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Who Is Killing The Restaurant Industry – Part 3 (The Landlord)

Our poor unsuspecting victim moved quietly about his business, opening the doors, mopping the floors, working IN his business instead of ON his business, completely oblivious of the danger that was lurking inside his filing cabinet. For there, in a dusty folder alongside the liquor license application that he has been meaning to submit was his lease agreement!

When he originally signed the document, life was soooooo good. Restaurant profitability (retention) was running at a very acceptable 18-24% and there appeared to be an endless stream of customers and certainly no shortage of buyers should he decide to exit. How had it all gone so terribly wrong?

Well the writing had been on the wall and the warning sign were there for all to see… Over-trading, new centers opening daily, falling foot counts, rising input costs, an increasingly selective clientele all coupled with a world recession, but why should this worry him? After all, people have to eat, don’t they?

Yes they do, but they don’t have to eat out, they don’t have to eat out as often and they certainly don’t have to eat out at YOU! Suddenly foot count plummeted by 30%, the customers that were still eating out were spending 30% less and the retention on the now diminishing turnover had dropped by well in excess of 30%.

Now in order to run a successful business our victim understands that there are three key fundamentals. An acceptable food cost (35-40% depending), an acceptable salary to turnover ratio (18-21%) and a rental to turnover ratio of UNDER 11%. He seems pretty confident that his food cost is correct despite only taking stock once a month and only occasionally glancing through the pile of invoices on the spike over the hot pass. He has been able to reduce staff to keep his wage bill ‘almost’ under control and all that seems to require his urgent attention is that ever escalating ratio between his turnover and his rental.

So, he wonders, if times are so tough for me, they must be that tough for my competitors, for my suppliers and of course for my landlord. “It is time to renegotiate my lease or at least to get some kind of break until the flood subsides, after all…” he thinks “we had such a great understanding when we first met; he seemed like such a nice chap!”

Well there is an old riddle in the Restaurant Industry. Question: How do you turn a pleasant, helpful, compassionate, approachable and understanding landlord into a friggin monster? Answer: Just sign the lease agreement!

Now I need to state that this assessment of landlords may not apply to each and every one BUT it remains the perception of the majority of restaurateurs that landlords are unapproachable and single-mindedly fixed on immediate profit at the expense of all else. (I would welcome any and all comments from landlords on the subject and will be more than willing to publish them here). There are certainly more and more landlords that are becoming increasingly amenable to rental negotiations IF the restaurant in question can prove that they have given the matter serious consideration and are able to put forward a compelling case.

BUT in order to understand this problem we need to look back to the circumstances surrounding the initial signing of the lease agreement.

Landlords have a tendency to play independents off against franchise groups – i.e. independents are prepared to pay more because they are sometimes ignorant of pitfalls and are driven by “the dream” of owning their own restaurant.

Landlords actually budget for an attrition rate (failures in new malls) – and when a shop does fails, they are merciless in enforcing compliancy to meet rental commitments. This even takes the form of installing a new tenant in the old tenant’s place, but if there is a shortfall, they will still charge the old tenant the difference until the period of their old lease expires. Watch that personal surety clause…

They always want something new with which to differentiate their mall from the competition – often ignoring tried and tested concepts and often with disastrous consequences for all involved. Or they put in exactly the same as every other mall and wonder why they can’t drive feet through the mall.

They install similar tenants at will without any consultation with existing tenants thereby cannibalising the trade of the existing tenants without bringing any new feet to the center.

The owners of the malls are not addressing the major issue – namely that anchors are paying nothing, but that the man in street is subsidizing the anchors. Restaurants are often expected to pay the same rental or higher for large premises that other tenants are paying for small premises on the pretext that they are not big enough to pay what the anchor tenants are paying.

Most tenanting is done by brokers – they get paid a commission (granted, they have now extended this period before full commission is paid out), but every time a shop fails, they get even more commission from putting in a new replacement. A commission claw back system and a “switching” policy need to be implemented just as they do for insurance and assurance brokers. This will ensure that brokers are considerably more careful who they install as tenants.

The “Ops Costs” are simply too high – these costs are paid to the brokers to run and maintain and make a profit out of managing the malls e.g. Ops Costs in Sandton City run to approximately R120/m2 (and with approx 130,000m2 – do the math). These costs have increased year after year with inflation, with no downward adjustments (and by the way, these costs inflate at approx 1 -2% higher than actual basic rental costs.)

This comment came in this morning and I felt it was too relevant to leave at the bottom where you might miss it…

Despite the empty stores in every mall this is the latest OTL received from Pareto for a store in Tyger Valley SC. Besides the ridiculous rental asked they have added a NEW charge called availability charge for items that one would expect to be provided as a normal course of business

Basic Rental R450.00 sqm escalating at 10%
Ops R 64.42 ……………………. 12%
Marketing R 26.14 ……………………. 10%
Ass Rates R 28.60 ………………….. councils discretion
Refuse R 2.31 ……………………… councils discretion
Availability Charges !!!!! you will still be billed for usage for each of these
Air Con R8.80 ……………………… ?
Water R1.00 …………………….. ?
Sewerage R2.77 …………………….. ?

TOTAL R597.04 sqm
based on the 10% rule means your little take-away store needs to turnover R600 000 p/m before VAT. Or based on an average transaction value of R45 you will need to serve 15 200 customers a month or 506 a day. Likely? I don’t think so.

Annual escalations are driving rental too high, whilst annual menu price increases do not translate into annual sales increases at same percentage. This is similar to the “subprime” crisis that has virtually crippled the world economies. Everybody was convinced that restaurant turnovers would continue to rise in excess of the rental clause turnover and that their value would continue to increase. So banks dished out money, landlords dished out leases and restaurant owners signed ANYTHING to get the premises. Store growth is in low single figures, inflation is ‘officially’ running at around five percent BUT rentals are rising by in excess of ELEVEN PERCENT… a recipe for disaster! Maybe this will be known one day as the Sub Prime Rib Crisis.

Rates increases are another killer! It would be interesting to survey all malls and mall owners to find out which malls have approached the local city councils to fight these ridiculous increases on behalf of their tenants or do they simply add these costs onto the rental. When you factor in the increase in electricity costs… more blood on the streets! And the increased costs don’t stop there… Landlords are adding more and more costs onto the tenant. For example in some cases even insurance costs are added on!

And one of the single biggest killers is the dreaded “Tenant Mix” Landlords are installing more and more of the same successful tenants, despite being aware that this will result in there now being two to three struggling stores instead of one to two successful stores. Little to no thought appears to be given to the mix often with disastrous consequences for all concerned. One only has to visit literally hundreds of malls around the country to realize the only ones making money are those who sell the fancy paper that landlords use to block the windows of empty stores. (Don’t believe me? Try Brightwater Common, Balfour Park, Bel Air, Norwood Mall, Stoneridge… and the list goes on and on. And rumours abound that Melrose Arch is to see a big casualty soon.)

Millions upon millions of Rands have been poured into the set up costs, hundreds of people have lost EVERYTHING and thousands of jobs have evaporated… Somebody has to stop the madness! I am not implying that nobody should buy or open a restaurant; I am not implying that nobody is making money; I am suggesting that before you do, do your homework as you would for ANY OTHER BUSINESS… This is not a dream job! Wipe the sleep from your eyes, investigate it carefully and ensure you don’t wake up screaming from a nightmare or the banging of the sheriff on your door.

What is required is a clear understanding of the pitfalls, a better working relationship between tenants and landlords and proactive property owners who better understand the challenges of their tenants/partners. The property owners are under pressure too… Loans were secured on projected turnovers and rental increases and empty stores are hurting everyone. There is a strong case to be made that no one was forced into signing the lease and “Ignorantia juris non excusat” ignorance of the law does not excuse BUT it does kill!

Please get some professional advice before you sign the lease, before you launch the concept or purchase an existing business. There are some great restaurant consultants out there, franchise advisory services (start with FASA), informed and helpful brokers and banks that are slowly beginning to understand the challenges of what is a wonderful industry. You may well be sitting on “the next big thing” and have all the passion and drive that is required, just make sure you couple that with the knowledge you will surely need

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