Restaurant Lease Transfers is part of Mission Peak Brokers’ How To Sell Your California Restaurant series.
To help California restaurant owners transact sell their restaurant businesses, Mission Peak Brokers is providing a How to Sell Your California Restaurant series of blog posts. We hope to provide restaurant sellers with information and insight on all the key elements involved in selling restaurants. Whether you are ready now or plan on selling in the future, arming yourself with essential information on the process of restaurant business sales will empower you throughout the business sale.
Also, be sure to also check out Also check out Restaurant Valuation: How To Successfully Sell Your California Restaurant, Restaurant Business Loans: How To Successfully Sell Your California Restaurant and Restaurant Business Sales: How To Successfully Sell Your California Restaurant
Restaurant Lease Transfers
For most restaurant business sales, restaurant lease transfers involve the buyer either assuming the seller’s lease, which is called a “lease assignment”, negotiate a new lease, or extend the existing lease. If you are financing the acquisition with a Small Business Administration (SBA) loan, you will have to show a duration of 10 years to be concurrent with the duration of the loan. The following provides basic information regarding lease assignments and negotiating a new lease.
Most restaurant lease transfers involve a lease assignment on the existing lease. The lease typically spells out the process for assigning the lease and whether any costs are involved.
Traditionally, the word “assignment” indicated that the seller completely transferred their interests whereas “sub-lease” indicated that the seller only transferred part of their interest. Why is this important? Depending on the language of the lease, an assignment could be defined as a partial transfer and that the seller is still liable on the lease should the buyer default. Read your lease carefully and spend some time understanding what exactly is involved with your lease assignment and whether you continue to remain liable should the buyer default on the lease, and for how long.
Landlords want to be able to pursue as many parties as possible in the case of default when it comes to restaurant lease transfers. Where possible, the seller should negotiate with the seller to remove their exposure from the lease on an assignment particularly where there are options to renew.
The assignment language, in a restaurant lease transfer, typically gives the landlord control as to who they will approve as the assignee of the lease (the buyer) with the common provision that the landlord can not unreasonably withhold their approval. So long as the buyer is creditworthy, has relevant experience and meets with the landlord’s approval, then assignments should transfer.
Unfortunately, there are challenging landlords that will use the restaurant lease transfer process to extract concessions causing frustrations and delays in the business transfer process. This is rather common. Keep a level head during the process and continue to professionally work with the landlord towards a reasonable outcome. While a landlord may try to leverage the situation for additional gain, they also do not want a lawsuit for unreasonably withholding approval in violation of the lease agreement. If you have a challenging landlord, you may want to consult a real estate attorney regarding your restaurant lease transfers.
The actual lease assignment is relatively simple document. It involves a straightforward statement that indicates the lease is being assigned by the restaurant seller to the buyer. It is also signed by the landlord.
Negotiating a New Lease
Preparing to Negotiate
When the lease expired or near expiration, the buyer will negotiate a new lease. Before the buyer meets with the landlord, the buyer will need to properly prepare. The buyer should organize the following:
- Comparable market rents.
- A business plan
- Relevant restaurant experience (resume, old menus, press info)
- Buyer’s financial information (credit report, recent tax returns, references)
- Any proposed remodeling, building modifications or renovations
- Any proposed equipment changes.
- Professional & personal references
Types of Leases
There are three general types of leases: Gross lease, NNN lease and Percentage Lease.
The Gross Lease is all-inclusive and typically does not involve any other charges.
The NNN (called Triple Net) includes a base rent along with a percentage of occupancy charge for common area maintenance (CAM), building insurance and real property tax. Some leases are only NN which are two of the additional charges.
The Percentage Lease involves the tenant paying the landlord a percentage of sales over base rent.
Most restaurants have a NNN lease. The net expenses are charged based on the percentage the unit has in the building complex. So, if the restaurant is 5% of the property complex, then the NNN charges to the tenants are 5% of expenses.
Ideally, you want to limit your lease expenses to 6-8% of gross sales. Once lease costs near ten percent or more of the business sales, the buyer risks not breaking even. In California, paying 10% of gross sales for rent is occurring more frequently due to high growth. Some restaurants can handle a 10% occupancy charge. These are typically restaurants that do a high volume of liquor sales.
Due to high rents, some restauranteurs have had to get creative and cut back in other areas to be able to turn a profit such as cutting back on labor via buffet or self-serve fine dining. High rents cause many restaurants to go under and we’ve seen too many desperate sellers trying to get pennies on the dollar.
Negotiating a new lease will require assertiveness to assure cost containment. When negotiating the lease, the buyer will need to be especially attentive to several factors to cap costs. The first is yearly rent increases. Typical increases are tethered to the Consumer Price Index (CPI) and range between 2-4%. It’s a very good idea to lock in these rates to fix the cost of your lease for the duration of the term.
It is important to negotiate caps on net expenses otherwise you’ll experience increases above normal cost of living expenses. On each type of net, insurance, tax and CAMs, it is a good idea to cap each in order to avoid oppressive costs. Of particular note, be sure to cap the real estate tax in the case of sale or transfer. When this occurs, the property tax is reassessed to current rates and will cause that expense to balloon. Limit the real estate tax to exclude any price adjustments due to transfer or sale increases.
If the buyer negotiates a Percentage Lease, then the cap should be 5-6% of yearly sales and a below market base rent. Additionally on a Percentage Lease, the buyer should assure that there is a Recapture provision to deduct NNN expenses from what was paid on the percentage of sales so that the percentage is adjusted and the tenant can recapture the amounts already paid via the percentage over the base rent.
Negotiate a lease term for at least 5 to 10 years to control your fixed costs. In addition to the lease term, buyers should also negotiate Options which are lease renewals. Ideally, you’ll want to negotiate 2-3 Options of 3-5 years to extend the lease as beneficial to the operation of your restaurant.
It’s also beneficial to have these shorter elements to the lease in case things go south to permit you to exit if necessary. Additionally, Options allow you further control your lease costs as the Options are usually tied to CPI increases unless you have a provision indicating that the Option will be negotiated based on then current market rents.
You’ll want to try and avoid the market rent formula since the amount will typically be higher leaving you without certainty and the benefit of a fixed cause.
If you would like a complimentary restaurant valuation contact us today.
If you are interested in selling your restaurant, Mission Peak Brokers can help. We are highly experienced and knowledgeable about restaurant business sales, including bars, cafes, nightclubs, etc. We have closed numerous eatery business sales in the Bay Area. We have represented sellers and buyers. In addition to business sales, we also provide commercial real estate sales and business/commercial financing. Contact us today for additional information.