Planning to open a restaurant? Finding the right space to lease is crucial but complex. This beginner's guide provides a comprehensive overview of restaurant leasing, covering how to locate and negotiate favorable lease terms. Our guide will help you navigate the leasing process with ease.
Buying vs. Leasing a Restaurant: Which is Right for You?
You need a space for your restaurant, but should you buy or lease? Consider these pros and cons before making your ultimate decision.
Pros and Cons of BUYING a Restaurant Space:
| Pros of Buying a Restaurant Space | Cons of Buying a Restaurant Space |
|---|---|
| Full control over the property. | High upfront costs and the potential for long-term debt. |
| Potential for long-term savings and investment. | Responsibility for all maintenance, repairs, and renovations. |
| Ability to customize the space to your liking. | Limited flexibility to move or expand the business. |
| There are no landlord or lease agreements to worry about. | Potential for market fluctuations and declining property values. |
| Potential for rental income if you own the property. | Limited ability to test a location before committing to a purchase. |
Pros and Cons of RENTING a Restaurant Space:
| Pros of Renting a Restaurant Space | Cons of Renting a Restaurant Space |
|---|---|
| Lower upfront costs and flexibility for expansion. | Limited control over the property and restrictions on renovations. |
| Potential to negotiate favorable lease terms and rental rates. | Potential for rental increases or lease termination by the landlord. |
| Ability to test a location before committing to a long-term investment. | No equity or long-term investment potential. |
| Less responsibility for maintenance and repairs. | Limited ability to customize the space. |
| Competition for prime rental locations. |
Restaurant Opening
Opening a new restaurant goes beyond getting licenses and permits. Whether you're opening your first eatery, or expanding your food truck into a full-service restaurant, you'll know what to do by the time you're read this.
What is the cost of leasing a restaurant?
To commit to leasing a restaurant, you must understand the associated costs. Location and size are the primary cost factors, with prime locations and larger spaces commanding higher rents.
Utilities, taxes, and insurance
In addition to leasing fees, tenants pay for utilities like electricity, gas, and water, which can raise monthly restaurant costs by several hundred dollars.
Property taxes depend on the building's location and value. It is advisable to research the property tax rates in the area where the restaurant is located to estimate the potential costs prior to leasing.
Insurance is another cost that must be factored in. As a tenant, you'll need insurance coverage for the restaurant space, including general liability insurance, property insurance, and possibly other specific policies depending on local regulations. Coverwallet can advise you regarding Restaurant Insurance. Insurance costs vary.
Security Deposit
When renting a property, remember to factor in the security deposit. Typically, this amounts to a few months' rent. That might seem exorbitant, but it protects the landlord in case of potential damages to the property or unpaid rent. If you're a responsible tenant, you'll likely get the deposit back when your lease agreement is up.
Carefully review the terms and conditions related to the security deposit before signing the lease agreement. Understanding the specific terms, such as the amount required and any potential deductions that may be made, will help tenants plan their finances.
It is possible to negotiate a security deposit on a restaurant lease, just like with any other commercial lease. While security deposit negotiations may vary, depending on the specific landlord and circumstances, it's worth exploring the possibility of reaching a mutually beneficial agreement.
Renovations
The potential costs of renovations or improvements must be budgeted in advance. The list of necessary renovations may include: plumbing, electrical work, HVAC systems, flooring, lighting, and fixtures.
To gain a clear understanding of the potential costs involved, tenants should seek quotes from reputable contractors and construction firms and request detailed estimates that encompass both materials and labor costs for each renovation aspect.
Renovations often involve unforeseen challenges, such as hidden structural issues or code compliance requirements. It is wise to allocate a contingency fund, typically around 10%-20% of the total renovation budget.
Survey: Restaurant Occupancy Cost
Restaurant.com conducted a survey with over 550 responses on how much they pay on base rent, percentage rent, and triple net charges. Based on this data, we compiled the results based on the cost per square foot for various restaurants nationwide.
| Base Rent | Lower Quartile | Median | Upper Quartile | Average | # of Respondents |
|---|---|---|---|---|---|
| Monthly base rent | $3,000 | $5,000 | $8,750 | $6,914 | 496 |
| Square footage of restaurant | 2,100 | 3,500 | 5,000 | 4,180 | 496 |
| Base rent per sq. ft. - monthly | $1.00 | $1.50 | $2.22 | $1.95 | 496 |
| Base rent per sq. ft. - annual | $12.00 | $18.00 | $26.64 | $23.39 | 496 |
Four Types of Commercial Leases
Commercial leases create a binding agreement between a landlord and a tenant. These legal contracts govern the use and occupation of a commercial property for business purposes. Each type of commercial lease has its own terms and conditions.
1. Gross Lease
A gross lease is sometimes called a full-service lease. The landlord pays for all expenses associated with the property, such as: property taxes, insurance and maintenance. However this cost is passed on to the tenant as they’re built into the fixed monthly rent.
2. Net Lease
A net lease means the tenant pays some property operating costs in addition to rent.
1. Single-Net Lease means the tenant pays for utilities and property taxes, in addition to the base rent.
2. Double-Net Lease means the tenant pays for utilities, property taxes, and insurance in addition to the base rent.
3. Triple-Net Lease means the tenant pays for utilities, property taxes, insurance, and maintenance (including janitorial services), in addition to the base rent.
TIP: Before signing a Net Lease, ensure you understand which of the three subtypes applies to you. Otherwise you could be left with lots of expenses to pay in addition to your base rent.
3. Percentage Lease
In a percentage lease, the tenant pays a fixed base rent, together with a percentage of their gross sales. The higher the tenant's business profits, the more he'll pay towards the rent. Typically, lessees are not obligated to pay a percentage of their profits until they reach a specific income threshold.
Imagine you agree to pay a fixed base rent of $2,000 per month plus 5% of your gross sales, on the condition that your gross sales exceed $20,000 per annum:
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In your first year of business, your gross sales reached $18,000. Since this falls below the agreed threshold of $20,000, you only pay the base rent of $2,000 per month. So at the end of the first year, you'll only pay $2,000 * 12 = $24,000.
-
In your second year of business, your gross sales reached $30,000. Since this exceeds the agreed threshold, you will pay the base rent of $2,000 per month + 5% of $30,000 = $2,000 + $1,500 = $3,500.
-
In your third year of business, your gross sales reached $45,000. Since this exceeds the agreed threshold, you will pay the base rent of $2,000 per month + 5% of $45,000 = $2,000 + $2,250 = $4,250.
A percentage lease structure allows the landlord to benefit from the tenant's success as their sales increase. The tenant benefits by only paying a small base rent while they're growing their business.
4. Variable Lease
A variable commercial lease allows for rent to fluctuate based on factors such as changes in: operating expenses, sales volume, or the consumer price index.
For instance, consider a retail space with a variable lease agreement where the rent is determined as a percentage of the tenant's monthly sales. As the tenant's sales increase, the rent would also increase accordingly, but the reverse is also true if the tenant suffers a drop in business.
A Variable Lease provides flexibility for both landlords and tenants in navigating uncertain situations, be it a downturn in the economy, Covid-like pandemics, natural disasters or any other harmful event. It enables both parties to adjust the rent to align with evolving business conditions.
It is important to take the time to research and explore the various opportunities that abound to find the perfect restaurant space.
Commercial Real Estate Websites
Commercial real estate websites serve as valuable resources for finding available restaurant spaces for rent.
Websites like LoopNet provide comprehensive listings of commercial properties. By utilizing such platforms, prospective tenants can easily discover properties that meet their specific requirements.
In addition to LoopNet, Cityfeet is another reputable commercial real estate website that offers commercial properties. With its filtering options, users can narrow down their search based on location, size, and price, enabling them to find suitable restaurant spaces more efficiently.
Other options include:
- <a rel="nofollow" href="href="https://commercial.century21.com/" target="_blank" rel="noopener">Century 21 Commercial
- Storefront
- Property Shark
Local real estate brokers
Working with a local real estate broker who specializes in commercial properties is a valuable option for finding the right restaurant space for rent.
These brokers possess in-depth knowledge of the market and can guide you through the process, ensuring you find spaces that align with your specific requirements.
A good real estate broker is an expert in negotiating lease terms. They can assist in navigating complex lease agreements and advocate on your behalf to secure favorable terms.
Some lease terms that brokers can help negotiate include rent amount, lease duration, renewal options, maintenance and repair responsibilities, and any special clauses or provisions.
Research Your Restaurant's Neighborhood: 6 Tips
Choosing the right location for your restaurant is crucial to its success. It needs to be easily accessible to your target market and also in an area where foot traffic is high and the competition is not too strong.
1. Understand the Neighborhood
Take the time to research the neighborhood thoroughly. Consider its demographics, cultural identity, and lifestyle. When opening a vegan restaurant, for example, there's no point in choosing a location that's known for its sausage. It will do much better in an area with a strong vegan community.
2. Observe the Street
The street where your restaurant is situated plays a vital role in attracting customers. Look for a busy street with high visibility and easy accessibility. For instance, a bustling downtown street with heavy foot traffic and nearby public transportation hubs can generate significant customer interest.
3. Take Note of Competition
Researching the competition in the area can help you identify gaps in the market and differentiate your restaurant from others. Observe their strengths and weaknesses, read reviews, and visit their restaurants to get a sense of what needs the existing restaurants fulfill and what you can add.
4. Consider the Turnover Rate
Evaluate the turnover rate in the vicinity. High turnover rates, meaning restaurants that have become established in and then vacated the area, may indicate underlying issues such as limited customer demand, excessively high rent costs, or market saturation. Conversely, a low turnover rate may signify a stable customer base. For instance, a neighborhood with a stable turnover rate and a mix of successful long-standing restaurants indicates a potential market for new dining options.
5. Know Your Customer Base
Gain a deep understanding of the customer base in the neighborhood you plan to operate in. Consider factors such as age group, income levels, and preferences.
For example, if the area has a large population of young professionals with disposable income, you may want to create a trendy and upscale dining experience to cater to their tastes.
6. Investigate Foot Traffic
Assessing the foot traffic at your desired location is vital for gauging customer potential. Foot traffic plays a significant role in the success of a restaurant.
To evaluate foot traffic accurately, you may consider hiring a professional who specializes in analyzing pedestrian activity. These experts utilize various tools and methodologies to measure and interpret foot traffic data, providing you with valuable insights into the volume and patterns of passersby.
Square Footage Requirements for New Restaurants
When starting a restaurant, determine the appropriate amount of square footage needed for your establishment.
Consider the Basics: What do you need?
Consider the number of customers you expect to serve, as this will determine your seating capacity and overall space needs. In addition, the restaurant's kitchen must provide sufficient space for equipment, staff, and food preparation.
Adequate storage space for inventory, supplies, and equipment should also be allocated. Industry guidelines commonly suggest allocating 60% of the total square footage for the dining room, with the remaining 40% dedicated to kitchen space.
Be aware of local zoning and building regulations, which may dictate minimum or maximum square footage requirements for restaurants.
Restaurant Concept and Square Footage
The required square footage for a restaurant is influenced by its size and style, resulting in varying guidelines for seating arrangements. Fine Dining: It is recommended to allocate 20 square feet per person for fine dining establishments.
- Full-Service: For full-service restaurants, allocating 15 square feet per person is advisable.
- Counter Service: Counter service restaurants typically require 20 square feet per person.
- Fast Food: Fast food establishments typically have a minimum requirement of 12 square feet per person.
- Table Service, Hotel/Club: Restaurants offering table service in hotels or clubs should consider allocating 18 square feet per person.
- Banquet: For banquet spaces, a minimum of 10 square feet per person is typically recommended.
Event Space Needs
It is important to take event space into consideration, as it provides the venue for hosting private gatherings such as meetings and receptions. The required space for event hosting is determined by the number of guests and the specific activities planned, including seating arrangements and catering services.
For example, if a restaurant aims to cater to corporate meetings, it should allocate sufficient space for a conference-style setup with appropriate seating and audiovisual equipment. Conversely, if the focus is on hosting wedding receptions, a larger event space accommodating a dance floor and buffet stations might be necessary.
Calculate estimated sales targets to cover expenses
To run a successful restaurant, you need to understand concepts like revenue, fixed costs, profit margins, and expenses. Without this understanding, you might not generate enough revenue to cover your operating costs.
| Fixed Costs | Variable Costs | Desired Profit Margin |
|---|---|---|
| Start by determining fixed costs. These expenses don't change. Some examples include rent, salaries, utilities, and insurance. Keep track of your fixed costs and add them up. | Variable costs are expenses that change based on how much you sell, such as food, beverages, and supplies. Implement a good tracking and accounting system to keep on top of how much of each item you'll sell and what the cost of goods sold will be. | Your profit margin is the amount you make on each sale after you subtract expenses. You'll need to decide what percentage profit margin you want to achieve. A good rule of thumb is to aim for a profit margin of 15% at minimum. |
EXAMPLE
Scenario:
- Sarah found a 1,500 square foot commercial space in Seattle priced at $45 per square foot.
- She conducted market research and identified a demand for her unique farm-to-table concept focusing on organic vegan cuisine.
- Sarah wants to ensure the space is a financially responsible long-term investment.
Lease Cost Calculation:
- Annual lease cost: 1,500 x $45 = $67,500
- Monthly lease cost: $67,500 / 12 = $5,625
Monthly Sales Target Calculation:
- Sarah aims to allocate only 10% of her total monthly sales towards rent, considering estimated food, labor, and utility costs.
- Monthly sales target: $5,625 x 100 / 10 = $56,250
Seating Capacity Calculation:
- Sarah plans to allocate 70% of the total square footage for the dining area.
- Available dining space: 1,500 x 0.70 = 1,050 square feet
- Seating capacity: 1,050 / 18 = 58 seats
Average Revenue per Seat Calculation:
- Sarah will operate two services per day (lunch and dinner) for six days a week.
- Services per week: 2 x 6 = 12
- Customers served per week: 12 x 58 = 696
- Average revenue per seat: $56,250 / 696 = $80.65
Conclusion:
- Sarah needs to generate an average of at least $80.65 per seat, per service, to cover her expenses.
- This information will help her design a menu that ensures each seat contributes to meeting or exceeding the revenue target during every service.
How to Set a Realistic Budget for Your Restaurant
Setting a realistic budget for opening a restaurant is laying a foundation for success. Without having a realistic budget that you can stick to, you may find yourself in a state of debt that is difficult or even impossible to overcome.
Projected Revenue
When projecting revenue for the initial months, consider factors like customer numbers, average check size, and visit frequency. Estimate customer demand through market research and understanding target demographics.
Calculate the average amount spent per customer based on menu prices and offerings. Estimate how often customers are likely to visit within a specific timeframe, considering cuisine type and dining habits.
Additionally, account for realistic factors like seasonality, competition, and location. Analyze seasonal fluctuations, assess competition strengths and weaknesses, and consider the impact of location on foot traffic and accessibility. Understanding these aspects ensures accurate revenue projections.
Add some room for error
Even with careful planning, unexpected expenses and setbacks can occur. It is important to add wiggle room to the budget to account for these contingencies. Set aside at least 10% of the total budget for unexpected expenses.
Examples of expenses and setbacks that can arise include equipment breakdown, permit delays, renovation complications, staffing challenges, supply chain disruptions, or regulatory compliance issues.
Another unexpected expense may be finding a space that is perfect for your restaurant but outside of your budget. You may have to change your overall plan to justify the cost of the ideal place.
Understanding Restaurant Lease Terms
Understanding leases is a basic skill that every restaurateur should learn. Know what you're looking at and what's expected of you before you enter an agreement with a landlord.
| Restaurant lease term | What is it? | Example | What you need to know |
|---|---|---|---|
| Lease Length | The lease length is how long the tenant will be leasing the property. | DURATION. This lease will last for nine (9) years in a row, starting from when the Property is finished, unless we have to end it earlier because of the law or the termination clause in the agreement. You should ensure that the Lease Length provides sufficient time for the restaurant to become established and profitable. | You should ensure that the Lease Length provides sufficient time for the restaurant to become established and profitable. |
| Renewal | Renewal options allow the tenant to extend the lease beyond the initial term. Typically, you can do this without renegotiating. | RENEWAL OPTION. To extend the Lease, the Lessee must notify the Lessor at least 180 days before the termination date of this Agreement. Renewal options can provide valuable security for your restaurant business and should be negotiated at the outset of the lease. | Renewal options can provide valuable security for your restaurant business and should be negotiated at the outset of the lease. |
| Rent | Tenants pay this in exchange for leasing the property. | RENT PAYMENT. The Lessee shall pay the monthly rent of X amount, due on the first day of each month, by electronic transfer to the Lessor's designated bank account. This section of a lease outlines the rental amount, payment terms, and any potential escalations or adjustments. Adding favorable rent terms, such as fixed increases or abatement clauses, can provide financial flexibility and should be carefully considered during lease negotiations. | Adding favorable rent terms, such as fixed increases or abatement clauses, can provide financial flexibility and should be carefully considered during lease negotiations. |
| Additional Expenses | Tenants should find out any additional expenses, such as common area maintenance fees, property taxes, insurance, and utilities. | ADDITIONAL EXPENSES. The Lessee shall be responsible for all utilities, maintenance costs, and property taxes associated with the leased premises, in addition to the base rent specified in this Agreement. Understanding costs like common area maintenance (CAM) charges and negotiating favorable terms, such as caps or shared expenses, can help manage overall operating costs and financial obligations more effectively. | Understanding costs like common area maintenance (CAM) charges and negotiating favorable terms, such as caps or shared expenses, can help manage overall operating costs and financial obligations more effectively. |
How to Renegotiate a Lease in 4 Steps
STEP 1: Understand your lease obligations and rights
To renegotiate a lease, start by understanding your current lease obligations (i.e. what you’ve promised to do) and rights (i.e. the expectations you should have based on what the Lessor has promised to do). Read your lease carefully from start to finish, ensuring you understand the rights and obligations of each party.
TIP: Copy the wording of your lease agreement, paste it into an AI tool and ask it to set out the Lessee’s obligations and rights in an easy-to-read table.
STEP 2: Identify the lease obligations that you wish to renegotiate
The lease terms which you may wish to renegotiate will be subjective, based on your new needs. Below are a few of the most common terms which lessees, like you, have renegotiated during their lease:
| Lease renegotiation term | What is it & what’s the benefit for the tenant? | Draft renegotiated clause |
|---|---|---|
| Rent Deferral. The deferral of rental payments, either in full or partially, for an agreed-upon period of time. | A rent deferral can help the tenant manage cash flow during periods of financial difficulty, such as during a slow season or unexpected economic downturn. By deferring rental payments, the tenant can free up funds to cover other important business expenses, such as inventory or staffing costs, without defaulting on the lease. | "Lessor may allow Lessee to delay rent payments for a set time, upon mutual agreement in writing. Lessee must pay deferred rent, with interest if applicable, in equal installments over a specific period following the deferral period." |
| Rent Abatement. The temporary halt of rental payments for a mutually agreed-upon duration. | Abatement grants a tenant temporary relief from making rental payments. It provides financial flexibility during unforeseen circumstances or when the leased space is not in usable condition, allowing the lessee to mitigate costs and maintain operations. | "In case of unforeseen circumstances rendering the premises unusable, the Lessor agrees to provide a rent abatement. The abatement amount and duration will be determined in good faith, relieving the Lessee from paying the abated portion during that period." |
| Rent Reduction. The adjustment of rental payments, either in full or partially, for a mutually agreed-upon duration, resulting in a lower overall rent expense. | Rent reduction refers to a negotiated decrease in the amount paid by a tenant in a commercial real estate lease. It offers tenants a financial advantage by lowering their ongoing expenses, increasing cash flow, and enhancing their ability to allocate resources to other areas of their business. A lessee might seek rent reduction when facing financial difficulties, a decline in business, or unforeseen circumstances that affect their ability to meet the original lease terms. | "In the event of significant disruptions or financial hardship, both parties may mutually agree to a temporary reduction in rent. The reduced rent amount and duration will be determined in good faith and agreed upon in writing." |
| Loan Conversion. When rent payments become overdue, a possible solution is to convert them into a structured loan repayment plan that spans a mutually agreed-upon period. | Loan conversion is the process of converting overdue rental payments on a commercial space into a loan, allowing lessees to repay the outstanding amount over an extended period. This approach offers benefits such as avoiding immediate eviction, preserving the business's occupancy, and providing an opportunity to address financial difficulties while maintaining the leased premises. | "In the event of prolonged financial hardship or inability to meet rental obligations, the Lessor may, at their discretion, offer the Lessee the option to convert overdue rental payments into a loan, subject to agreed-upon terms and interest rates. The terms of the loan conversion will be documented in a separate agreement." |
STEP 3: Open negotiations with your landlord
Just because you want to renegotiate doesn’t mean your landlord is obliged to accept. Now that you know what you want, now’s your time to “persuade” your landlord to accept your new proposals or at least to meet you halfway. Here’s how you do that:
Initiate your written communications by using the term "without prejudice" to indicate your intent for negotiation rather than lease default.
Detail the hardships your business has faced and highlight the proactive measures you have taken to address and mitigate those challenges.
Clearly explain the increasing difficulty you are encountering in meeting all lease obligations, attributing it to the unprecedented nature of current events. Reaffirm your genuine commitment to restore your previous standing once operations fully resume.
Express a sincere interest in understanding your landlord's financial situation and difficulties. Show empathy and a willingness to comprehend their perspective, fostering an environment conducive to lease renegotiations.
By actively listening to your landlord's position, you can gain insights into potential adjustments that can be made to the lease terms.
Refer to the specific lease term that you wish to renegotiate, and propose some draft wording for the new clause, making it clear that the landlord is free to make additions.
Develop a mutually beneficial solution. If your new proposed clause prejudices the landlord in any significant way, then offer a mutually beneficial solution for both of you.
STEP 4: Document Your Restructured Lease Agreement
- Obtain written confirmation from your landlord stating that no default notices will be issued during the negotiation and documentation process.
- Generate a physical copy of the lease addendum, clearly outlining the agreed-upon changes.
- Seek legal counsel to review the modifications made to the lease, ensuring their compliance with relevant laws and regulations.
- Ensure that all parties involved, including both tenant and landlord, sign the restructured lease agreement and/or addendum, signifying their acceptance and commitment to the new terms.
Hidden Dangers in Restaurant Lease Agreements: NNN & CAM
What are they and why could they be dangerous for you? Let’s break them down.
1. NNN: "Net, Net, Net" or "Triple Net."
NNN refers to a type of lease agreement commonly used in commercial real estate.
In a triple net lease, the tenant is responsible for paying the base rent plus all three "nets," which include property taxes (N), building insurance (N), and common area maintenance (N). The tenant assumes these additional costs in addition to the base rent.
2. CAM: "Common Area Maintenance."
CAM represents the costs associated with maintaining and operating the common areas of a commercial property or shared space within a multi-tenant building.
Common area maintenance expenses typically include cleaning, landscaping, repairs, security, utilities, and other ongoing maintenance services necessary to keep the common areas in good condition.
These costs are shared among the tenants in proportion to their leased space or as specified in their lease agreements.
Why is it dangerous to see NNN/CAM in your lease?
Tenants have limited control over how net charges and CAM charges are calculated and allocated, which can be a disadvantage if they believe that the landlord is inflating the charges or not using them to maintain the property properly.
What should you know about NNN/CAM?
You should understand how these charges are calculated. Know when they are due, and find out any caps or limits on the amount that can be charged. It is also important to ensure that these charges are reasonable and properly documented, and to negotiate for provisions that provide for transparency and accountability in the management of these expenses.
FREE Resources for Restaurant Owners
Takeaways
- Consider the pros and cons of buying versus leasing a restaurant space before making a decision.
- Understand the costs of leasing a restaurant space, including utilities, taxes, insurance, and security deposits.
- Budget for renovations or improvements needed in the leased space and allocate a contingency fund.
- Become familiar with the types of commercial leases, such as gross lease, net lease, percentage lease, and variable lease.
- Utilize commercial real estate websites to find restaurant spaces for rent.
- Work with a local real estate broker who specializes in commercial properties to navigate the leasing process and negotiate favorable terms.
- Research the neighborhood thoroughly to understand its demographics, competition, turnover rate, customer base, and foot traffic.
- Determine the appropriate square footage for your restaurant based on seating capacity, kitchen space, storage needs, and local zoning regulations.
- Consider the type of lease agreement that suits your business model and financial goals.
- Set a realistic budget for your restaurant by projecting revenue based on customer numbers, average check size, visit frequency, and market research.
Armed with this knowledge, you are now equipped to navigate the leasing process with confidence, ensuring the success of your culinary venture. Keep exploring, keep learning, and let your passion for food drive you towards a rewarding and prosperous future in the restaurant industry!