December 1, 2021

McKenzielee Blog

Wicked Clever House Experts

A new way to look at restaurant real estate

5 min read

When it comes to restaurant real estate, the calculus on everything from new store decisions to lease-negotiation strategies is changing fast.

Depending on the nature of the real estate and business in question, many key variables in restaurants’ real estate strategies have been shaken like a snow globe in the wake of Covid-19. Consider that:

  • Work-from-home trends mean that more customers are out in the suburbs rather than in downtown office corridors;
  • Major reductions in workforce availability have become a huge problem for thousands of restaurants across North America;
  • Supply-chain disruption and the construction labor shortage have thrown costs, pricing and new-store buildout timetables into question; and
  • Consumers have dramatically embraced new behaviors such as steering clear of indoor dining and making heavier use of mobile ordering, whether for pickup or delivery.

So how can restaurants adapt their store portfolio and market strategies to these fast-changing wildcards?

The first step is to reexamine your longstanding decision-making approach. Some operators have always taken a dynamic approach to real estate; others have been a bit more tactical and formulaic. To what extent does your strategy better reflect today’s realities?

Looking within

In particular, consider how alterations in one variable may affect the rest. For instance, many operators are prioritizing drive-thrus, pickup windows and outdoor dining. This stands to shape the square footage, layout and location (i.e., outparcel, inline or endcap) of new stores, with cascading effects on factors such as site-selection criteria, timetables for permitting/construction, and lease-negotiation strategies.

A shopping center that was right in the bullseye of your strategy in 2019 may now be unsuitable due to the lack of drive-thru/pickup availability. Likewise, another tenant’s exclusive lease clause could suddenly become a dealbreaker if it prevents you from adding your own drive-thru or outdoor dining area at that prospective location.

New ‘tipping points’

If a store had stronger-than-average sales throughout the pandemic, it may merit reinvestment. But most chains have at least a few “on the bubble” stores for which decisions may be trickier. Imagine two middling stores that are roughly the same on paper. At one shopping center, the landlord is willing to fund construction of a drive-thru as part of your lease-renewal negotiation; at the other, the landlord is less flexible, with lower cash reserves.

Clearly, the first center would likely be preferable given the addition of a critical element to meet changed customer needs and expectations.

Along the same lines, you could have two submarkets that boast roughly equivalent growth trajectories and demographics — tight markets with lots of online orders and not much available space. In one of them, you have an opportunity to lease space in a ghost kitchen that is performing well on behalf of several restaurants. In the other, your only option is to sign a high-rent lease.

While a new approach for the company that generates far less topline revenue, the ghost kitchen may be the best and most profitable option in the end — but that can only happen if you evaluate all possibilities and adopt a strategy that is flexible enough given the range of opportunities.

Price of inaction

When there’s a fundamental shift in the terrain, looking in the rearview mirror ceases to be a good predictor of the journey ahead. The industry cannot disproportionately rely on past performance until market conditions stabilize, which could take a few years.

Naturally, then, some operators may be tempted to “wait until all of this settles down.” But sitting on your hands is just not an option in today’s restaurant business. All too often, waiting longer to execute an adaptive real estate strategy will translate into spending more time doing things like:

  • Paying above-market rents;
  • Operating disadvantaged real estate that erodes profitability;
  • Losing well positioned locations to nimble competitors; and
  • Failing to capitalize on opportunities to differentiate versus the competition through adaptive approaches (drive-thrus, ghost kitchens, outdoor seating, smaller formats, etc.).

It is important to consider the potential effects of slowdowns in permitting, buildout and hiring on your planned-for timetables. And franchisees may want to get an early start on discussions with franchisors as well due to the need to secure franchisor approval for major real estate moves.

Let’s say that, for strategic reasons, a franchisee wants to reinvest in one store and close another one, even though both locations have performed about the same historically. If the franchisor is laser-focused on performance alone, the franchisee could be in for an extraordinarily difficult and time-consuming conversation about that store closure.

After walking the franchisor through the capital investment and portfolio plan, the franchisee may agree to some obligations that are outside of the franchise agreement per se, in exchange for greater franchisor support and flexibility. The conversation could be both difficult and time-consuming. Better plan ahead.

Being creative

Greater creativity in lease negotiations may also be called for. Suppose a restaurant operator wants to add a new heated outdoor seating area and reconfigure some space to keep third-party delivery drivers from interfering with customers. The lease-renewal negotiation could involve a swap in which the restaurant pays percentage rent and signs a longer lease and the landlord contributes substantial tenant improvement dollars. Or maybe the restaurant reinvests in the store and signs a longer lease in exchange for substantially lower rent.

Since there is so much demand for second-generation restaurant space, now is also a good time for some operators to consider pruning their store portfolios of underperforming locations.

Such things take time. Operators that put off planning and executing their real estate decisions could find it harder to hit the ground running later, thus putting themselves at a disadvantage. For most restaurants, the time is now to press ahead with multiyear, comprehensive real estate portfolio reviews and make some educated and well placed bets on the future.

AUTHOR BIO

Joe McKeska is a Senior Managing Director at A&G Real Estate Partners. The Melville, N.Y.-based firm has provided occupancy-cost reductions, lease terminations, dispositions and other services to dozens of restaurants and retailers, including Sbarro, Pizza Rev, Snap Kitchen, City Barbeque, Garden Fresh Restaurants, Café Rio Mexican Grill, major Pizza Hut franchisor NPC International, TooJays, Cava, and a national white-tablecloth restaurant chain.

https://www.nrn.com/operations/new-way-look-restaurant-real-estate

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