Navigating a Restaurant Lease Renewal as a Landlord/Broker
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On today's episode of The Restaurant Realty in 10 host, Michael Carro, explains special lease details to consider as you re-sign a long-term restaurant tenant.
He walks you through a conversation he recently had with a friend who wanted advice on how to retain a great restaurant tenant and put himself in a position where selling the building as a NNN investment may be possible in the future.
“When engaging in some type of [lease] renewal activity, you have to understand if your goals for this asset have changed since you bought it. ”
If your goal has changed from “long-term hold” to considering selling a leased property as a NNN investment here are a few tips from today’s episode:
Consider below market lease rate and negotiating building improvements such as improved signage or covering patios
Set annual lease increases to bring the lease to market value over time
Creating an Absolute NNN lease where the tenant is responsible for all building upkeep
Having an initial lease term of 10 -years
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Rather Read? Check out the full episode notes below.
Michael Carro 0:01 Welcome to The Restaurant Realty in 10. Ten minutes of uncensored straight talk for restaurant entrepreneurs twice weekly The Restaurant Realty intense dives into restaurant operations, facilities, real estate and investments.
Michael Carro 0:13 Welcome to The Restaurant Realty. This is Michael Carro.
Michael Carro 0:15 And I wanted to share a phone call I received this week from a friend. He has a restaurant that is coming up for renewal. The tenant has been there for 10 years. And he was calling me to ask what I thought the market was in this world and where this restaurant is located and how he should proceed with some type of renewal. Now the restaurants a good restaurant, great location. And there are several things that I had walked him through that appeared to be extremely meaningful to him. And again, this is a person who's been in commercial real estate a very long time, but does not specialize in restaurants.
Michael Carro 0:50 So he's charging his tenant about $14 a square foot he has low operating costs because he's on the property for so long. The tenant wants to renew in the market is probably closer to 18 to $20 a square foot. And so we discussed how to move forward. Now this is a person who may want to sell this asset sooner rather than later.
Michael Carro 1:12 So keeping that in mind, so when you're talking to people or you yourself are engaging in some type of renewal activity, you have to understand have your goals for this asset changed since you bought it. So if this gentleman has owned it for 20 years, he may have had a long term hold. And guess what he held it a long term, but he now might be at the point that "you know what i want to consider selling". So your approach to the lease and the renewal may be very, very different. So this tenant does not have a renewal built into their lease. So we're talking about a whole new lease negotiation. So let's assume for the sake of argument, that the property, he could lease it up on the open market for $18 to $20 a square foot so he can get more than what he's getting now, but this tenant he wants to show them good faith in working with them honestly to renew. So my suggestions were as follows.
Michael Carro 2:05 First of all, I'm very familiar with the restaurant, and they do a great job really good location. So we don't have to always bring up a tenant to the full market value because we want to ensure their future success. And so my recommendation to him was to go two dollars below market because if we want to plan on a potential sale, I want this tenant to have a great deal of success. I had suggested that he'd renew them at $16 a square foot but require them to improve their marketing and signage of the building. They currently do not have a sign on the physical building. They have a blade sign which kind of hangs down from the building, but it's in a higher visibility area. So to me, I really would like to see better signage on the building. In addition, they have this great outdoor sidewalk area that is not covered. So the customers that want to sit outside are in the direct sunlight in addition to this discounted rent, have the tenant invest into the building where the awnings come out further to provide the level of protection and shade and this ultimately will improve the customer experience and should yield higher revenue for this restaurant making them even more successful. So sometimes that give back in a lower rent is to help ensure that the tenant has the money to then invest into the property itself. So that's my first suggestion for this.
Michael Carro 3:32 The second thing is, is we need a 10 year lease. Apparently they had a five year lease with one five year option. So they're completing their 10 years of term. I'm recommending a 10 year initial lease term for this new lease that we're negotiating with a couple of other caveats. Because a triple net investor or an investor of real estate where there's a tenant in place, look for a few things more sophisticated investors are going to be looking for the following a longer term lease in this case, 10 years is better than five, an absolute triple net investment. Now this landlord told me he recently put on a brand new roof, which typically means it's going to have a 20 year warranty associated with it. So now having that tenant take the responsibility of the roof in their new lease, would now give a future buyer comfort knowing that they do not have to replace the roof while that tenant is there. The good thing is the tenant should now be okay with taking on that additional responsibility because it's already under warranty. So that's a big step.
Michael Carro 4:35 Another factor is I'd like to see annual increases. So while the tenant is getting a slightly lower than market rent, we're going to get them to market over a period of time with these annual increases. And a lot of times the annual increases might be two or 3% per year. Now if you're starting out at a higher lease rate, if we started off at $18 per square foot or $20 a square foot then annual lease rate increases might be little problematic because now we're going to outpace the market in many circumstances. So starting off with a slightly lower lease rate, and yet having these annual increases, again is something that an investor who might want to buy this is going to find to be very, very attractive.
Michael Carro 5:15 So we talked about the signs and awnings, we talked about the absolute triple net, we talked about the annual increases and we talked about the 10 year lease term. Now we have built this property into a situation that once he signs a new lease, if this tenant agrees to all this, they've improved the building, which ultimately will yield a higher sales revenue for them, making them more secure for the landlord whether or not he ever sells it or doesn't. He should have a better tenant situation with a longer term security in his cash flow. And then if he ultimately decides to sell it, the buyer will know that there's a tenant in place that has been there 10 years so far, who just signed a new 10 year lease going forward. Which should also give them a level of comfort.
Michael Carro 6:00 Just want to give you a little bit of feedback for a conversation that took place this week that I thought was meaningful. Have a great day. Thank you for listening to The Restaurant Realty in 10. If you're interested in restaurants, whether operations facilities buying, leasing or investment, The Restaurant Realty in 10 is for you. Please subscribe to this podcast and you can also visit TheRestaurantRealty.com for show notes, topics and additional information.