Restaurants - Food for Thought Before You Negotiate the Lease
 
May 17, 2004
 

While the typical retail deal may give landlords heartburn in this era of economic uncertainty, an almost sure-fire return on investment can be gained from the addition of a restaurant to a center or a building. In addition, the benefits of adding a restaurant go beyond the economic return on the unit itself. A restaurant may bring a certain amount of panache to a center or building, but, most importantly, the addition of a restaurant may make your entire project more profitable. In a project with retail, a restaurant can bring in greater consumer traffic to the surrounding tenancies due to its destination quality, and boost sales for those tenancies. In an office project which has no other retail, the building will be more desirable to tenants due to the restaurant amenity, and therefore, you may be able to demand higher rents. The above are all good reasons to lease to a restaurant. However, before you go to lease, there are many issues to consider which can affect the projected profitability arising out of the presence of a restaurant.

The Exit Strategy

While it may seem unusual to first think of how the deal will possibly unravel and the consequences of such unraveling, the termination of any deal can have a large impact on profitability. As the initial financial outlay of a restaurant deal is higher than an average retail deal, this effect is amplified. Perhaps the biggest concern is that of re-leasing the space and the costs to do so. It is logical that once office or standard retail space is converted to restaurant space the landlord will typically want to maintain the space as a restaurant space, as it is costly to re-convert the space. While we are all aware that typical leases state that the tenant will pay for re-letting costs, one must consider whether this provision will be modified in negotiation to delete payment for alterations. Looking to the worst case scenario, how will a landlord get the money owed to it for re-letting from a bankrupt tenant (given the proclivity towards the use of single asset entities). While these concerns are not different than the typical retail deal, the effect of the deal demise can be amplified, so great care needs to be taken in negotiating the restaurant deal.

“I’m Sure that We Can Put a Restaurant In” and Location of the Restaurant Space

Is the landlord/developer absolutely sure that a restaurant can be added to the project? It goes without saying that the landlord should first determine whether the existing zoning ordinances will permit a restaurant to be located within the center or building. It is not usually as simple as just verifying whether a restaurant use is permitted. The landlord needs to review all components of zoning to determine if the restaurant use is acceptable. Typically, the most problematic issues relate to specific parking ratios required for a restaurant use, and floor to area ratios (FAR). FAR limits the amount of space in the project, and often turns on the question of what is and is not space for the computation, e.g., the patio area of the restaurant and any mezzanine. While these are important zoning issues to the landlord/developer, an issue of equal importance for the restaurateur is his or her ability to obtain a liquor license. Liquor boosts restaurant profitability. Of course, if the restaurant use does not satisfy the components of the existing zoning, it is always possible to amend the zoning. That involves a cost-benefit analysis beyond the scope of this discussion, but one can easily see how the projected profitability arising out of the addition of a restaurant may be affected by spending the funds necessary to revise the zoning.

If the restaurant use is acceptable under all components of the zoning, the next step is to determine possible locations for the restaurant in the center or the building. A restaurant will almost always want direct access to the street so that its customers can easily enter the restaurant, and certainly that type of space will make construction less difficult and possibly less costly, as described below. However, does leasing that space to the restaurant serve the purposes of the landlord/developer? Could that very valuable space or out-parcel be put to a more profitable use?

Practical Issues of Locating and Constructing the Restaurant: Configuration, Aesthetic Design, Mechanical, Electrical, Venting, Plumbing and Grease

Presuming that the landlord/developer gets over the hurdle of leasing the space or out-parcel to a restaurant, next comes the decision on configuration of the space, aesthetic design, mechanical, electrical, venting, plumbing and grease traps for the restaurant.

Oftentimes, due to the typical ground lease arrangements for an out-parcel, the landlord/developer’s input on these issues is limited to a discussion of any objective effect on the project’s mechanical, electrical and plumbing systems. Where the restaurant is to be located inside a building, the landlord/developer typically has a greater ability to influence decisions. That said, certainly the configuration of the restaurant layout will be somewhat dictated by the restaurant itself. From the author’s perspective, however, unless there is great effect on the project, the landlord/developer should let the restaurateur dictate their own kitchen layout, as they are the experts. Even so, the restaurateur may benefit from the landlord/developer input with regard to the remainder of space layout. But, what if the restaurant wants to occupy two levels? As discussed above, the landlord/developer’s first thought should be about the exit strategy. It is easier to re-let a one-level space than a two-level space.

After analyzing the exit strategy, and presuming that the project can accommodate a two-level restaurant, one must examine the same aesthetic design, mechanical, electrical, venting, plumbing and grease issues as contemplated with a single level space. Those issues just become more complicated by a two-level design.

Aesthetic design may be the easiest of the issues to tackle. While subjectively viewed, as part of the creative process of conceptualizing and constructing a new restaurant, restaurateurs are masters at inventing the concept or theme for the restaurant, and the correct “look” to carry out that concept or theme. However, whether the restaurant is in the building of a project or on an out-parcel, the restaurant will need to have a unified look that fits the architecture of the project, while satisfying the restaurateurs aesthetic sensibilities and theme. Some compromises may be necessary for all sides to achieve their objectives. Landlord/developers may permit the restaurateur great leeway in developing the concept and aesthetic design for the interior and some portions of the exterior. This makes some sense as a fully developed theme adds to the excitement and draw of the tenancy. However, this author advocates that the landlord/developer avoid making too many exterior changes if the restaurant is to be located within a building. Notwithstanding, if the landlord/developer has a great financial deal with a successful restaurateur, the long-term benefit of permitting the exterior changes may outweigh the exit costs. It is always important to keep in mind that whether the changes to the space are interior or exterior, the look will need to be reversed at some point in the future. One can imagine the difficulties the landlord/developer will encounter when “de-identifying” the second level exterior of a two-level restaurant located in a project building.

While a two-level out-parcel restaurant may avoid many of the concerns stated below, in the context of a restaurant within a project building, the most difficult of the issues to resolve can be those involving the mechanical, electrical, venting, plumbing and grease traps. The questions are simple. Is it physically possible to install the necessary mechanical, electrical, venting, plumbing and grease traps within the building, and to comply with health code requirements? If so, how much it will cost? The answers depend on the location and an experienced engineer can help. The following issues should at least be considered: (1) running equipment through a two-level space is more costly than running through one-level ; (2) Will it be possible for the landlord/developer or restaurateur to enter another tenant’s premises should it be necessary to install or repair equipment ? Clearly, this is a difficult coordination issue that must be handled delicately so as to avoid disruption to another tenant’s business; and (3) will the operation of the restaurateur’s equipment itself interrupt the operations of other tenancies? Many landlords/developers have had to deal with noise and odor conditions caused by the inappropriate placement of the mechanical, venting and grease traps. Landlords/developers should be prepared to handle these issues whether or not codes were met in the construction and these systems were professionally engineered. Another special consideration of a two-level space within a project building is whether the Americans with Disabilities Act requires an elevator to be installed. The installation of an elevator is costly and time consuming, so the landlord/developer should determine well in advance who will bear that cost.

Due to the cost intensive nature of constructing a restaurant, construction issues require detailed attention. It should be made clear whether the tenant or landlord/developer is responsible for constructing specific items, and at whose cost. Architects and engineers experienced with restaurant construction should be retained by both parties to prepare detailed drawings. Due to the typically long amount of time required to build a restaurant, and the possibility of delay due to its detailed nature, the landlord/developer will want a firm rent commencement date identified in the lease. Conversely, the restaurateur may find it necessary to build extra time into the opening schedule so that rent will not commence before the restaurant can open.

The Impact on Project Services and Building Systems

Finally, the landlord/developer should seriously contemplate the possible additional services required by a restaurant tenancy and the demand that such a tenancy may make on the building systems. A primary area of concern is utilities. Most restaurants will want utilities separately metered, at the landlord/developer’s cost, so they can monitor their exact consumption. While separate meters can be costly to install, if this may avoid future disputes over usage and costs, then landlord/developer may well consider the expenditure to be worthwhile.

Utility usage should be analyzed in determining whether to lease to a restaurant. It has been estimated that the typical office space takes 200-400 amps of electricity per square foot, a retail space with average lighting takes 100 amps per square foot, while a restaurant space takes 600-800 amps per square foot. Because a restaurant generates a lot of heat due to cooking, lighting and the number of people that occupy the space, it will require more heating, ventilating and cooling (HVAC) than a typical retail or office space. In addition, if the restaurant operates after normal business hours and the building has only a central plant HVAC system, a landlord/developer may want to consider installing an independent HVAC system for the space. If no independent HVAC is installed, supplemental cooling may be needed. The responsibility and cost for the initial installation and ongoing maintenance must be allocated between the landlord/developer and the tenant. The existence of natural gas lines available to the space is another concern of restaurateurs. While increasingly found at newer projects, this utility may not be available in older buildings. Most restaurateurs in a stand-alone building require gas for cooking. Finally, it should be noted that restaurants consume more water than most, if not all, other tenants. The increased use of utilities means increased wear and tear on the Landlord’s equipment in addition to increased usage costs. It is imperative that the landlord/developer factor this cost into the deal as an item of cost reimbursable by the tenant.

Security is also of great concern in today’s world and must be considered as another cost reimbursable by the tenant. The security concern is more evident with restaurants due to the hours of operation. The after-hours traffic can be regulated through control of the building’s entrances and exits to avoid entry into spaces other than the restaurant. Control is better handled, however, by having a dedicated exterior entrance to a restaurant. Where such an entrance is not possible to construct or, if other access is required due to code issues, it may be necessary to have a security guard on duty to assure that the traffic goes only to the restaurant. Security may also be needed to avoid disruption of common areas due to crowds attending the restaurant. After hours lighting can also be used to assist security.

Usage of the building’s common area is another concern when leasing to a restaurant. More traffic will be attracted to a building or project that contains a restaurant, and more traffic can mean more problems. The common areas can be disrupted by the volume of patrons entering and exiting a building or center, and by patrons queuing or waiting for entry into the restaurant. Existing tenants may complain of disruption to their business, and if the disruption is consistently disorderly, the landlord’s image may suffer. Crowd control, either by the tenant or the landlord/developer or both, may be required to keep order. The question is who will bear the cost. Disruption can be increased if the restaurateur uses a patio area. Additional common area issues include trash cleanup; the timing, location, and sanitation of deliveries; and the removal of garbage generated by the restaurant.

This article only touched on a few of the most important issues to be analyzed when leasing to restaurants. When good planning and analysis occurs, the tenancy is destined for much greater success, and both the tenant and landlord/developer will reap the benefits of a successful partnership.

For more information, e-mail Carole Pechi at carole.pechi@hklaw.com or call toll free, 1-888-688-8500.