Restaurant Leases - Deliciously Profitable or the Path to Heartburn
June 7, 2005
James M. "Jim" Norman- Ft Lauderdale
Restaurant Leases – Deliciously Profitable or the Path to Heartburn
There is fairly broad consensus that adding a restaurant to a center or an office building has the potential to reap considerable profits for the landlord. The economic benefits would go along with enhancing the "panache value" of the project, increasing consumer traffic due to its destination quality, and thereby increasing the profitability of the project. In an office project, which may have no other retail, the building will be more desirable to tenants due to the restaurant amenity, and therefore, the project may be able to demand higher rents. But before we run off in search of restaurant tenants and profits, let''s discuss some of the legal and practical issues that can affect the projected profitability from the restaurant.
Check Out Covenants and Zoning
As a first consideration, are there recorded covenants, conditions and restrictions or municipal zoning requirements that might prevent or limit locating a restaurant in the most desirable or likely location? This may not be as simple as it sounds, and there may need to be an analysis of all of the components of the zoning to determine if restaurant use is acceptable. Some of the more serious issues concern any specific parking ratios required for restaurant use, and floor-to-area ratios (FAR) that limit the amount of space in the project. FAR issues frequently depend on what is and is not "space" for the computation of the FAR, e.g. the patio area of the restaurant and any mezzanine. A close cousin to the zoning analysis is the alcoholic beverage licensing considerations. If the restaurant intends to serve alcoholic beverages, which it should consider in most jurisdictions, and if there is an interest in boosting customer traffic and profits, then the restaurant must be in a position to obtain a liquor license. If the zoning does not permit alcoholic beverages, there is a process to seek administrative relief or to amend the zoning, but this will be an additional cost in both time and money to factor into the pro forma. The point is that the projected profitability arising out of the addition of a restaurant can be adversely affected by the cost to revise the zoning. The landlord''s goose could be cooked even before it is in the oven.
Can You Get There From Here?
A restaurant will almost always want direct access to the street so that its customers can easily enter the restaurant. This is good news as to the ease and cost of construction. But the space still needs to be configured, with special attention to aesthetic design, mechanical, electrical, venting, plumbing and grease traps for the restaurant.
In the context of a typical ground lease arrangement for an outparcel of a center, landlord/developer input on configuration-related issues of space, aesthetic design, mechanical, electrical, venting, plumbing and grease traps is limited to a discussion of any objective effect on the overall project''s mechanical, electrical and plumbing systems. In a project in which the restaurant is inside an office building, typically the landlord/developer has a greater ability to offer input because the impact of the restaurant configuration has a greater effect on the building. In that context, the configuration of the restaurant layout will be somewhat dictated by the restaurant itself. Unless there is some significant adverse affect on the project, the wise landlord may let the restaurateur dictate their kitchen design as they are the experts as to how best to lay out a kitchen for their use. Yet, the restaurant may benefit from a collaborative landlord/developer''s input to assist with the remainder of space layout in order to provide the seats needed to make the restaurant profitable. This dialogue will become more complex as the restaurant becomes more complex, such as multilevel designs and specialty theme concepts, and as will be mentioned below, it is the landlord''s need for an exit strategy that will heavily influence this aspect of the discussion. Quite simply, presuming for a moment that the project can accommodate the concept of a two-level restaurant, after analyzing the exit strategy, one must nevertheless examine the aesthetic design, mechanical, electrical, venting, plumbing and grease issues. In the context of a restaurant within a building, some of the questions and issues are as follows:
- Is it physically possible to install the necessary mechanical, electrical, venting, plumbing and grease traps within the building and comply with health code requirements?
- How much it will cost?
- Will the landlord or tenant need to enter another tenant''s premises to install equipment initially or in the event of repair? Will that be physically possible and legally achievable under the lease?
- Will the operation of the equipment itself and/or the operation of the restaurant interrupt the operations of other tenancies? What about noise and odor conditions caused by the placement of the mechanical and venting equipment and grease traps?
- In the two level or multilevel space, will the Americans with Disabilities Act operate to require an elevator within the space?
From a lawyer''s perspective, construction issues for restaurants require much more detailed attention and negotiation because they are cost intensive. It should be clear from the start whether the tenant or landlord/developer is constructing specific items of work and at whose cost. Architects and engineers who have experience with restaurants should be retained by both parties to prepare detailed construction drawings. From the landlord/developer''s standpoint, due to the longer than typical amount of time required for a restaurant buildout and the possibility of delay due to the detailed nature of the buildout, a firm rent commencement date must be placed in the lease. From the restaurateur''s standpoint, it may be necessary to build extra time into the opening schedule so that rent does not commence before the restaurant can open.
The Exit Strategy
When a restaurant deal unravels, the consequences can be very ugly. Because the initial financial outlay of a restaurant deal is higher than an average retail deal, any bad news translates into greater losses. Perhaps the biggest practical and legal concern for the landlord is that of releasing 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 want to maintain the space as restaurant space. It is too costly to reconvert the space back to office space. Landlord/developers often 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 overall appeal and therefore the draw of the tenancy. Having the theme fully developed may bring some economic benefit, it just must be considered against the retrofit costs if there is an early exit of the restaurant. 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 to "de-identify" the second-level exterior when the landlord/developer finds itself in possession of that multilevel space. The typical lease states that the tenant will pay for reletting costs upon a tenant default. Care should be taken if any material elements of this provision are modified during the lease negotiations. As is typical for lawyers, we look first to the worst case scenario. For example, how will a landlord recover the money owed to it for refitting and reletting
restaurant space in the face of a tenant bankruptcy? (Remember to also
consider the tendency to use single asset entities.) While these legal
concerns are not different than the typical retail deal, it is the overall
cost and effect of the demise of the deal that is amplified in the
restaurant context. So, you can eat whatever you want and avoid getting
heartburn by taking care when negotiating your restaurant deals!
A similar article was published in Real Estate Forum Magazine in 2004.
For more information, e-mail Jim Norman or Carole Laude Pechi at
jim.norman@hklaw.com or
carole.pechi@hklaw.com, respectively, or call toll free, 1-888-688-8500.
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