Restaurant Lease Lecture

This article is copyright 2015 Dikran Iskenderian. You can share this post on social media but please do not reprint, reproduce, or copy and paste without written permission from the author. Thank You

The Top 30 Things to Consider Before Signing a New Restaurant Lease

1) When the location was an existing restaurant that failed or the owner sold the location to you and moved on, consider that it may have to do with that area not being so great. This puts you in an advantageous position during bargaining with the landlord. Whether it was the fault of the leaders of the existing restaurant or the economic situation in that area is irrelevant. You can negotiate better, and you should use the fact that it failed before to ask for these terms:

a) No charge for the first 3-9 months during construction. Extend the lease commencement date as far as possible.
b) Not paying rent until the doors open for business
c) Rent increases start on year 5-7, not on the first year.
d) The landlord pays for part or all of the requirements to get a new restaurant up and running.
e) The landlord pays for large signage and includes it in the lease, free of charge.
f) Get plenty of parking. The rule is you need at at least 10-15 dedicated parking spots for a busy restaurant. You don’t wantto argue about this with your neighbors later on. If the rule for the shopping center is shared parking for all, get that in writing and make sure they post signs forbidding all employees to park there as well. Here in Los Angeles not having enough parking is a sure way to kill off your restaurant even before it starts making money.

2) Check the area for any damages. If there was a fire,it is usually considered a total loss for the area the fire consumed. Make sure the city’s fire department inspects it and clears it as safe for a new restaurant. If not, the landlord should pay the fixing costs, after all what happened before you came into the picture is not your responsibility.

3) If you are not 100% certain the restaurant will succeed (and how would we know unless we try, right), make sure you include a break clause in the lease contract. This can be worded in multiple ways. Some people write it as a clause that if the restaurant is not profitable within the first 1-3 years, you can move out without any penalties.

4) If the space is in an indoor mall, or a large outdoor shopping center, consider an exclusivity clause. For example, if we opened a Zankou Chicken at the Grove, we wouldn’t want another chicken restaurant or kabob restaurant to open in the exact same shopping center.

5) Make sure the wording of the contract does not overt penalize you for missing a payment. A lease contract for a commercial restaurant can be written in a million different ways. There is no standard contract, so make sure that it doesn’t have writing in there allowing for your eviction within 3 days of non-payment. Your check can default for a variety of reasons, and you would need at least 30 days to get your finances in order.

6) Make sure you hire a licensed contactor to measure the restaurant space with accurate tools. This is common practice, and these experts have the tools of the trade in order to do this effectively. Make sure you get the square footage in writing, and present it to the landlord as an objective, third-party measurement of the location. Often landlords miscalculate the square footage of their property. Sometimes they include exterior walls, and other areas you can’t use. More often than not, it tends tobe in their favor (overestimating how large the space is).

7) Your “Pro Rata” share of expenses is determined by dividing the size of your store by the total size of the property. For example, a 2,000 square feet (your restaurant space) divided by 20,000 square feet (total shopping center) equals ten percent(10%). If you are the only occupant you will have to pay 100%, but sometimes if your restaurant is very popular landlords tend to charge you even higher than the pro rata share. Never let this happen under any circumstances.

8) Make sure you ask to see what the triple net is being paid towards. Do your due diligence and see if the landlord is actually paying his or her taxes. We had one situation where we were paying the property taxes through the triple net, only to find out the landlord was a crook and pocketed the money and ran. We had to pay an entire year’s worth of property taxes, which was over $100,000. It was a disaster.

9) Speaking of the triple net, if the landlord is charging for area maintenance and not actually conducting any real maintenance, the responsibility is on you to remind them to do so. Trees need to be trimmed, lights need to be replaced, and broken floor tiles must be replaced. If you ask the landlord to fix it and he/she doesn’t, this can become a problem. You may have to speak to an attorney and send legal letters unless they fix it. Take pictures, send letters, have witnesses, and do everything you can to build a case.

10) What will the landlord be responsible for? Items that should be addressed include the size and capacity of the HVAC system, the capacity of the electrical system and whois responsible for making modifications to hoods and ceilings.

11) Will the landlord make any necessary changes to have the place be ADA compliant? Have it all in writing. You should get a professional contractor that specializes in ADA to let you know if you need to add a ramp, change the doors, and have a wider hallway or a lower counter. These things can cost tens of thousands of dollars.

12) Make sure you have a well-worded assignment agreement. What if you want to sell the business?If the lease doesn’t have a nicely worded assignment clause, you may have no choice about moving out or you may be forced to sell under the landlord’sconditions. The worst-case scenario is that you sell your own business and the landlord pockets part or all of the money. This is how many crooked landlords have the contracts written, so be very careful.

13) Make sure to include extensions to the lease if you feel the place will be truly profitable.Here in Los Angeles, we often include a 5 year or 10 year (2x 5 years) terms of extension. Make sure the option to extend the lease is not tied personally to you and your business, such that when you choose to sell it, the new owner would also have the option to extend. Otherwise, selling the business may prove difficult.

14) Limit the personal guarantee. If you are signing a 5 -15 year lease, you can negotiate to have only the first 2-3 years under the personal guarantee. Otherwise, having an LLC or corporation will not protect you should you default on your loans and the business goes under. The landlord can come after you for the entire duration of the lease, depending on the wording of the lease and the personal guarantee. Many people assume that just because their business is a Limited Liability Corporation they are off the hook, when in fact they’re not.

15) Give yourself time to do homework before the lease is about to expire. Typically, you should be thinking about and renewing your lease 1-2 years before it expires, before the landlord tries to not respond to letters, or avoid you during this process. It is in their best interest to delay this as much as possible. You need to see the new market rent rates in the area, and see other market conditions like vacancies in the vicinity.

Prepare a lease expiration schedule that lists all your locations, when the leases expire, and which locations have extensions, including how many years the extensions are for. Work backwards and start negotiations to renew the leases least 4-6 months before they expire. I prefer one year. Give a copy of this schedule to your real estate attorney, your lease advisor, and all partners.Remind each other so that everyone can be held accountable. Speaking of lease advisors, you should get one…

16) Use a professional service like the Lease Doctor™. Please read and carefully study the chapter on this, and remember that lawyers are not good at helping you form these contracts. They are good at only reading over them (see#30). A professional commercial lease negotiator will do the heavy lifting for you, and you can come in and iron out the details. They will typically earn you 100x, sometimes a 1,000 x what you pay them for the life of the lease. There is no better investment.

17) Choose a corner location or a drive-through. Many major restaurants and coffee houses like Starbucks are now exclusively signing corner leases or locations that can afford a drive-through. City laws that allow drive-through locations vary, but are usually very strict.

18) Pick your battles. Don’t try to negotiate every detail of the entire lease. You will annoy the landlord very quickly with that kind of strategy. Choose the few,very important details that matter to you most and push for those. It can be an exclusivity caluse, corner signage, a nice patio, negotiating for the drive-through spot in the shopping center, etc. The devil is in the details,but not during the beginning or middle of negotiations. Be reasonable.

19) If you care about certain things you want to take with you at the end of the lease, write it down in the contract. Anything that is bolted to the ground, the fixtures and hoods,all belong to the landlord. Any fixed improvements like tiles and fixed furniture also can’t be taken. So if something really matters to you make sure you make a point of having it in writing.

20) Research the comparable rents in the area and show the landlord. Third party, independent research is difficult to argue with. This does not guarantee that the landlord will listen or bend, but it’s much better than your opinion of “This is tooexpensive”.

21) Have your architect inspect the premises before signing the lease. Make sure that the place is up to code on structure requirements with the city. Any city code requirements and mandatory updates that are the landlord’s responsibilityshould be paid for by the landlord and/or deducted from the lease.

22) Inspect the bathrooms. Every city has code requirements for space in the bathrooms,typically for your handicapped guests. Some cities require two bathrooms, and some are OK with having just one. In older establishments and tight spaces,restaurants used to be able to get away with having NO bathrooms, although this has become exceedingly rare with any new construction.

23) Make sure you have a grease trap. Here in Los Angeles, a restaurant is required by law to have and maintain a grease trap, which is basically a small-car sized steel box that traps grease and doesn’t allow it to flow through the cities pipes,clogging sewers. It usually costs thousands of dollars. If the restaurant has no grease trap, you will be required to create one. Will you pay for this or will the landlord? Even if you will pay for it, asking the landlord to pay for it can be used as a concession in further negotiation. By the way, if you open a restaurant without a grease trap, it will cost you $10,000-$15,000 MORE to doit later because the entire ground has to be removed and dug, in addition to steep city fines.

24) Construct a clean, well-ventilated garbage disposal area. Many neighborhoods are now very well organized, and it’s a good idea to carve out this area in stone and make sure there is a brick wall surrounding the dump. If not done well, vagrants can come and pick at the food or remove plastic containers, creating a mess. Our landlord at one of our locations paid her own construction company and didn’tallow us to do it ourselves. The cost? $17,500 for a simple brick square around the dump. We had to pay for it along with the other renter. So consider this in the lease and kindly ask the landlord to pay for it beforehand.

25) Do a criminal background check on the landlord. This is especially for people you know nothing about. One of our landlords was a crook, who had loan sharks looking for him and a sheriff showing up every few weeks asking about his whereabouts.You need to know whom you are dealing with.

26) Don’t feel pressured by the broker. Most brokers make deals every week, so for them you are just another commission. For us restaurant owners, however, we are in it for the long haul. So always be ready to walk away and act as though you have the upper hand.

Don’t getemotionally attached to the property just because you signed a letter of intent. Always remember that the broker’s best intentions are only to themselves, not to you, since they work off of commissions. That means the higher the rent you pay, the more they make. Depending on their contract they can also make a slice off the deposit and other fees as well. Negotiate the deposit down to as low as you can, because most of us never get that back.

Don’t fallfor lines like, “There is someone else willing to take it next week?” Ask many questions to the broker about the landlord, and when they refuse to answer ordon’t have an answer do the research yourself. The more you know about their positions, their strengths and weaknesses, the better off you’ll be.

Really, well then let them take it. Nothing bothers me more than people who don’t have along-term interest in your business acting like they care more than they actually do. So take your time, play your cards right, and always act in the best interest of yourself and your family business. Let the broker wait. Always have one foot out the door if it doesn’t go your way, which leads me to the next point.

27) Have a strong BATNA. BATNA is negotiation terminology that stands for “Best Alternative To a Negotiated Agreement.” It’s another way of saying that you have many good options. Which bring up another question. Do you have many options?

Have you looked at or talked to other landlords in the area? You should have at least 2-3 other option in that area you are willing to give rent to. If you don’t, you don’t REALLY have a BATNA and this will show during negotiations. You won’t be able to always fake your hand and pretend you have better cards than you already do. Just like in real poker, the stakes here are really high. So have well-researched and measured alternatives.

28) Make sure you can afford to pay the rent before you sign. Typically, the rent should not be much more than 10% of your projected sales. If you expect to make $150,000 per month, the rent should not be more than $15,000 per month. Can you have a place that charges much less but also makes you a lot of money? Sure. You can have a restaurant that pays $4,7000 per month in rent and pulls in $270,000 per month. It’s all in how you plan it, where you open, and how rich the landlord thinks you really are. If you have a strong brand name or are negotiating on behalf of a well-known franchise business, consider opening an anonymous sounding LLC and negotiate under that name.

Walt Disney was smart because he negotiated and purchased miles of empty land in Florida many decades ago. There was were nothing but dead land, swamps, or dry open fields. Him and his brother Roy were buying all this land under anonymous names. Here’s a fun fact:many of those names are now on the windows in Disneyland’s Main Street USA. After people found out that Disney was going to combine all the purchased land together and make Disney World, the prices for all the surrounding land immediately skyrocketed.

Anyway, the point is you are much likely to get a better deal if people don’t know who you are vs. using a well-known name or brand.

29) If you are investing a lot of money in the building, consider a longer lease. A 10-year lease is not that long for a tenant that has spent $800,000 in renovations. For example on our Burbank store, that’s how much we spent. We have a hand-painted dome,hand-made tiles, beautiful lighting fixtures, and a $100,000 glass dome on the patio. That’s not easy to walk away from. So consider doing a long-term lease if this is the case. Cheesecake Factory is known to spend upwards of $6 -$12million on some of their locations, and they routinely sign 30-year leases with extensions.
30) Finally,make sure a qualified commercial real estate attorney goes over your contract before you sign any lease. Make sure it’s not a clown who doesn’t know anything about real estate. We once worked with a guy who charged us $50,000 and made us sign a terrible lease that was still 99% favorable to the landlord.

Some lawyers are great at pretending they are good at something when they are terrible at negotiation and know little to nothing about real estate contracts. Remember,they don’t teach them this stuff in law school. They only teach them how to not get in trouble, which is very different from solid, aggressive tactics you are going to need.

To determine whether they are right for you, get referrals of previous people they have worked with, and call these people up. Ask them questions such as “should I need sublease clause (to allow you to sublet the space to another business if necessary)?”

Should I get a break clause?

Should I add a paragraph detailing co-tenancy (if the landlord has an anchor tenant that is extremely popular and draws in a lot of foot traffic, this clause allows you to break the lease if this tenant is not replaced within a certain timeframe)?

Ask that the lease be put in the name of your LLC and not your name personally. Ask if they know how to structure it like this.

Do they know how to word the lease so that you are not obligated to pay the landlord any legal costs should there be litigation down the line?

Do they know how to deal with a default payment?

Ask the lawyer how they intend to help you make the lease better. If they say you can’t make it better,fire them on the spot. They should find out weaknesses in the contract, outline line danger flags all over the place, and save you from potential trouble.That’s their job. Their job is not to pat you on the back, praise you, and wish you good luck on your restaurant.

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