Landlords to Restaurant Chains: Let's Make a Deal
The recession has turned the tables on landlords, who are now offering restaurant chains attractive rents and more.
By David Farkas, Senior Editor -- Chain Leader, 1/15/2010 12:00:00 AM
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Pizza Inn, an aging chain in a crowded category, says the chain is
nonetheless attracting more tenant improvement dollars than ever, says Vice President of Franchising Madison Jobe. |
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This past year, mall landlords gave Häagen-Dazs build-out extensions for the first time, saving the ice-cream chain tens of thousands of dollars. |
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| Kevin Kruse, vice president of franchise development for Einstein Noah Restaurant Group, claims he's hasn't seen “this many high quality sites in a very, very long time.” |
Had more landlords been willing to work with Chili's Grill & Bar in the 1980s, the casual-dining chain might have opened a lot more restaurants. But developers sometimes balked at Chili's loudly striped awnings, a crucial brand element.
“We killed many deals if they wanted us to have their awning,” recalls Clark Knippers, then vice president of real estate and development for Chili's parent company Brinker International.
Until recently, landlords have had no problem asking for—and often getting—their awningsor whatever else they wanted in leasehold agreements. Competition for good sites was fierce among fast-growing restaurants and retailers, which typically acceded to landlords' demands.
Not anymore. “Supply and demand has flipped; now it's a tenants' market,” says Knippers, founder and president of Dallas-based Foremark, a consultancy specializing in restaurant real estate.
Space Available
Blame the poor economy, which is tanking businesses and freeing up loads of commercial space at attractive prices. Spring ReCount data from market research firm NPD Group show the U.S. total restaurant count slipped 0.6 percent in 2008, to 570,980. Experts believe that percentage is sure to climb when new data are out later this month. “I definitely think there is reason to believe so given persistently weak industry sales trends,” offers restaurant analyst Mark Kalinowski of Janney Montgomery Scott.
Excess capacity means lower rents, already down 10 percent on average nationally, according to Jones Lang LaSalle. They will tumble another 5 to 7 percent this year, especially in secondary markets, notes a report from the Chicago-based real-estate services firm. “Rent declines in the most construction-heavy markets like Atlanta, Charlotte and Miami will approach double digits in the first half of [2010],” the report adds. The firm doesn't expect rents to begin rising until well into 2011.
And a fall survey of property owners by National Real Estate Investor, a trade publication, showed that 52 percent expected effective rents to decrease for the next 12 months compared to 38 percent who projected declines three months earlier.
The upside for restaurant chains, especially growth-oriented chains, is deals galore. Lease terms (including mid-lease) have changed dramatically over the last 12 months.
“We are getting real-estate deals we've never gotten before,” declares Larry Feldman, CEO of Subway Development Corp. of Washington, sub-franchisor of more than 1,000 sandwich shops in the mid-Atlantic region. “Landlords are splitting space and cutting rents.”
In one case, a landlord is charging Feldman half the rent he would have paid two years ago in a rehabbed food court in Washington, D.C. In another, a Georgetown, Md., developer divided a shuttered Blockbuster, offering Feldman's franchisee 3,500 square feet—a deal Feldman claims never would have happened two years ago. “We walk into a landlord, and now we're on top,” he says.
Rent Relief
Perhaps the most remarked-upon change in lease structures has been landlords' willingness to grant rent relief mid-lease, a practice all but unheard of until recently.
“I have never seen anything like this,” says Madison Jobe, vice president of development for Dallas-based, 315-unit Pizza Inn, referring to rent restructuring. “I have never experienced anything like what we are going through now, nor have any colleagues I've talked to.”
“Rent relief is part of the reason occupancy is where it is today,” Taubman Centers CEO Robert Taubman told investors in the company's third-quarter 2009 conference call. Occupancy had slipped just 1.4 percent in the prior 12 months at the 25 malls the Bloomfield Hills, Mich.-based company operates. Tenant sales per square foot, however, tumbled nearly 12 percent, to $497 per square foot.
Taubman was mum on how many tenants have received abatement. “We would prefer not to be specific about the absolute number of rent relief cases,” he said.
Rents won't rise (or even stabilize) until more consumers renew their love affair with meals away from home. That's unlikely until the second half of the year, when NPD Group predicts traffic will turn slightly positive. It likely won't spark new building. The International Franchise Association forecasts new-unit growth of just 2 percent among franchised businesses overall, well below the 5 percent average annual increase from 2001 to 2008.
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| Subway sub-franchisee Larry Feldman tries to negotiate with landlords to keep rent at about 8 percent of sales. |
As a result, many landlords will remain on the hunt for tenants as well as working to keep those they now have. “The dynamics have turned around so much that my e-mail is going crazy with landlords asking, 'What it will take to get you to stay in our center,'” says Sam Osborne, an area developer for Destin, Fla.-based Tropical Smoothie Café who has opened 20 locations in Central Florida.
For instance, Osborne recently helped renegotiate a lease, saving a franchisee $1,000 a month, or about $20,000 on the remainder of the lease. He says he told the landlord the franchisee wanted to stay but was exploring options. Osborne then asked the landlord “to work with us.”
Don't Bite the Hand
As good as rents are, Galardi Group Director of Real Estate Lou Boemia advises operators to resist the temptation during negotiations to stand on a landlord's neck. In exchange for significantly lowering rent on a Weinerschnitzel or Tastee-Freeze (the Irvine, Calif.-based company operates and franchises 360 of them), Boemia offers to add two years to the lease with a rental increase based on a measure like the Consumer Price Index plus 1 percent. “That way, the landlord can save face by saying he was able to raise the rent despite cutting it when he goes to his lenders or bosses,” he explains.
Feldman, who tries to keep Subway rents at 8 percent of sales, also recommends a light touch. “We can work out deals with three-year instead of five-year reviews. We can work out percentage rent deals,” he says. “It's becoming more of a partnership between tenant and landlord.”
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| Tropical Smoothie Café area developer Sam Osborne says landlords are willing to work with existing tenants and new ones. |
Tenant representative Dan Wirth, CEO of Windsor Realty in Atlanta, suggests taking a plan to the landlord instead of telling him things aren't working and you need rent relief. “Make it a win-win situation,” he advises. “Say, 'Let's fix the partnership so we can be in this for the long term. Here is what I will do as a tenant, and here is what you need to do as a landlord.'”
“Partnering” can only go so far at times. Boemia cites a landlord who offered to cut a Weinerschnitzel's rent by roughly half if it would renew a lease in Fontana, Calif., a city battered by the recession. Boemia, who has negotiated many leases in hard-hit locales, countered the landlord's offer by saying he'd only pay maintenance and insurance fees on a month-to-month basis until a new tenant could be found. The landlord agreed.
Storefronts gone dark don't look good, Boemia notes. “Once you have a business failure, your [shopping center] starts to develop a stigma. I know I'm leery about going into them,” he explains.
TI Surprise
Landlords today are also more generous with tenant improvement (TI) dollars, which are flowing to once unlikely candidates. Pizza Inn, an aging chain that has been opening buffet restaurants in recent years, is a beneficiary. “We are having more TI per square foot being thrown at us, in some cases more than I have ever seen,” says Jobe, adding TI ranges from $20 to $30 per square foot. That significantly trims the capital outlay for new franchised restaurants, improving cash-on-cash returns despite slightly higher occupancy costs.
Dan Ogiba, director of franchise development for Minneapolis-based Häagen-Dazs, is also surprised. “A small tenant like us never got TI,” he says. “Now we are getting it even from large developers, often in the form of free rent or extended build-out periods from 90 to 120 days. Savings from such largesse, which might include deferred rent, extended leases or kiosk locations within malls, has totaled anywhere from $25,000 to $55,000 per site.
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| The Galardi Group, which operates and franchises Weinerschnitzel and Tastee-Freeze, offers to add two years to the lease with a rental increase based on a measure like the CPI plus 1 percent in exchange for significantly reduced rents. |
Another bonus for the dip stores: High-traffic storefronts in Boston, Long Island and South Florida are now affordable. The 260-unit company recently opened its first location in Boston's Back Bay and is looking for its third spot in South Beach. “Two years ago we would not have made those sites work,” Ogiba says. Häagen-Dazs expects to open 20 stores in 2010.
Show Me Your Losses
Successful real-estate negotiations have always hinged on sharing certain financial information, chiefly tenant sales and expenses, with landlords. In this recession, however, landlords are asking for more, according to Jerry Herman, a Cleveland-based commercial real estate broker who specializes in restaurants. Some of the more financially savvy landlords now want to see detailed P&Ls and tax returns when a tenant requests rent relief.
The request may sound reasonable, considering an operator is asking a strapped landlord to take a potential bath. After all, highly leveraged developers are worried about breaking loan covenants. Still, Herman warns, never reveal too much.
A sophisticated landlord, provided enough financial data, could reasonably calculate a restaurant's “real” break-even point, a number in better economic times he wouldn't need to know. “[The landlord] might ask, 'Are you really losing money? You're charging expenses to the home office that are unusually high,'” Herman explains. “If he's a big developer and you have other restaurants in his properties, he can then assume their profitability. Now they want a percentage rent over a break-even they never knew about.”
Not everyone shares that fear. Kevin Kruse, who has heard of landlords asking for P&Ls, thinks chains looking for wholesale rent relief should be prepared to show financials. “I think it's a reasonable request,” says the vice president of franchise development for Einstein Noah Restaurant Group, which began franchising the Einstein concept two-and-a-half years ago.
| Slowly it Turns | |||||
| Piper Jaffray Senior Research Analyst Nicole Regan Miller predicts restaurant companies won't add units in significant numbers until 2011. (Restaurant growth over the same period the prior year.) | |||||
| Q1 '10 | Q2 '10 | Q3 '10 | Q4 '10 | 2011 | |
| Source: Piper Jaffray | |||||
| Quick service | 0.5% | 0.6% | 0.6% | 0.5% | 4.1% |
| Premium convenience | 1.6 | 1.7 | 2.1 | 2.4 | 9.7 |
| Casual dining | 1.1 | 1.1 | 1.1 | 1.2 | 5.9 |
| Fine dining | 0.6 | 0.6 | 0.3 | 1.2 | 3.3 |
Knippers, too, understands landlords wanting to see a restaurant's P&L. “If you say, 'I need rent relief,' it's fair for him to say, “Show me,'” he says. But, “I don't think you offer it up unless there is benefit.”
If you refuse to reveal the P&L, don't be surprised by skeptical landlords, Wirth warns. “If I am not showing the P&L, landlords would say, 'You are still making money.'” In any case, he adds, given gross sales figures landlords can do the math. “I'm not sure there's much of a mystery to hold back,” Wirth says.
Maybe not. But Jobe, not Pizza Inn franchisees, feels better when landlords get nosy. “If landlords are asking [for financials] during honest negotiations, that can be a good sign, because the landlord wants to see what you're doing,” he explains. “I sometimes get concerned if they don't ask.”
MORE: CEO Larry Feldman of Subway Development Co. of Washington looks for alternative ways to help fund franchisees.
MORE: How a T.G.I. Friday's franchisee convinced landlords to help pay for an expensive remodel program.
MORE: The weak commercial real-estate market has operators thinking about asking landlords for better deals—and some landlords are listening.
