Most restaurant sales involve lease assignments whereby the lease is transferred to the buyer. New leases in restaurant sales, however, come up fairly regularly. This situation can work in a buyer’s favor with the right information-gathering, preparation and negotiation.
Set Realistic Expectations
For new leases in restaurant business sales, It is important for the restaurant buyer to set realistic expectations about rental rates and project revenue to assure that the ratio of earnings to occupancy expenses provide a fixed cost that allows for healthy cashflow for the buyer. To set realistic expectations, read the existing lease. Usually landlords rehash the same lease so spend some time reading it and become familiar with the terms and provisions.
The lease will be part of your business at least 5 years and preferably longer. The more familiar you are with this contract, the more successful you will be in negotiations. If you are overwhelmed by the lease provisions, request that a real estate attorney review the lease for you and provide you with advise on what favorable terms you should negotiate to assure are included and what draconian terms you should have eliminated or limited.
Set Realistic Lease Rates
You will also want to assure that your lease rate is no more than 6% of your gross sales. More than that amount pinches your cashflow and if there’s a downturn in sales, you might have a hard time breaking even. In an establishment with high liquor sales, you can increase occupancy costs up to 8% but, for the most part, keep that fixed cost under control.
The 6% lease rate should include the base rate along with the net expenses. Most restaurant leases are net leases. The “net” refers to either tax, insurance or Common Area Maintenance (CAM) charges (i.e. landscaping, exterior repairs, sidewalk/parking, security, etc.). Usually, you will have a triple net (NNN) lease which includes all three.
The NNN lease involves a base rate along with the triple net charges which are a proportion of the restaurant unit’s square footage within the building. So if a restaurant makes up 5% of a building’s square footage, then the NNN charge to the buyer-tenant will be 5% of the total costs.
The numbers that are right for your business may be lower or higher depending on other factors (seasonality factors? outdoor seating?). If the sales projection is equal to $1,000,000 per year, the annual rent you can afford is about $60,000 ($1,000,000 @ 6%= $60,000). Depending on other factors, however, the rental rate may be between $5,000 and $8,300 per month. The closer you can set the overall occupancy costs to 6% of gross sales, the more likely your restaurant will be profitable.
When you write a new lease along with the sale of the restaurant, you’ll want to cap these charges so that you aren’t paying in excess of market value. Additionally, you will want to assure that if there is a tax reassessment, your lease is not affected. A tax reassessment occurs on the sale or transfer of the building. If the building seller has owned the building for a substantial period, the new owner’s tax rate will be much higher and that increase will be passed down to you unless your new lease prevents that from occurring.
Additionally, it is important that you do your research on lease rates within the restaurant area. An industry resource is Loopnet.com which is great to obtain good comparable rates to gauge the amount the landlord wants to charge you in preparation of new leases in restaurant business sales.
Does The Restaurant Concept Work In The Location?
Depending on the success of the restaurant that you are acquiring, you may or may not keep the existing restaurant concept. You will want to determine your annual gross sales. If the existing restaurant is generating $150 per square foot, then it’s likely profitable and the concept/menu is working. If it’s not generating that amount, then you should consider revamping the menu or concept in light of the location.
You want to match the restaurant concept to the location. Your concept and business plan will be determined by many additional factors but the location of the restaurant is essential for the right concept. If your restaurant is in a region with modest housing and apartments, then a high-end restaurant makes no sense but a QSR or sports theme restaurant could be perfect.
Additional factors to consider include the type of menu, the longevity of the existing restaurant concept, menu prices in light of local income levels, convenience, parking, your target customer (families? office workers?), etc. Considering all these factors in light of the existing restaurant and drafting a new lease would benefit from developing a business plan to determine your acquisition costs, capitalization costs, and anticipated profits. Having a strong grip on your plan and numbers will help clarify what you can spend on rent. It is very wise for you to spend the time to figure this out before you enter negotiations with the landlord for new leases in restaurant business sales.
Preparation & Negotiation
Before you meet with the landlord, prepare your documents and yourself for the meeting. Avoid waiting until the last minute to prepare. Good preparation will pay off. You are looking at a long term contractual relationship, so you want to lay down the right foundation.
The following are documents to prepare for the landlord in advance of lease negotiations. You may not need all of them particularly if there’s an SBA loan involved since the landlord knows you are be carefully vetted by the bank. Nonetheless, you are going to negotiate a new lease and want to make a good impression on the landlord and present yourself as an informed and dynamic business owner.
- Business Plan
- Personal Balance sheet listing assets and liabilities
- Credit report
- Bank statements
- (2) Years Personal Tax return
Key Lease Questions
Questions to ask the landlord:
- Is there an existing hood system? Age? Useful life?
- Is there a grease interceptor? Age? Useful life?
- How much is the NNN charge?
- How long has the unit been a restaurant?
- Are there any exclusive use clauses that may affect the existing or proposed restaurant concept? (Exclusive use is a limit on the concept that you can have and other eateries can have within the landlord’s property).
- How much parking is provided?
- Is the building going to be transferred or sold in the near future?
Letter of Intent
Once you have all the necessary information to negotiate, you are ready to submit a proposal to the landlord regarding new leases in restaurant business sales. Either you can have an attorney prepare a Letter of Intent (LOI) or the restaurant broker can assist you in preparing it. Some of the typical terms in an LOI include:
- Size of Premises
- Term of Lease
- Base Rent
- Lease Commencement/Rent Commencement
- Tenant Improvement Allowance
- Rent Abatement
- Options to Extend
- Assignment Rights
- Landlords Delivery Condition
In most cases the LOI is non-binding on either landlord or buyer-tenant. It essentially serves as an outline to prepare the lease. Once the LOI reflects the parties’ agreement, then the landlord prepares the lease.
The lease includes all the terms outlined in the LOI. Additionally, there are added typical lease terms which cover more traditional items not usually discussed during the LOI stage. Upon receipt of the lease, the buyer serves their interests by consulting with a real estate attorney who specializes in commercial lease agreements.
Lease negotiations are typically handled directly between the landlord and the tenant and/or with the broker. Alternatively, lease negotiations occur between the landlord and tenant’s respective attorneys. Once completed, then the documents are prepared for signature at which time the buyer provides the security deposit (unless handled in escrow) and the first month’s rent.
New leases in restaurant business sales can be highly beneficial for restaurant buyers, particularly for buyers who plan well. Take your time optimizing your new lease terms as you proceed with the acquisition. Learn as much as you can, compare rental rates, develop a business plan and prepare yourself for negotiations.
If you would like assistance in evaluating and pursuing a restaurant acquisition, contact us so that we can schedule your consultation and assist you in pursuing your dream of restaurant ownership.