Restaurants Face Shrinking Margins As Food, Labor Costs Increase

Restaurants are facing shrinking margins with higher food, fuel, labor and transportation costs, according to a report from the Restaurant Finance group at Mitsubishi UFJ Financial Group.

The rise in labor costs comes from a number of post-pandemic factors including the increased difficulty in drawing new workers and retaining existing ones in a labor market that is demanding higher wages and being more selective in choosing employers, says Nick Cole, head of restaurant finance for the firm.

The decline in profitability will make restaurant companies less attractive as mergers and acquisition targets in the first quarter of next year, MUFG is predicting. The M&A pullback should be significant unless there is an improvement in margins, Cole asserts.

He attributes the recent M&A boom in the restaurant industry⁠—especially in the quick-service sector⁠—in part to the generational transfer of businesses.

Supply chain interruptions and worker scarcity among commodity producers and transporters have added to the cost woes of the eateries, says Quinn Hall, the leader of loan underwriting and portfolio management for the MUFG Restaurant Finance Group.

To attract workers, Hall says restaurants will have to spend more on health benefits as well as wages and offer flexible work schedules.

With the problems with margins, he says banks are continuing to accept a higher leverage profile among borrowers and offer loose amortization, pricing and covenant terms which will become more stringent in 2022 if interest rates rise and borrowing costs grow—and certain businesses may experience credit downgrades.

The trend to more off-premises dining that started during the pandemic and continues is spurring a retooling of restaurant real estate to allow for more drive-through and digital pick-up lanes while deemphasizing dining-room space to lower dependence on in-restaurant business, Brian Geraghty, Head of Loan Originations at MUFG adds.

“Over the long run, we believe you’ll see restaurants shrinking in size to reflect smaller onsite patronage but better built to support off-premises business,” Geraghty says.

Marcus & Millichap is predicting labor shortages and wage increases will continue to be headwinds but then should abate a bit in 2022.

Recovery of restaurants, and other businesses hit hard during the pandemic will be bumpy, but Marcus & Millichap Senior Vice President and National Director Research Services John Chang noted multi-tenant retail vacancy rates only increased by 90 basis points to 6.6% and current absorption should continue into next year.