I. Real Estate Budgets

Determining an optimal real estate budget can be a daunting task, but one that is absolutely critical in your search for potential locations. As such, below are some questions you should consider when determining how much you should pay for your restaurant space.

1. How much free cash / capital do you have access to prior to opening your restaurant (excluding any interest or loan repayments)? 
Calculating the total free cash / capital you have upfront is absolutely necessary for determining your real estate budget limitations. Note that a significant portion of this total will be used for supplies and services also necessary prior to opening (e.g. equipment, ingredients, service fees). Thus, be sure to leverage our financials / capital section for additional insights on allocations beyond real estate / occupancy costs.

2. How much gross sales did you forecast in your business plan / financial forecast? 
If leasing a space, the general rule of thumb is that your total occupancy cost (which includes rent and additional fees for property taxes, insurances, etc.) should NOT exceed 6-10% of your gross sales.

3. What is the range of square feet necessary to satisfy your restaurant concept? 
According to restaurantowner.com, the typical establishment needs approximately 4,000 square feet, but this varies greatly depending on your restaurant concept.

4. What do competitors pay for rent? 
While it is unlikely a competitor will give you this information, you can ask your competitors’ neighbors, which may provide you with some information on their rent on a per square foot basis.

5. What is the market rent for the potential areas you are considering? 
Obtaining the market rent on a per square foot basis for each potential area (e.g. city, county, town) generally reflects what you should expect to pay for a location in that area.

III. Leasing vs. Buying Real Estate

The decision to lease or buy restaurant real estate often comes down to how steep the investment to buy is and whether the success of the previous owners is worth that investment. In most cases, new restaurant owners start by leasing a space instead of buying and eventually work their way up to purchasing their location once they have established a solid customer base.

Keep in mind that the process of obtaining a great lease is generally different than that of a great buy and each have their own advantages and disadvantages.

LeasingGenerally the cheaper option, leasing can be advantageous to a new restaurant owner because it allows you to allocate more capital toward upgrading your kitchen, designing your dining area, and promoting your restaurant. It may also limit risk by offering an easier exit in the event you need to close down your restaurant. When leasing a restaurant space, the key things to keep in mind are the location and lease terms.

Regarding lease terms, it is important to clearly understand what actions the landlord does and does not permit on the space and the costs associated with making any changes / upgrades. Keep in mind that the space will need to have the wiring, ventilation, and plumbing to run your specific restaurant concept. Since you may need to do some remodeling to meet your standards as well as certain regulatory codes, you must always confirm that any remodeling plans will satisfy the proposed lease terms and how much they will cost in total.

For additional tips on getting good lease, make sure to check out the Negotiating a Lease section.

BuyingGenerally the more expensive option, buying property for your restaurant is a major and, often times, long-term commitment. Thus, it is typically carried out by people with either a ton of experience in the restaurant industry, a large pool of capital upfront, or a popular name or brand that can attract business right away.

As with any location, carefully surveying the property is a huge part of buying restaurant real estate. However, since buying a space is generally a longer term commitment than leasing it, you need to have a much deeper understanding of the economic stability of surrounding communities and confirm that they are unlikely to change or grow in the coming years. It is also very important to recognize any future construction or zoning / accessibility changes by the local planning commission.

While buying real estate is often times more time and capital intensive, there are major advantages for those that do it right. First, you will not have to worry about a rent hike. In addition, you will have more flexibility to do what you wish on your property (as long as it continues to satisfy local safety and health codes) as you will not have to worry about any landlord parameters.

Another major factor to consider when buying any real estate is the projected value of the property. In other words, will the property itself increase in price over the coming years? While the goal of most restaurateurs is to build a successful dining establishment, the acquisition of prime real estate can make ownership much more rewarding. However, the real estate market is subject to change and property values can also decline in the same way they can increase. That said, we highly recommend consulting your real estate agent for the latest trends / analyses in addition to your own research prior to signing the dotted lines.

IV. Negotiating a Lease

In general, try your best to avoid long leases for your first year of business. The last thing you want is to be locked into additional years of rent that you cannot pay if your business fails. Remember, a lease is a legal binding document and the landlord has the right to sue should you fail to satisfy the terms. Most landlords are usually willing to start with a one year lease, but if your favorite property only offers a long term lease (longer than one or two years), make sure to carefully consider all the risks involved.

Since lease agreements vary so much, it is difficult to identify a standard for lease agreements. However, this creates an opportunity to negotiate favorable lease terms for your restaurant. As such, below are 10 common lease items to consider negotiating before signing on the dotted line.

Always remember that what your landlord tells you and what your contract actually says can be two different things. Thus, we also highly recommend consulting a professional to help negotiate / review your lease terms.

1. Percentage RentMany leases require “percentage rent.” This means that once your sales reach a certain level, you must pay your landlord a specified percentage of your restaurant’s revenue. While this is very common in the restaurant industry, agreeing to a “percentage rent” also means providing information on how your restaurant is performing financially, which can materially and negatively impact future flexibility on your lease. Assuming all things equal, always try your best to avoid a “percentage rent”. Nevertheless, if you ultimately agree to it, always try to negotiate the terms.

2. Exclusivity and Radius RestrictionsInquire and try to negotiate any ways to prevent direct competition near your location. While it is unusual to block all restaurants, you may be able to negotiate exclusivity within a food category, such as pizza joints. In contrast, your landlord may also want to impose radius restrictions, which would prevent you from opening another establishment nearby. All things equal, try to avoid these restrictions as it would negatively impact your flexibility in expanding your business.

3. Assignment and Subletting ClausesAs a measure to mitigate risk, you always want to have the right to sublet or assign the space to another tenant with as little restriction as possible. In the event you need to close or sell your restaurant, the last thing you want to face are any stringent requirements that would prevent you from exiting. Some of these restrictions come in the form of requiring the transferee to have the same net worth or experience as you. Carefully examine the assignment and subletting clauses to recognize these restrictions and try your best to avoid them.

4. Renewal OptionsInstead of automatically agreeing to your option to renew, try your best to negotiate the renewal terms. For example, try removing clauses in lease renewals that are contingent on you remaining the tenant because the resale value of your restaurant will generally decrease.

5. Future Rent PricesFuture rent prices generally tend to be based on percentage increases or tied to fair market value. If provided the choice, go for percentage increases because they are easier to budget for, unless you have solid evidence / research to prove fair market values will be lower in the future.

6. Kick-out ClausesAll things equal, try your best to negotiate a kick-out clause. A kick-out clause gives you a one-time right to cancel a lease after a specified time period if your sales haven’t surpassed a certain amount. However, be sure to confirm that there aren’t any exceedingly high cancellation fees or penalties associated with the kick-out clause and that the clause is an option, not an obligation.

7. Rent Start DateMany landlords waive rent payments during the build-out period, which generally range from 60 to 90 days, or until you open for business, whichever comes first. Try negotiating the landlord to start the clock on that build-out period after, not before, you get a building permit.

8. Change of UseTry to negotiate as much flexibility for changing restaurant concepts or subleasing / assigning the space to a different business

9. Operating ExpensesNegotiate which operating expenses, if any, you will be responsible for. This includes items like property taxes, insurance costs, and management fees. Some landlords may add in clauses that aren’t industry standard like administrative fees and capital improvement costs, so be sure to recognize and negotiate on all of those items.

10. Building Repairs If you plan to make significant repairs to the plumbing or heating, try asking your landlord if those costs can be deducted from your regular rent. Most landlords would rather give free or reduced rent for a specific month than shell out additional cash to make repairs.

V. Buying an Existing Restaurant

Buying an existing restaurant often appears like a simple business transaction. However, the process is often times very nuanced and time consuming. Thus, we highly recommend enlisting a professional broker and/or a lawyer to help in asking the right questions, interpreting the answers, and drafting a purchase contract that accurately protects your interests.

As a starting point, below are key questions to carefully consider for each potential purchase. 

1. Why is the existing restaurant for sale? There are several reasons that existing restaurants could be for sale. If the restaurant was not doing well financially and the owners wanted to exit the sinking ship, the restaurant could still be a great opportunity. However, you have to be extra careful in your research as some of the reasons why the restaurant failed may not be fixable, even under new ownership. Always remember that a low price tag does necessarily make the restaurant a good buy. You may have to spend much more capital on repairs and upgrades as well as risk facing problems that new ownership or management cannot solve. There are many instances where a failing restaurant is just impossible to turnaround, even with a large pool of resources at your disposal.

2. Does the lease transfer? Landlords are often hesitant to assign leases to new owners, especially those that lack prior restaurant or small business experience. Unless you plan on securing a new lease, make sure the existing restaurant can transfer its lease and without any major contingencies.

3. What is the restaurant’s actual cash flow? With restaurants, the amount of income the seller reports can vary from the amount found in their financial statements. Since the value of a restaurant is generally based on it’s cash flow, it’s important to obtain a verifiable cash flow figure, not the owner’s personal estimate. Always demand to see the restaurant’s official bank records instead of just personal estimates as anyone can create a phony profit and loss statement that bolsters the success of a failing restaurant. If the current owners refuse to show their bank records or tax returns, you should not proceed with the acquisition.

4. What is the condition of the equipment?As a new restaurant owner, equipment repairs or replacements are expenses you need to avoid. Consult with a professional to properly inspect the building and the equipment.

5. If the existing restaurant serves liquor, can the liquor license be transferred? Always inquire whether the restaurant’s liquor license is included in the sale and if it can be transferred. Local jurisdictions generally issue a limited number of liquor licenses and may have limitations or additional requirements to transfer a liquor license.

6. Are there existing liabilities? Always identify the liabilities associated with the restaurant and make sure they are all considered in the selling price. Ask whether there is unpaid overtime, unpaid sales tax, health code violations or other liabilities that could hinder the restaurant’s operations.

7. How is the restaurant’s reputation in the community? Reputation and reviews are everything in the restaurant space. Since a change in ownership is not always clear to customers, make sure to identify if the existing restaurant has a negative reputation by evaluating customer feedback on Yelp and other review sites.

8. Is the seller willing to sign a non-compete clause? Independent restaurants are often built on the owner’s own recipes, cuisine and culinary style. Without a non-compete clause, there is nothing preventing the seller from opening a similar establishment in close proximity to the one you’re buying.