Do you remember the first car you bought with your own hard-earned money? That car was shiny and beautiful. It was the new love of your life. Then, a month or two later—after some of the novelty had begun to wane—you said to yourself, “I probably overpaid for that car a bit.” But who cares, right? You loved that car, and it didn’t matter if you got fleeced on the price. The money was already spent, and you were happy.
Those same feelings can start to creep in again when restaurateurs see a wonderful space available for lease. We instantly envision our beautiful pizza restaurant thriving in that now-empty space. The mirage can start to look quite real in our imagination. But we need to exercise discipline and keep those romantic emotions in check. Falling in love and overpaying on a commercial lease can have disastrous consequences. Brokers and agents can provide a seemingly endless checklist of things that need to be considered and negotiated. It can be overwhelming. Let’s look at seven major points to consider before you put pen to paper and sign that next lease.
1) Hiring an Attorney
Signing a lease and building your dream pizzeria is a life-changing move, and it should be treated as such. You would never perform open-heart surgery on yourself, because you’re not a doctor. The same logic holds true when it comes to negotiating and signing that lease: Do not attempt to go it alone. Attorneys don’t come cheap, yet they are a necessary expenditure that cannot be overlooked. They are your one true protection in a field in which you are not a professional. In addition, by hiring that attorney, you’ve just established a business relationship and probably gained him/her as your first loyal customer. Well done!
2) Selecting a Site
“Oh, what beautiful awnings!” “Did you see that gorgeous entryway?” “Those bushes and the landscaping are spectacular.” Resist the urge to fall head over heels in love. Remember that first car you bought and overpaid for. A commercial real estate broker can be a huge asset when it comes to site selection. The property’s listing agent or broker has the landlord’s and their own best interests in mind and might not be the appropriate person from whom to get advice. Instead, consult with a local commercial agent or broker. Be up-front and tell the broker your exact intentions. Offer to take the person out for a cup of coffee or lunch. You will be surprised at how many will actually make time to meet with you. Their business reach is based on relationships, and many will gladly take a few minutes to build that relationship with you, even if they do not formally represent you. That relationship can lead to new deals down the road.
These brokers have a war chest of research and statistics that you probably didn’t even know existed. They can provide traffic counts and studies on a given location that show which direction has heavier flows at certain times of day. For example, is your potential space located on the side of the road that sees heavier traffic in the morning or evening (i.e., commuters going to or coming home from work)? This can have a definite impact on the value of the space. Studies show drivers are less inclined to turn left across oncoming traffic. This type of data helps to determine which sides of which roads will be conducive to the success of breakfast and coffee establishments (morning traffic patterns) and which work better for restaurants (evening traffic patterns). A relationship with an agent or broker who can share these insights will have tremendous value. And you’ve probably just gained another loyal customer!
3) Rent Tolerance
Rent will be one of your biggest recurring expenses, so that dollar figure must fall in line with your financial projections. The restaurant industry standard is approximately 10% of total sales. However, since pizza-based restaurants generally operate on a higher profit margin than standard restaurants, 8% of total sales is commonly used. In other words, if you’re looking at a potential lease payment of $50,000 per year, you will need to generate $625,000 per year in total sales. Before you sign on that dotted line, make sure your financial projections support these numbers. There is no wiggle room here. Anything less would be setting yourself up for failure. Be prepared to say no and walk away if those numbers cannot be realistically met. You will thank
4) Personal Guarantees
Every landlord wants a personal guarantee, and no tenant wants to provide one. This means that you, personally, will provide payment for the term of the lease regardless of any LLC or corporate dissolution. We always want to plan for the best with our businesses, yet we always need to be prepared for the worst. This can become a point of careful negotiation between the parties. Keep the following in mind:
Work to limit the length of the guarantee. It can be negotiated that, after an initial term period has elapsed, it’s obvious your restaurant is unlikely to fail and go out of business, thus limiting the need for such a guarantee.
Offer a potential close-ended guarantee, where you would provide rent payment for a predetermined amount of time after the business closes. Six to 12 months could suffice, as it would give a landlord ample time to re-rent the space.
Pay a higher security deposit only as a last resort. Anyone opening a restaurant knows capital is key. Avoid tying up needed dollars in a security deposit at all costs.
Unfortunately, life and business can take unexpected turns, resulting in financial discord. Adding the personal guarantee of a lease term on top of this risk can create a mountain of fiscal peril. It is imperative to take your time and negotiate to a common ground where both parties feel comfortable moving forward.
5) Requiring a No-Compete Clause
Requiring a no-compete or exclusive-rights clause in your lease can be key to success. A landlord wants to lease all available spaces for 100% occupancy. The last thing you want is to pour your heart, soul, and hard-earned money into a space, only to learn the landlord has leased the space two doors down to another restaurant with pizza on the menu. A landlord will probably not agree to turn away other potential restaurant tenants. But you can certainly negotiate an agreement that would preclude any other restaurant from serving pizza or perhaps other menu items essential to your success. Some operators have negotiated exclusive rights to employing waitstaff. This can prevent any other full-service restaurants from operating on the property. There is a lot of room for creativity here, and negotiating this should not be overlooked.
6) Requiring Assignability
There is no gray area when it comes to assignability on your lease. It must be included and should be considered nonnegotiable on your end. If, for any reason, you can’t continue to operate the business, you need to be able to sell it and free yourself from the obligations of the lease. Otherwise, in the event of some unforeseen occurrence, you will be stuck with an asset that you cannot sell and is thus worthless.
7) Determining Layout
You don’t need to be an architect to roughly figure out your restaurant’s potential layout. You should have an idea of the kitchen equipment you’ll need and its dimensions. Be sure to take into consideration local fire codes and required clearances. Find out how many ADA-compliant restrooms your local jurisdiction will require. Allocate space for storage, refrigeration, server stations and an office. Does the remaining space allow you enough room to comfortably install the number of dining seats you had anticipated? Remember, you need to generate X number of dollars per seat to meet those financial projections you laid out when determining whether you could afford this lease. If the answer is no, then put that pen down, walk away, and move on to another potential space. This one will not magically work just because you fell in love with it.
In closing, contact that attorney now and have him or her review all of your upcoming legal documents. There are many issues to be considered and discussed when it comes to your commercial lease, and that’s what attorneys are best at. We’ll chat again when it’s time to renew your lease. Buona fortuna!
Michael Androw, a 30-plus-year restaurant veteran, began making pizzas in 1986 and currently owns the award-winning E&D Pizza Company in Avon, Connecticut.