With challenges including high interest rates, construction prices and longer permitting timelines, the cost to own, build, remodel and lease restaurant space today has gone through the roof. Forward-thinking restaurant tenants and retail landlords, though, are finding creative ways to make things work.
In today’s environment, it’s necessary to find imaginative solutions when neogitating lease terms and structures, in order make both tenants and landlords comfortable and willing to close transactions. Colliers’ retail brokerage team in Central Florida has recently observed several trends that illustrate this ingenuity.
Annual increases in rent
Historically, retail lease terms have typically included increases to rental rates every five years. Now, some tenants are agreeing to annual increases in base rent, often with extended lease terms of 12 to 15 years, rather than a traditional 10-year base term. Because the cost of borrowing money is so high right now, the potential benefit to retail developers — who might also hope to later renegotiate for lower interest rates on their debt — is that implementing annual rent increases offer more frequent and stronger returns to help cover the center’s debt service expense. For existing retail spaces, an annual increase in rent may allow the landlord to attract new tenants at a slightly lower market rate for the first year or two, knowing that the base rent payment will increase every year.
Leveraging TI
These higher rents can be daunting to tenants, especially if the landlords are also asking for longer base-term guarantees. In light of this, restaurant tenants are requesting more robust tenant-improvement-allowance (TI) packages in exchange. Some tenants leverage their credit in order to secure a certain fixed amount of TI dollars (in exchange for a higher rental rate on the front end). This allows the tenant to achieve better return rates on their investment into the space based on expected sales.
Specifying build-out preferences
Restaurant owners and operators know that their needs are quite different than those of a traditional retailer. For this reason, it is advantageous for restaurant tenants to negotiate certain build-out preferences that meet their specific needs in ways that a traditional retail space wouldn’t, before the building is constructed.
When a restaurant tenant can specify their needs pre-construction, they may achieve savings in the form of TI credit from the landlord, because the landlord avoids unnecessary construction costs, and both landlord and tenant can benefit from not having to modify aspects of the newly built space to meet their specific needs. In particular, restaurant tenants should consider requesting that pre-construction retail space include features such as a dirt floor, allowing for more extensive plumbing needs; cutouts for air conditioning and no duct work, due to more complex HVAC needs; and appropriate power needs, due to significant amperage requirements.
— David Gabbai, executive vice president, retail services with Colliers in Orlando. Gabbai specializes in retail and restaurant landlord and tenant representation services.