RESTAURANT SOLUTIONS

Today as I was driving around visiting and inspecting properties and complexes, I was listening to a radio talk show as I usually do. After all, I might learn something by listening to industry leaders during work time instead of listening to music that I’ve already heard. The later I do on my own time.

The conversation revolved around the China Virus, Covid-19 pandemic, etc. implications for small businesses. In particular, restaurants and bars were singled out as the worst possible economic activity under these lock downs. The expectation is that this industry group will experience the highest failure rate of all effected industries. The projected failure rate is just under fifty percent (50%). The specialists were discussing that franchises and chains also are experiencing difficulties, but not as badly as the independent restaurant entrepreneur.

I manage several commercial and retail complexes and had developed a formula for restaurant success under multiple scenarios that has had great appeal to the operator. Since a number of my properties fall into a category of resort locations or tourist areas, I found that the franchises and small chains were quite resilient during bad economic conditions, but the stand-alone restaurant was not, just as in this pandemic.

That’s even the case when a team with significant operational experience and financial backing founded the restaurant. A restaurant often has the resources to survive a poor primary quarter, meaning an under performing three months of operations. This might be attributable to a cold rainy summer for a summer resort or a muddy winter for a ski resort. Yes, this can be extended to forest fires in the west during an otherwise beautiful summer and many additional scenarios during the peak season.

However, should that restaurant experience a poor peak season and then the following quarter is also significantly substandard as well, that restaurant will be in trouble! Many areas during this medical crises are now facing three bad quarters. That’s nine months of substandard sales. The Payroll Protection Plan has helped get them through one quarter, so they are again at the breaking point.

The provisions that I propose will work in most locations, but not all. Specifically, what I found that has significant appeal to restauranteurs is a gross lease with a minimum monthly payment. The gross lease payment is based on sales. When sales go up, rent goes up. When sales are down, the rent is reduced. The minimum rent is intended to cover a landlord’s fixed costs of operation. In this manner, if the landlord has an excellent location with extreme seasonality, both the landlord and restaurant are protected. The landlord will have the minimum to keep the doors open and the restauranteur will have rent more or less commensurate with their sales.

It is highly possible for the landlord to achieve higher rents in this manner than under stable or flat rent scenarios, even those with fixed steps. Of course all the specifics are negotiable and are site specific. Some sites will have lower costs than others and all these costs are factored in on the landlord side. On the restauranteurs end, the percentage of the gross will also reflect the type of operation and the mix of sales generated.

Of course, the landlord will be interested in some form of proof of gross sales and the tenant, likewise, will look to copies of receipts. In most jurisdictions there are some form of sales taxes, or meals taxes. A restauranteur will have to comply with the taxing authority with a statement or completed form. A copy of this form is substantial proof of gross sales. On the landlord's side, Common Area and Maintenance (CAM) charges are a similar proof of accepted costs totaled from invoices for services. Just what percentage of the tax statement or what items are included in CAM is subject to negotiation and mutual agreement. Income taxes are not considered an appropriate mechanism in this process.

The mechanism would be that the landlord receives at least the itemized and projected CAM charge reduced to the appropriate rental period and as much as the stated percentage of the tax statement for the appropriate rental period. The period is based on the frequency of the tax statement, which verifies the upper realm of the rental payment.

A claw back provision may be suitable in most instances. The claw back would allow for CAM charge payments that exceed the percentage of the tax statement for rent to be offset against future restaurant sales thereby reducing the percentage rent in future periods. For example, this provision would be suitable for a restaurant deep in the Snow Belt that depends on lake front dining. Too much snow would drive up plowing and sanding components of the CAM charges and perhaps at the same time reducing the number of patrons and dollar amounts of restaurant sales for the same period. The CAM exceeds the percentage rent for the period.

There are two alternatives subject to negotiation. In the first, the landlord is paid for the high CAM costs exceeding percentage rent in the same period, and the restauranteur pays the overage but then is reimbursed in the next period. Alternatively, the higher CAM charges are carried forward to the next period when the sales percentage rent is higher and the landlord is out the excess for one period – but not forever. In this way both landlords and tenants can weather the storm.

This concept is not likely to be appropriate in every instance. It is inappropriate for most tax free exchanges, or franchise restaurants where the lending institution intends to sell the mortgage. The concept works best when single proprietor restaurants are a portion of the portfolio or a part of the complex being developed. It’s not a panacea, but will help to keep many operations and properties viable.