Food and Beverage Industry Seeks New Rent Structures, Partnerships to Survive COVID-19
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Some U.S. restaurants are going to great lengths to try to protect patrons during the pandemic. In Ohio, tables are partitioned by clear vinyl shower curtains in an attempt to create a safer haven for diners. In Ocean City, Maryland, a restaurant rolled out tables that look like large inner tubes so customers maintain appropriate 6-foot social distancing. And an upscale eatery in Virginia is using mannequins to fill empty seats as it keeps diners apart.
(The first of two parts examining the future of restaurants in the commercial real estate industry.)
While these initiatives may prompt chuckles, they also reflect serious business issues that run to heart of the survival of the food-and-beverage industry, a key component of the U.S. economy. Restaurants are trying to lure customers back in a public health environment in which officials say crowds risk increasing exposure to a potentially fatal illness like the coronavirus. And it’s an open question how long it will take for diners to feel comfortable enough to return.
Until patrons return, restaurant owners and landlords must figure out how to make ends meet. Some are considering lease changes making them joint-venture partners, or allowing payments to change with income or just not opening until they can reasonably expect customers will come.
Few are immune. National chains face challenges and independent restaurants — from high-end eateries to mom-and-pop operations — are ill equipped to survive monthslong shutdowns and, when they reopen, operating at less than 100% capacity. Many have already, or will, close permanently.
“This is the equivalent of the asteroid hitting Planet Restaurant,” said Phil Colicchio, Cushman & Wakefield executive managing director and co-lead of its food, beverage and entertainment consulting practice.
The numbers show the devastation to the industry. More than 8 million restaurant workers were laid off or furloughed, and the industry lost roughly $80 billion in revenue in March and April, according to the National Restaurant Association. Restaurants fail because of lack of cash flow, and COVID-19-related shutdowns have virtually stripped them of that, said Jeff McNeal, president of the hospitality consulting firm Fessel International.
For the commercial real estate industry, at the very least, permanent restaurant closings will leave landlords with vacant space that experts said won’t be easy to fill, at least immediately. The effects could be worse because, pre-pandemic, developers often cited restaurants as the must-have amenity, the secret sauce, to add vibrancy and appeal to shopping malls, office and apartment properties, and mixed-use projects that tout their “live-work-play” environments.
In the coming months and perhaps years, until there is a COVID-19 vaccine or other solution, those restaurants may not be able to survive paying fixed rents under traditional long-term leases. Some restaurateurs are looking for their rents to be adjusted as they are financially squeezed, struggling because they must operate dining rooms at smaller capacities to observe social distancing and invest in costly COVID-19-related safety measures such as face masks, design changes, temperature checking and more frequent cleaning to keep employees and customers as safe as they can be.
Restaurants have devised creative ways to help their customers feel safer. Kim Shapiro, the owner of the Twisted Citrus cafe in North Canton, Ohio, uses clear plastic shower curtains hung from rolling racks as protective barriers for her seated customers. Revolution Event Design in Baltimore created the special bumper tables that debuted at the restaurant Fish Tales in Maryland, and the firm will customize them for other eateries to use. And The Inn at Little Washington, an upscale restaurant in Washington, Virginia, has seated mannequins at some of its table so its dining room looks occupied, even with social distancing in place.
Even when restaurants across the nation can reopen, restaurateurs don’t know how quickly sales will return to prior levels. When Georgia first allowed its restaurants to reopen their dining rooms in April by allowing only 10 customers per 500 square feet, large numbers of patrons weren’t flowing in, according to Anita Summers, an architect and principal in the Atlanta office of the Johnson Studio at Cooper Carry, a design and architectural firm specializing in hospitality and restaurants. A coalition of local restaurateurs even balked at the Peach State’s early timetable for reopening eateries.
When the Chipotle Mexican Grill chain had several outbreaks of food-related illnesses that sickened more than 1,000 customers in several states, it took time for people to return, said Darren Tristano, CEO of consulting firm FoodserviceResults. He predicted a similar scenario will play out because of the ongoing pandemic.
“Consumers are very forgiving, but it took them [Chipotle] 18 months before things started to get back on track,” he said. “This is affecting all of us, and those that are older, those who are affluent, those who have underlying health risks are probably going to wait three to six more months.” And, he added, “I think they’ll be a lot of consumers that just hold out for the next 12 months because they fear for losing their life.”
Revenue Sharing Versus Rent
For restaurants, options such as short-term leases and paying landlords based on revenue sharing instead of having to fork over a set monthly rent could be the lifeline they need to weather the current coronavirus pandemic, and a potential second wave of infections. In some cases, the typical landlord-tenant relationship will need to evolve into a partnership, a joint venture with developers willing to invest in tenant improvements to give eateries a lift, according to Colicchio, an attorney as well as consultant who has advised more than 50 James Beard Award-winning chefs and restaurateurs.
“From our experience and data, and seeing it working already prior to the pandemic, it’s going to be the commercial real estate industry that is going to be able to dictate how quickly and how sustainably the restaurant industry will come back,” said Colicchio.
Restaurants in the United States occupy 1.4 billion square feet, according to an estimate from CoStar. The National Restaurant Association in a letter told Congress in April that 15% of the nation’s restaurants had closed permanently or were at risk of closing shortly. Based on CoStar’s data, that would equate to more than 200 million square feet of empty retail space. Other forecasters have far more dire predictions. In April, a report by UBS said as many as 20% of U.S. restaurants may end up permanently shuttered.
About 7 of 10 U.S.restaurants are independent, not affiliated with a franchise brand, and as such are the most vulnerable, according to food and beverage industry data.
“You will see a lot of independent full-service restaurants closing permanently,” Tristano said. He pegged overall permanent U.S. restaurant closings this year between 12% and 13%.
But even big chains are at risk. The likelihood of publicly traded restaurants defaulting on their debt has jumped since the start of the year because of the pandemic, according to a recent report by S&P Global Market Intelligence. As of mid-May, the chance of default was 24%, compared with 5% in the early months of 2020, S&P said. That calculation is based on the odds that a company will default on its debt within the next year based on fluctuations in its stock price and other risks based on its country and industry.
Perhaps one of the biggest reality checks from the COVID-19 crisis has been that the public, and some business sectors, never realized how vulnerable the restaurant sector was, some industry executives said. Independent restaurateurs often get their financing from friends and family, and have limited or nonexistent cash reserves, leading to the devastation and massive layoffs the food and beverage sector has seen.
“I think landlords have been very forgiving [to restaurants] in the short term,” Summers said. “And in the long term, I kind of think this has been eye-opening for landlords and everybody else to see” the financial fragility of the restaurant industry.
The reopening rules make up a patchwork, varying state to state, with the National Restaurant Association and the Centers for Disease Control and Prevention also issuing their own health-safety guidelines for eateries. In some cases, restaurants were initially allowed to reopen dine-in business at only 25% capacity, while others have been allowed to reopen at 50%.
Under state restrictions, restaurants can increase that capacity as time goes on, but the reality is that they must be able to hang on until there is some semblance of normalcy. And that math just doesn’t work financially for some restaurateurs, who have opted not to reopen yet as a result.
“That is the biggest concern I am hearing,” Summers said. “We have gotten to a state where before all this, pre-COVID, the profit margins were just razor thin already — food costs and staff costing more and more. Most restaurants are trying to provide more benefits for their staff, which never used to happen, back in the day, so that’s costing more. And then leases are more. They’re just out of touch with what a restaurant can afford and so, especially a fine-dining place with higher food costs, it’s tough. It was difficult pre-COVID-19 to make a profit. Now, you’ve got 50% less table or even less than that.”
Danny Meyers, CEO of Union Square Hospitality Group in New York City, has said he won’t reopen his fine-dining eateries while capacity limits are still in place and there is no COVID-19 vaccine. The company, which laid off more than 2,000 employees in March, owns eateries such as the Gramercy Cafe, Union Square Cafe, The Modern and Marta.
Tristano said such decisions make sense because “most [fine-dining] restaurants need to fill 80% of their tables in peak time to stay afloat. With these restrictions, it’s going to be hard.”
Landlords will end up with vacancies when restaurants can’t hold out, and it may be hard to find tenants for that space initially, several executives said.
“What this does mean is that we’re going to have more vacant restaurants, and it will be in the short term more difficult to back fill them for a number of reasons,” said James Cook, real estate firm JLL’s director of retail research for the Americas.
“The restaurateurs out there that are closing, they’ll eventually be able to [do] whatever it is — work through bankruptcy — and then start a new restaurant eventually,” he said. “But you have to find new backers. It doesn’t happen overnight. Long term, I think it’s an opportunity for a lot reinvention for these small restaurants. But in the short term, it’s going to be tough for landlords to backfill these spaces because tenant improvements are really expensive for restaurants.”
The obvious candidates to lease that space will be other restaurants, tenants that can use the features and equipment already in place, according to Cook. Restaurant space has features such as pipes, grease traps and kitchens that make it harder for a landlord to shift it to a different type of use, Tristano said. But the battered restaurant industry is in no position for a quick rebound where it can swiftly snap up and lease vacant space.
In order for restaurants to survive despite the challenges of the COVID-19 outbreak and its aftermath, they are going to need an assist from landlords, said Cook and others. And it makes sense, because in some cases restaurants almost serve as loss leaders for developers, an attraction for other tenants and a way to build foot traffic at a property, according to Cook.
“Restaurants are a key component of mixed-use development, ground floor of multifamily and office,” he said. “A lot of developers look at them as amenities, not as money makers, which is actually good news if you own a restaurant in one of those locations, because the landlord is much more likely to cut you a break because they’re making their money on the apartment rents. They’re making their money on the office rents, depending on what kind of projects we’re talking about. So they get rent premiums [on those rents] because they have the cool restaurants in the lobby.”
Several large real estate investment trusts are giving strapped restaurant tenants one to three months of rent forgiveness, according to McNeal.
Savvy developers have already been partnering with their restaurants, at locations such as Hudson Yards in New York City, the much-celebrated mixed-use project from Related Cos. on Manhattan’s West Side, according to Colicchio.
“The restaurateur and the real estate developer have to get much more comfortable with the joint-venture model,” Colicchio said. “Those restaurants at Hudson Yards in New York are effectively joint ventures between the restaurateurs and the developer.”
In partnership scenarios, landlords can build out a restaurant space for its occupant, or perhaps fund the restaurateur’s working capital costs, according to Colicchio. Landlords can then craft a deal in which they will be repaid for their investment, perhaps taking a percent of revenue.
Related didn’t respond to several emails seeking comment. But CEO Jeff Blau recently told CNBC that Hudson Yards has startup companies and restaurants that are going to have a difficult time paying their rent.
The firm will work with them on a payment plan or “whatever needs to get done,” Blau told CNBC, “and hopefully our lenders and partners will work with us so we can accommodate them.”
The Wall Street Journal reported that some retail tenants at Hudson Yards pay Related a percentage of their sales, not a fixed monthly rent.
Rents Eat Into Sales
In the pre-coronavirus environment, fixed-rent costs didn’t typically cause a restaurant to fail, according to Colicchio.
“It is rarely rent that puts a restaurant in its grave, usually the murder weapon of a restaurant failure is poor labor management, poor food-cost management and failure to achieve top-line revenue,” Colicchio said.
But that was before COVID-19. While rents traditionally were some 8% of a restaurant’s sales, now rent has ballooned to as much as 20% of sales with eateries operating at a fraction of their usual capacity, according to McNeal.
Colicchio sai, in general, he doesn’t believe restaurants should have fixed-rent leases like other kinds of retailers.
“The idea of treating a restaurant tenant the same way you would treat a sneaker store makes no sense,” he said. “It never made sense to me, but that’s me. The expense of operating a restaurant and the business of operating a restaurant, even though it might be in the same square footage as the sneaker store, is a completely different thing. A sneaker store has a moderate labor force, a fixed cost of goods and is usually a business that has cash reserves. Yet sometimes getting a person to the sneaker store requires having a restaurant in your space, because it’s the amenity” that consumers like.
Going forward, Colicchio said, there may be a silver lining to the coronavirus outbreak.
“My deepest hope is that a more efficient, more effective profitable restaurant model can come out of this,” he said. “My instinct says that it will. My firm belief, as opposed to a hope, is it will be the commercial real estate industry that brings that resurrection.”