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As a Consultant, Advisor, and Certified Executive Coach, I’ve had the opportunity to work with a number of clients, recently, who are interested in opening their first restaurant, adding a second location, or expanding their multi-unit “empire.” It is now my pleasure to share the insights they have learned regarding lease negotiations with you.
The journey of opening a restaurant is a bold endeavor, filled with dreams of food, beverage, & hospitality excellence, building & developing a team of professionals, and becoming a cherished pillar of your neighborhood & community. However, amid the excitement of choosing a logo, planning menus, and designing interiors (you know you’ve considered having the reclaimed sconces from the Titanic’s dining room adorn your walls), one crucial aspect demands careful attention: renting the perfect space. Securing the right Location, Landlord, and Lease (the new “Three L’s” of commercial real estate, as one of my colleagues has repeatedly said) can significantly impact the success and sustainability of your restaurant. In this article, we dive into the essential terms and considerations involved in renting space for your restaurant.
Build Your Support Team
It’s important to understand that you can’t do this alone. Not only is it ok to ask for help, it's a clear demonstration of how smart you are! You need people with experience and a deep knowledge base to support and advise you throughout this project. There are five key partners at this stage of development, all of whom should have specific and significant experience working directly with clients in the restaurant and hospitality industry:
Restaurant Consultant: The Restaurant Consultant is essentially your project manager, overseeing and guiding many aspects of your project as well as acting as your translator for people who “do not speak restaurant.” They will build and keep your timeline, write your pre-opening budget (expense list) as well as your first-year operating budget, provide the framework for your human resources program, help you find your trusted partners with experience specific to the restaurant industry, and will be your advisor, mentor & coach, always asking you the tough questions to get to the better outcome.
Real Estate Agent / Broker: Your Commercial Real Estate Agent or Broker is the person who will not only set appointments and show you properties, but also act as your representative during initial and ongoing contact with the property owner. They will understand what type of tenant the landlord is looking for, what their financial requirements are to move forward, and key information about each location.
Commercial Landlord / Tenant Attorney: This is one of up to three attorneys you may work with (General Business and Liquor Licensing) as you work toward opening your business. It is essential that you engage this attorney PRIOR to beginning the negotiation of any Letter of Intent (covered later), as the LOI will become the foundation of your lease.
General Contractor: You will want to engage your General Contractor (GC) prior to touring potential properties. First and foremost, you will want to be sure they have room on their construction calendar for your project. Additionally, it will be important for components of lease negotiation for them to be able to assess the various conditions of any property to tell you the pros and cons, as well as to explain any hidden expenses that may pop up. They will also be able to give you a preliminary estimate on the price per square foot to build out your restaurant, which will be essential for your overall budget.
Architect (and Designer): The Architect and Designer partner directly with your GC to help bring your vision to life. They also know all of the rules, regulations, and permitting requirements, such as how many restrooms you must have based on your occupancy, what the ADA requirements of your space are based on the municipality you are located in, and they will be the artistic interpreters of what you want your guests to see, feel, and experience when the walk in the door. They will also provide significant pre-opening budget information.
Your Documents
There are two principal documents that you will be negotiating, reviewing, and signing as you work toward reaching an agreement on your location.
Letter of Intent: Your journey typically begins with a Letter of Intent (LOI). This document outlines the preliminary understanding between the prospective tenant (you) and the landlord regarding the lease of the space. It covers crucial details such as the proposed lease terms, rental rates, any tenant improvement allowances, and other essential conditions. While not legally binding, the LOI serves as a blueprint for negotiating the lease agreement. While your Commercial Real Estate Agent / Broker will certainly help guide you regarding what they already know about the landlord, it is essential that your Real Estate Attorney is involved “this early” in the process.
Lease: The lease agreement is the cornerstone of the landlord-tenant relationship. It delineates the rights, responsibilities, and obligations of both parties throughout the lease term. As a restaurant tenant, it's crucial to review the lease meticulously, paying close attention to provisions regarding rent escalation, maintenance responsibilities, permitted use of the premises, and any restrictions that may impact your restaurant operations. It is not uncommon for a commercial real estate lease to be 35 pages long or more. Again, the assistance of your Real Estate Attorney in determining final terms and conditions is necessary.
Flipping The Levers
During the course of lease negotiation, there are a number of components that all live in the same ecosystem, and THEY ARE ALL NEGOTIABLE! Remember, the lease negotiation is a series of requirements, concessions, tradeoffs, and collaboration to get to a mutually beneficial end. Your landlord has a vested interest in YOUR success as their tenant, and they should act as such throughout the lease negotiations. If you can’t get the delivery conditions you are seeking, perhaps you can negotiate increased TIA. If you must include percentage rent, perhaps you can negotiate a longer rent abatement period. As you will see, there are any number of levers that can be flipped, turned, pulled, and adjusted.
Price per Square Foot and Base Rent: The price per square foot and base rent are fundamental components of the lease agreement. The price per square foot refers to the cost of renting each unit of occupiable space within the premises. Base rent, on the other hand, is the fixed monthly or annual amount payable to the landlord for occupying the space. As an example, if you rent a space that is 1200 square feet (of occupiable space) for $35 per square foot, your base rent is $42,000 per year, or $3,500 per month.
Triple Net (NNN) Lease: In a Triple Net (NNN) lease arrangement, tenants are responsible for paying not only the base rent but also additional expenses such as property taxes, insurance, and maintenance costs (Common Area Maintenance – CAM) associated with the leased property. It is important to understand that this is not a fixed cost, as an increase in property taxes, insurance costs, or a major parking lot renovation, among other things, could cause this number to go up every year. NNN is also charged at a “per square foot” rate, with an annual fee being projected and collected on a monthly basis and can potentially be trued up at the end of the year with additional money either being owed or rebated back.
Percentage Rent: Some lease agreements include a percentage rent clause, wherein tenants are required to pay a percentage of their gross sales in addition to the base rent and NNN. Ideally, do not agree to percentage rent as part of your lease agreement, as it will also require that you turn over verified sales documentation to your landlord that they would not otherwise be entitled to see. If you must agree to a percentage rent provision, be certain that there is a negotiated sales threshold that you must exceed in order for the lease term to “kick in,” a cap over which percentage rent will not continue, and while you are at it, see if you can negotiate percentage rent as a function of net sales (sales after comps, promos, and other discounts) as opposed to gross.
Tenant Improvement Allowance: Tenant improvement allowances (TIA) are funds provided by the landlord to customize, renovate, or improve the leased space to meet the tenant's specific needs. This will also be negotiated on a “per square foot” basis resulting in a total lump sum. Negotiating a reasonable tenant improvement allowance can alleviate upfront costs associated with building out your restaurant space. Pay close attention to and negotiate favorable terms allowing you to take partial payments throughout the build out process, as opposed to stringent requirements that won’t get you paid until 30 to 60 days after construction is complete, you are open for business, and you have paid 100% of the build out costs directly out of your pocket.
Delivery Conditions: Delivery conditions for restaurant commercial real estate refer to the state in which the leased space is provided to the tenant by the landlord, and also go hand-in-hand with the TIA. Examples can be existing or upgraded electrical and plumbing conditions, guaranteeing that the bathroom(s) meet all current ADA requirements, the warranty of working condition for all HVAC systems, including the hood vent (if the space is a second-generation restaurant space), the grease trap, gas lines, or any myriad of other conditions.
Rent Abatement: Rent abatement, also known as free rent, or rent holidays, refers to a period during which tenants are not required to pay rent. Landlords may offer rent abatement as an incentive for tenants to lease their space or to compensate for construction delays or other issues that prevent immediate occupancy. Build out of a first-generation restaurant space can take 4 to 15 months depending on the nature of the concept and the complexity of the build, also considering supply chain issues for both building supplies and commercial equipment. Will your landlord abate rent for 15 months? Not very likely…but you have to start somewhere! When negotiating rent abatement, also clarify any conditions attached to the concession, such as a required Certificate of Occupancy or opening date.
Lease Length: The lease length, or term, determines the duration of the tenant's occupancy rights. As a restaurant operator, striking the right balance between a short-term and long-term lease is essential. A shorter lease term offers flexibility but may entail higher rental rates, while a longer lease provides stability but limits flexibility. One way to combat this is to ensure you have additional lease term options. For example, you may sign a five-year lease and it may include two successive five-year term options, rather than signing a 15-year lease.
Personal Guarantee: Landlords often require a personal guarantee from the business owner, especially for new or small businesses, as a form of security against lease defaults. A personal guarantee destroys the protection of your business entity (corporation, LLC, or S-Corp), and makes the business owner personally liable for fulfilling the terms of the lease, even if the business entity fails. Look into the possibility of a time limit on the personal guarantee. If you must sign a personal guarantee, carefully assess the potential risks, and consult with legal and financial advisors.
Wrap It Up
Renting space for your restaurant involves navigating a complex landscape of terms and considerations. By understanding the nuances of lease agreements, negotiating favorable terms, and conducting due diligence, you can secure a space that meets your operational needs and sets the stage for your restaurant's success, long-term sustainability, and profitability. While this article can’t possibly cover every variable or individual circumstance, this is the ultimate overview to help you begin the necessary conversations. Remember, the right Location, Landlord, and Lease can be the secret ingredients that transform your dream into a thriving reality.
* The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available in this article are for general informational purposes only.