? You can’t argue with math.
At the end of the day, as a commercial landlord, you have to ask: What are you optimizing for?
Do you want to optimize the risk-free rent on 3,000 sf? Then you really shouldn’t have a restaurant. Find a liquor store. Or maybe check-cashing. Do they make doc-in-a-boxes that small? A restaurant isn’t your answer.
But are you trying to optimize the rent on the apartments or the offices upstairs? Or even – pro move—on your giant lifestyle center? Or the long-term profitability of that 3,000 SF? Then restaurants ARE your answer, but the old credit lease structure isn’t.
So to help small restaurants survive we in commercial real estate need to become their partners. CRE is long on money and short on pizazz. Every building owner in the country wants to make their place special: restaurateurs know just how to do exactly that! Mix your chocolate with the restaurateur’s peanut butter and make it a real partnership.
All we have to do is change our mindsets. The old way doesn’t work. The new way isn’t that complicated:
You’re going to to partner with someone to create and run your restaurant(s)
You’re going to put in all of the money in to open it
You’re going to get all of the money out until you’re square (sounds fair)
After that the profits are split on some basis with the operator / manager
If you can take a little uncertainty in the short term I promise you that you’ll make more money in the long run. And you’ll control your front door, and you’ll make your building special, and you’ll help keep independent restaurants thriving for years to come. What’s not to like about that?
Merry Christmas! I hope you and yours have a lovely holiday and a happy and healthy new year. I can’t thank you enough for the lovely responses I always get when I write these. Your kind words mean a great deal to me.