ROSEVILLE, CA—Hardly a week goes by without news of another celebrity restaurant operator who is having trouble with his landlord. Is the celebrity tenant at a disadvantage, as compared with a non-celebrity, when it comes to negotiating with the landlord? We chatted with Jim Haslem, a principal with Huntley, Mullaney, Spargo & Sullivan Inc., a real estate and financial restructuring firm, on the subject.
According to Haslem, if a high profile restaurant operator, such as Gordon Ramsay or Bobby Flay, has difficulty with a lease or his landlord, you’re sure to read about it in the press. “That coverage may imply that celebrity tenants actually are at a disadvantage in dealing with their landlords.”
Reality, however, appears to be more nuanced, he says. “On the plus side, the celebrity operator may enjoy advantages over non-celebrity operators in terms of attracting publicity, patrons and investors. The celebrity operator may also be courted by landlords seeking to raise the profile of their retail centers.”
GlobeSt.com: When it comes to the nuts and bolts of the lease, what should the celebrity operator keep in mind?
Jim Haslem: When it comes to the nuts and bolts of the lease, the celebrity operator must be vigilant not to go overboard on tenant improvements or to overestimate sales projections. Those factors can translate into a rent that proves fatal to the business. Over time, economics will trump whatever edge the celebrity may have at the outset with the landlord. The celebrity tenant, like the non-celebrity, has to get the lease right.
GlobeSt.com: What are some of the things that retailers and restaurant operators should consider when negotiating a lease?
Haslem: Among the key factors are rent, rent escalations, lease term and options to renew. Most important of all is rent as it’s usually in the top three of the largest costs on the store’s P&L. The rent burden has a disproportionate impact on the financial viability of a store or restaurant. Time and again we’ve seen the impact. For instance, a restaurant can be doing everything right, such as great food, service and marketing, but if the rent is too high, the chances of failure are high. Even if the rent is just a little too high, the chances of failure are higher than many operators realize. Getting the right rent for the business is essential. Finding the right rent is not the same thing as making a determination of the market rent. What’s market is often subjective and may have little bearing on the business. The more germane question is what rent makes sense for the particular business. Often the right rent for a particular site is expressed as a percentage of sales at that site.
GlobeSt.com: What are the current trends that you’re seeing with retail and restaurant tenants?
Haslem: There are several macro trends churning in the marketplace. On one hand, you have an improving economy and a growing population base. These factors should translate into greater demand for goods and services, and therefore, greater demand for retail and restaurant space. On the other hand, the Great Recession caused a shift in the consumer’s attitude toward spending, including becoming more cautious about their spending and keeping a close eye on their debt. Also, wage growth and new household formations are sluggish. Amongst the biggest change is of course the impact of the internet. All of these factors are changing and curtailing demand for leased premises.
GlobeSt.com: What impact is the internet having on the demand for retail and restaurant space?
Haslem: It’s accepted knowledge that the internet is dramatically affecting retailers and restaurants. The impacts are profound and ongoing. In a few years, we’ll be able to look back and see the changes clearly, but even today, we can foresee certain impacts. The most obvious impact of internet retailing is on brick and mortar retailing. There is a clear move away from big box retailing and shopping malls are under pressure. At one point, restaurants were thought to be an answer to backfilling excess retail space. That strategy can backfire. Where we’ve seen a high concentration of restaurants, the competition is fierce and tenants find it difficult to pay the rent and make money. For the foreseeable future, landlords will compete for the most desirable tenants and they will likely continue to see high turnover in their tenant mix.
GlobeSt.com: What are some of the changes in retail and restaurant leasing since the Great Recession?
Haslem: The macro trends above are translating into a “new normal” for restaurants and retailers. There is a pronounced stratification in lease pricing where the top sites are garnering top rents, as well as the continued slack in demand and rents for the larger inventory of less than optimal sites. Since the Great Recession we’ve seen a resurgence in rents, particularly at the well-positioned malls and in major metros, such as coastal cities. Landlords are harvesting profits where they can. For top sites, landlords are demanding high rents and steep rent increases from existing tenants. Additionally, the landlord-tenant relationship has also changed. As the economy has improved, we see that economics trump relationships. Even longstanding tenants who have had a good relationship with their landlord are finding it harder to renew their leases on terms that are financially viable. Another consequence of the distressed real estate cycle that we’ve been through is that many tenants now have new landlords. Tenants whose landlords lost their properties to lenders and special servicers find that they have little or no relationship with the new landlord.
GlobeSt.com: What are some of the recommendations that you have for landlords and tenants?
Haslem: To landlords, it’s important they work with their tenants to get a lease that makes sense for both parties. The transaction costs of replacing a tenant are high. In many cases, you can avoid those costs by working with the tenant. For tenants, you need an analytical approach. Ask yourself the following questions: What is the right rent; what escalations can I tolerate; how much term do I need; and do I need an escape hatch, such as an early termination clause? Review and rank the sites in your lease portfolio on a regular basis to see if the rent for each site is in line with your target metric. Start lease renewals early so that you have time to relocate, if necessary. If there is a problem with a particular site, develop an action plan and approach the landlord. It’s often said that everything is negotiable. Not all negotiations are successful, but that’s not a reason not to try. If you are negotiating with your landlord, avoid emotion and deliver on your promises. In many cases, engaging a third party advisor to take the lead in negotiations will optimize the result. Finally, avoid naming a store or restaurant after a particular location because, you never know, someday you might have to move.