Tenants and Landlords both have the same end goal:
Maximize the Value of Their Investment.
Sometimes it can be tempting for either side to try to improve their own situation at the expense of the other; it can be tempting to trust one another to have a genuine interest in your own investment’s success. The important point to consider here, however, is that the tenant’s investment and the landlord’s investment are one and the same. The tenant and landlord, whether they like it or not, became business partners when they both entered into a lease agreement. With that in mind, you cannot build a sustainable business and maximize business profits without trusting the partner you are in business with. In order for a landlord to maximize the value and sustainability of their property, and for a tenant to do the same for their business, there must be a constant Win-Win mindset on both sides. When both sides give, the entire investment thrives. This article serves to highlight some of the most common tenant/landlord relationship hurdles, how to maintain a Win-Win mindset for each, and then current applications of this Win-Win mindset in today’s evolving Food & Beverage industry.
Lease Guarantees and Credit
To start, let us highlight a few of the most common tenant/landlord relationship hurdles
A tenant would not sign their name in ink if they thought their business was going to fail. Lease agreements are signed by tenants eager to be successful, but whether you are a tenant operating the business or a landlord investing in their business as a tenant, there is risk involved with entering any agreement. It is the landlord/investor’s job to weigh that risk against the return of their investment dollars, while it is the tenant’s job to mitigate that risk for the landlord and prove that they will back up all their talk with a profitable walk through the next real estate cycle. More important than proof of concept doing business under a lease is the credit and guaranty backing that lease. Having a Nationally recognized concept holds little weight when the guaranty on the lease is a 1-unit operator without money to pay for a new AC unit, let alone money for rent this month. Similarly, you may have a tenant that no one has ever heard of, but a personal guarantee on the lease worth hundreds of millions of dollars. The lease risk is in the guaranty and while a tenant may be reluctant to give an ideal scenario of a corporate guaranty in an attempt to protect their business, there should be a happy medium for both parties that coincides with the long-term value of the expected cash flow stream. When it comes to what credit is backing the lease, the bottom line is that if a tenant wants out, they will find a way out. A tenant with money that wants out will fight you hard to get out. A tenant without money will disappear in the dark of the night and take all the lightbulbs with them. As an investor, you may be buying the guarantee, but you are also investing in the success of their business. If you are not willing to grow together, you are both bound to fail.
Which Came First: Unit-Level Sales? Or a Sustainable Rent-to-Sales Ratio?
As a tenant, your gut reaction may be to hoard your financial data in an attempt to secure a well below-market rent and add that money to your bottom line. What happens when the market shifts, your sales dip below sustainable levels and you need a rent reduction, but your landlord does not believe you because they have no access to hard facts around the financial health of your business?
Unit-Level Sales and Tenant Financials are imperative to both parties getting on the same page and coming to a mutually beneficial agreement for long-term success. Without this transparency, tenants cannot trust their landlords and landlords cannot trust their tenants. When there is no trust, every engagement is a head-to-head battle to keep hold of their chips. Tenants become over-leveraged on rent putting their business at risk, while landlords cannot effectively maximize the value of their asset and cash flow stream for sustainable long-term growth.
For a Win-Win to occur, there needs to be transparency on both sides. Landlords should be requesting and requiring financial data before even signing a lease, while tenants should be concerned if their landlords are not doing so. It is simply bad business on both sides. As a landlord, how can you maximize cash flow while maintaining sustainability and mitigating risk without an indication of how well their business is operating? As a tenant, how can you get your landlord’s buy-in to manage your occupancy costs or even get a lease agreement signed without some kind of proof of concept? The paradox is that once both sides let go of that information control, both sides acquire an even more solid control of their business and investment.
Tenant’s should not be the only ones concerned with encroaching competitive concepts. A landlord remain aware of what other restaurants are entering the surrounding market. This awareness includes staying conscious to who they actively recruit to be neighboring tenants within their shopping centers or adjacent single-tenant properties. While some restaurant concepts can complement each other, others can cannibalize each other. A competitor moving in could mean a 20%-40% loss in sales. Alternatively, it could mean monster sales growth in the same respect if a competitor down the street shuts its doors. Landlords and tenants should work together to share intel on the surrounding landscape so that both sides can stay ahead of any market shifts and craft their long-term investment strategy accordingly.
Landlords used to buying into established cash flow streams and then watching them get chiseled down by struggling tenants asking for rent reductions can become desensitized to the core of what a sustainable tenant/landlord relationship should look like. For an investor or landlord trying to protect their investment and their cash flow stream, the instinctual reaction is to be adversarial towards the tenant. In a situation where the tenant does not share their financials or sales data, the landlord can feel like the tenant may be crafting a sob story and taking advantage of their relationship to pocket additional profit in a rent reduction, which is all the more reason that tenants should be more than willing to share their financial situation with their landlord. As an investor, this instinctual reaction is simply a function of trying not to feel like you’ve taken one step forward, but two steps backwards; backed into a corner, a landlord will scratch and claw their way back to where they started even if it means giving no concessions and keeping rents as high as possible. This mindset, however, will run a restaurant out of business and eliminate the entire cash flow stream for the investment; neither of which is forward progress for the landlord or the tenant.
Landlords should keep in mind that when working with tenants, the best chance for big success is a great build out. Sometimes additional T.I. for a tenant works wonders for their balance sheet as it sets them up for the most success, but allows them to maintain cash on hand. That extra T.I. will often create better visibility, better landscaping, and the ambiance necessary to capture higher guest volume and solidify a location for long-term success. The tenant on the other side also needs to understand that many times, for an existing landlord, T.I. is an unexpected capital expenditure in the midst of a diminishing or completely depleted cash flow stream. In the end, like everything else, both parties benefit most from a Win-Win.
Food & Beverage Trends
From speaking with landlords, tenants, developers, and investors in the restaurant sector, there are a few common threads we are seeing begin to trend in newly successful restaurant concepts. Below is a summary of what we have heard lately:
- Chicken and Asian-Inspired Cuisine is Trending in the Southeastern United States
- Flavor Profiles are Becoming Less Important
- The Focus is on Volume and Quick Service
- Footprints are Shrinking
- 7,000 SF Concepts Finding Ways to Shrink to 3,000 SF Prototypes
- Health Conscious Food Transparency Becoming a Necessity
- Customization/Individualization is Driving Traffic
- Localized Design and Community Integration a Consumer Focus
- The Dine-In Experience is Evolving to Compete with Delivery Alternatives
New concepts having success with these business model shifts are a sign of changing consumer preferences and the major players are not naïve to these changes. Everyone we talk to is proactively striving to evolve to meet the desires of consumers and maintain relevant in this ever-changing industry.
Overall though, Restaurants are moving up in the retail world. It used to be that Food & Beverage accounted for close to 10% of shopping center occupancy, but that has been moving closer to 30% today. Some fear that the market is becoming too saturated with restaurants and that the general population will not support sustainable sales for the density of restaurants entering the market. Keeping this in mind, tenants should think critically about their plans for expansion and the numbers they are crunching to get there, while landlords should remain focused on the key elements of a good investment:
- Core Real Estate Characteristics
- Tenant Overall Credit/Track Record
- Tenant’s Commitment to Site
- Recent Capital Expenditures
- Extended Lease Term
- Tenant Financials/Sustainable Unit-Level Rent-to-Sales
Ultimately, retail and restaurants will ebb and flow. In any given year, whether concepts are expanding or contracting, the general population will still need to eat. The tenants that will be left standing will be those that have secured A+ real estate, have enough equity to slip through the slumps, optimize their infrastructure to maximize profitability, and most importantly those that keep a close eye on their occupancy/food costs; raising labor/food costs can put unanticipated pressure on occupancy costs/rent. The good news is that all of those tenant characteristics scream slam dunk investment for investors and property owners.
Sustainability of business and of cash flow is based on that kind of Win-Win.
We are actively working to help our clients bridge the gap between tenants and opportunities. Whether you are a tenant actively seeking growth opportunities or a landlord working to maximize the health and value of your property, give us a call to see how best we can serve you.