Restaurants

"Typical" is a difficult concept to apply to restaurants. One standard model is a vehicular-oriented pad site occupied by a franchise to the front of an anchored suburban retail strip, with parking provided on-site. Another is the independent proprietor in an older storefront that takes advantage of otherwise unused on-street night-time parking. Franchises pay high rent for high-traffic locations serving one-time customers. Mom and pop restaurants occupy low-rent space and serve a repeat clientele. Malls make use of restaurants in combination as food courts, which, in the absence of department stores, can function as anchors. Restaurants in hotels serve a semi-captive population of travelers and suffer a reputation for blandness. Restaurants are in basements and on the top floors of skyscrapers, at airports and in inns. The locations and clientele to which they adapt are as diverse as their cuisine.

For all their diversity, their valuation is simplified by a common factor: percentage rent. Percentage rent is rent paid as a percent of gross business. The Dollars and Cents of Shopping Centers reports a range nationally from 4.0% to 7.0%, with a tighter range from 5.5% to 6% more prevalent locally. A standard lease calls for payment of base rent as a minimum. Additional rent under a percentage clause is affordable for the tenant when the business succeeds, and it allows the landlord to share in the tenant's success. Investors view the rental income that results from restaurant leases as more risk-prone than that from more general-purpose commercial space. Restaurants experience life cycles that consist of establishment and growth; stability, at a plateau of maximum business volume; and, for any of a variety of reasons, decline. A restaurant's success is heavily dependent on strong management and, for some, on key personnel, like a chef. For these reasons, a higher capitalization rate (resulting, conversely, in a lower value than would otherwise be the case) is required to attract investors to restaurants than to less risk-prone general-purpose commercial space.

The question arises, if the value of a restaurant depends on the rent and the rent may vary with the business, then, when we value a restaurant, don't we value more than "bricks and sticks"? The answer is yes. Two buildings that are identical in strictly real estate terms but that differ in occupancy appeal differently to the market of buyers and so achieve different levels of value. The broader picture for real estate of this type consists of a value presuming the business at failure stage, or vacancy, and a value at maximum business, or success, with changing value at stages between. Clients committing assets to property that may go rapidly from one stage to another need advice concerning the difference. A restaurant, like a hotel, a nursing home, or a gas station, is real estate intertwined with a business. The components of value consist of the real estate; furnishings, fixtures, and equipment; stock; and goodwill. All work to produce income. To separate them for valuation can be difficult and, for some clients' purposes, is academic. Is the walk-in cooler built in (and therefore real estate) or removable (and therefore equipment)? Where does the business begin and the real estate end? As a solution, valuation experts sometimes address not simply a component but the "going concern." Such a solution may serve some clients and not others. Appraisers and clients alike are well advised to agree at the start as to the identity of the components to be valued, which may differ depending on the client's need.

Restaurants have weathered a long five-year winter. Joe Rogers of the Boston office of the Restaurant Brokers of America notes that the day when some of the city's best chef-oriented restaurants "removed the tablecloths and brought out the crayons" in an effort to make themselves more child-friendly and down scale seems to be in the past. He finds 1994 "a time of enthusiasm in the industry," with this year "a better time for new chefs" and for "national organizations to come into town and make deals." Restaurants demonstrate trends in the spending of discretionary income and reflect the public psyche. If recent months are a guide, the trend, after a long decline, is toward optimism and confidence.

The Reenstierna Associates Report is published as a service to the clients of Eric Reenstierna Associates and other real estate professionals. The views expressed are those of the articles' authors and do not necessarily reflect those of other members of the organization. Copyright 1996. All rights reserved.

Eric Reenstierna Associates
24 Thorndike Street
Cambridge, Massachusetts 02141
(617) 577-0096

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