Author: Debi Sommars
Ever think every article, blog or hashtag talks about chain restaurants or large publicly traded companies? The independent restaurant operators make up about 70% of the American restaurant industry.
Overwhelmed by everything you need to know to get into the location you love? You have so many hats to wear! Let’s talk about your lease(s). Are you excluding bank fees? Credit card fees, Employee Meals, Charitable Donations… to name a few, in your percentage rent to your Landlord? It’s hard to be the small guy and know what you can (and can’t) ask for when negotiating a lease. Let’s face it. It’s tough out there!
Restaurant Leases – FAQs
So let’s cover some ground on your lease. Below are commonly asked questions:
1. Get your own agent. The landlord’s agent might not have your best interest in mind. Have and advocate on your behalf. If you find a good commercial real estate agent they become a part of your team. If your goals are to be in the restaurant business forever chances are likely you will have more than one restaurant. Good idea to check in with your agent from time to time see if there are any opportunity’s in the marketplace for site number 2. Let your agent know about 6 months prior to wanting your next location.
2. Have your business finances in order. In order to lease a space, the landlord is going to want to know how you are going to pay the lease? You need to have a pro forma that shows your ticket average per customer, how many seats you’ll turn in a day, labor, and all your fixed costs. The second page should be the cost of goods that are based on your menu. This is a very important item. Everyone wants to know you know what you’re doing! There’s more; does the restaurant have the capital to open? How much money do you have? Do you have enough to cover getting the restaurant open plus a minimum of 6 months of operating? If not, you might want to find an investor.
3. Have your personal finances in order. You will need to sign a personal guarantee or have a co-signor sign a guarantee stating you will pay the lease even if the restaurant is defunct. If things happen to go in the wrong direction the landlord will want to know some of his costs are covered to remove you. You have to show that there is liquid money available. The trend today is 6 months of rent, brokerage fees and attorney’s fees for the new lease that will be generated (typically this is negotiable depending on what city but a good range to create this new lease is $1,500 to $2,500) for the new operator going into your space. Sometimes in lieu of a personal guarantee, you can offer to put a “chunk” of money in a savings account for a period of time. For example, your offer is to put $150,000 in an interest bearing savings account for 3 years. (most restaurants either live or die within 3 years) After year one, you are allowed to “burn-off” or reduce that sum by $50,000, after year two you can “burn off” another $50,000 at the end of year three your guarantee period is over and the last $50,000 is relinquished and so is your guarantee.
4. What is CAM? What is percentage rent? CAM, Common Area Maintenance is probably one of the most confusing sections of the lease and you will be surprised by how much you are paying for. Check to make sure you are not paying for things that relate to the landlord’s marketing efforts or legal fees associated with negotiating other leases.
Other things you may want to strike are any administration fees of more than 5%, today I’m seeing 10 to 15%, this is negotiable. And check to make sure you and the Landlord are talking about the same square footage. In other words, you want to put the gross leased square footage of your restaurant divided by that of the overall center (building, strip mall), it’s a percentage. That percentage is what you want to pay your CAMs on, regardless of occupancy of the rest of the center. 90% of the leases I see have a provision in the CAMs where if there is a vacant space in the center the Landlord can charge CAMs to the tenants who are in the center of a portion of the vacant space.
Percentage Rent. What is percentage rent? It means you pay a base rent and then on top of that amount pay a percentage based on monthly, quarterly or yearly sale volumes. Go for the yearly! There are fluctuations by season, yearly gives the yearly gross income (less deductions mentioned in the first paragraph) versus monthly where you kill it in the summer months and are paying percentage rent for those 3 months when you might not have too if the overall gross yearly sales doesn’t exceed the breakpoint.
I’m not opposed to having my clients pay percentage rent as long as the Landlord is contributing greatly to their build out. If percentage rent is determined by taking the base rent and dividing it by the percentage (ex: $5,000/7% = $71,428 monthly or $60,000/7% =$857,143) When sales exceed $71,428, you pay 7% of every dollar over the $71,428 yearly, if your sales exceed $857,143 you pay 7% on anything more than the $857,413. There is no law that requires you to stick to the natural breakpoint. You can negotiate the breakpoint higher (an un-natural breakpoint) or the percentage amount lower, like 5%. Look at your pro forma, see what you think gross sales will be in year 3 compare it to year 1, how quickly did sales rise? The landlord wants to be reimbursed for his added costs to your build out. Percentage rent allows for that, it’s a moving target….always negotiate it especially if your income is projected to rise quickly, you will want an un-natural breakpoint or higher rent at a natural breakpoint to pay the landlord at the last possible minute.
I’ve hit areas where I find the most oversight and also where I get the most questions. But, a lease can be 3 pages to 143 pages with Exhibits. I’ve seen them both. With all the hats you wear I hope this takes some of the mystery out of leases and look at number 1 again, create room on your team, there are some really good commercial real estate brokers who can help, let them wear this hat!
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