Dealing with New York City’s Harsh Rental Reality

Today’s restaurant owners and managers face an abundance of stress factors coming at them from multiple directions. Trendy food trucks, with their lower overhead and low-cost fare, lure diners from indoor tables. “Ghost” restaurants that only take online orders and deliver also take a toll on dining revenue, while the costs of compliance with the Affordable Care Act impact larger establishments and chains.

But the concern we hear the most in our New York City-based Food and Beverage practice is that soaring rents are squeezing even successful eateries with large followings out of business. Some fine establishments, including Danny Meyer’s flagship Union Square Cafe, have recently shut their doors and many more have had to find ways to cut costs to absorb those increases. Even legendary chef Bobby Flay closed his Mesa Grill in the Flatiron District when the rent doubled.

Passing a rent increase along to the customer via menu prices is a risky game, especially if your competitors, some of whom own their property, aren’t following suit. Skimping on the quality of food ingredients or level of service is also ill-advised in an age when bad Yelp reviews can take a significant bite out of business.

The harsh reality is that restaurant proprietors these days simply have little leverage for negotiating rents.

The harsh reality is that restaurant proprietors these days simply have little leverage for negotiating rents.

Landlords know they can quickly turn around a vacant property for the next occupant and recoup any lost revenue not covered by the departing tenant’s security deposit. As New York City property values soar–not just in Manhattan but in many Brooklyn and Queens neighborhoods, as well–restaurateurs must become real estate experts (or hire one) to properly assess values.

Some landlords would sooner see their property vacant than rent it for sub-market value cost. In many cases they have a responsibility to their shareholders to increase return and they face rising costs of their own as tax assessments increase with value. Many observers have noted the irony of restaurants boosting the allure of neighborhoods only to be forced out by the resulting higher values.

In some cases, rent increases are only catching up to current values after the expiration of long-term leases negotiated by the proprietors. In New York’s West Village, Empire Szechuan recently announced it was closing after a 500 percent increase. However, the store had been paying an extremely reasonable $5,000 per month for 30 years for the 1,800-square-foot property on Seventh Avenue, the owner said in press interviews.

This shows the importance of strong negotiation by owners at the outset of a lease that builds in structured cost increases. They must not expect infinite patience from landlords to wait for them to be profitable. Landlords should be cognizant that on average it takes a restaurant close to a year to break even after start-up costs, less so for those who take over an established eatery that already has equipment, fixtures and a customer base. It is then important to reinvest profit for future growth or to weather tough times.

Restaurateurs who already have successful properties elsewhere may have a better hand at negotiating since they can demonstrate their long-term viability with a proper agreement that considers the needs of both parties.

Typically, restaurant owners try to keep occupancy costs at eight to 12 percent of revenue, or higher in areas like Manhattan. They can expect to pay rent increases of two to four percent per year, depending on location, tied to cost of living increases and based on published indexes. A typical lease covers five years with two five-year renewal periods. In some areas, renewed leases can see increases of about 20 percent.

On the plus side, restaurant owners are benefiting from continued low interest rates on debt and lower fuel costs, which decrease heating bills and the cost of incoming and outgoing deliveries. The cost of other commodities, such as meat, is also fairly low.

More good news: Congress and the Obama administration agreed to make a 15-year recovery period for deductions on improvements at qualified restaurants permanent.

When rents rise, owners can further reduce expenses by consolidating vendors to see if they can get a better deal on varied items from a single distributor. For those operating chains or portfolios of restaurants, proven managers can be asked to oversee multiple locations.

Entrepreneurs searching for locations should keep in mind that they can often find better deals in malls or shopping centers, which count on attractive eateries to draw traffic. An outward-facing restaurant with a street entrance stands to entice passersby to then visit the retailers inside the mall. High vacancies in such centers create better negotiating opportunity. It’s also important to think up front about the potential for expansion at a property and whether the infrastructure is modern enough for trouble-free operation and potential upgrades.

Most of all, we advise restaurant clients to always be communicative with landlords about factors affecting their business, such as area transportation issues, street repairs, unforeseen maintenance or other costs. No one should expect property owners to lose money, but it is in the best interest of the proprietor, landlord and the communities on which they rely to foster the most productive and enduring long-term relationships.