The evil landlord who would kick a widow out of her home for back rent in the middle of a winter night is one of popular culture’s favorite villains. From Dostoyevsky to silent movies, Broadway and the Village Voice’s annual listing of the worst of the lot in New York City, inhuman, greedy landlords are the iconic bad guys that everybody loves to hate.
But some commercial landlords and property developers who depend on restaurateurs to make their projects a success say that restaurateurs who cast them in the same stereotypical light as those brutal landlords of lore are either economically naïve or living in the past.
They insist that when it comes to raising the rent on restaurant properties, a phenomenon that many operators say could drive them out of business, they are doing nothing more than their jobs: increasing shareholder value by maximizing return on investment, which, in this case, means charging for occupancy costs as much as the market will allow.
In a dramatic case in New York City that epitomizes the trend, Tony May, owner of the award-winning, fine-dining Italian restaurant San Domenico NY on Central Park South, says he was informed that his rent would be quadrupled, from $300,000 a year to $1.2 million, when the 20-year-old lease at his 6,000-square-foot, 138-seat operation expires next spring.
What made his predicament so intimidating up until recently, May says, is that the landlord of the luxury co-op building where San Domenico occupies the ground floor ignored phone calls May had placed during the past four years in a bid to discuss new terms before the lease expired. Brokers advise that it is wise to start negotiations years before leases expire.
While May has since spoken with his landlord, for many of his peers nationwide time has run out. In June 50-year-old Melvin B’s, located in Chicago’s affluent Gold Coast area, lost its lease and is scheduled for demolition in August to make way for a boutique hotel.
In Philadelphia, the 10-year-old Zanzibar Blues fine-dining jazz supper club shut its doors in April when the owners decided to close the place rather than pay rent slated to double to $400,000.
Some landlords are unsparing in their assessment that independent operators who enjoyed 10, 20 or more years at one location are bound to encounter soaring occupancy rates upon lease renewal if the location or the neighborhood has become trendy and upscale. Other influences also inflate leases, experts say.
First, fixed-rate leases, which once were the norm in foodservice, are becoming increasingly rare as landlords push percentage-rate leases, often with provisions to adjust upwards when the restaurant’s business exceeds certain sales goals.
Second, landlords of newer mixed-use retail, residential, lodging and office complexes or affluent lifestyle communities increasingly are pursuing such anchor brands as The Cheesecake Factory or Maggiano’s Little Italy and concepts by operators like Lettuce Entertain You Enterprises or fine-dining celebrity-chef entrepreneurs, such as Tom Colicchio, Jean-Georges Vongerichten or Wolfgang Puck. Not only do such players have cachet that can lend distinction to a building, they have financial strength many local operators can’t match.
In addition, the immigration of affluent retirees and other upper-income people from suburbs to hot inner-city communities is forcing landlords to fill their properties with quality brands to satisfy middle- and upper-income tastes.
But nothing, landlords say, is pushing rents up more than the free-market economy.
“Harry Helmsley [the late real estate mogul] was once asked by the press, ‘Why are you no longer building residential or office properties and are totally focused on hotels?’ ” says former employee Peter Hayback, now the head of the restaurant leasing team for Chicago-based General Growth Properties, or GGP. “And he said something to the effect of, ‘If I build an office or retail property, I write a 10- or 15-year lease, and that means I can’t raise the rent for 10 to 15 years. But if I build a hotel, I can raise the rent every time someone checks out.’
“I think the lesson in that story as it applies to the restaurant industry is that it is all market driven. If I’m the owner with a bunch of partners of a hot piece of commercial rental property and a tenant’s lease is up for renewal, it’s our obligation to our investors and ourselves to try to achieve the highest maximum return possible in closing the deal.”
GGP is the world’s second-largest real-estate investment trust, owner of 220 regional shopping malls, mixed-used retail and office complexes, and high-end living communities in 44 states. For the year ended 2006, the company reported revenues from consolidated leaseholds and other property charges of $2.7 billion on property assets of $28 billion.
Hayback admits that the irony in lease negotiations these days is that it is easier for both chain and independent operators to sign new deals than to renew.
“With a new lease, it’s a clean slate,” he says. “You know you have to do X-million dollars a year to pay X-amount of dollars. But if there is history behind that, the ante is up because the projections for the property are higher in a market-driven environment.”
While many operators contend that landlords are not their partners, Hayback says his company sees such restaurant tenants as The Cheesecake Factory, P.F. Chang’s, Maggiano’s and other high-volume chain operators as key partners in the success of the property.
“I know every landlord on this level is looking for the next Cheesecake Factory to come along, but so much goes into the negotiations and how you as a landlord weigh the right deal,” he says. “Obviously it is important, given the kinds of properties we have, that you get a marquee guy. And since it is our duty to maximize the value of the property, it might mean offering a slightly lower rent if the tenant has a proven track record for attracting customers.
“Even though I know nothing about this Tony May deal, you can’t assume he is getting screwed by his landlord because the landlord is just doing his job. He thinks he can get that kind of rent.
“The big problem is that in Manhattan, where retail space is scarce, May is really up against it.”
Hayback says that after adjusting for the escalating costs of remodeling, construction and inflation, as well as looking at the tenant’s financial health, demographic characteristics and traffic flow patterns, landlords also are obligated to write leases that protect themselves.
“From a landlord’s perspective, you want the space to produce income,” Hayback says. “And while there’s no value to anyone if the space sits empty, you are also mindful that the lease you sign today, you are going to have to live with for 10, 15 or 20 years.”
But signing leases that protect the business over the long haul is a game two can play, says Charlie Robinson, president of Orlando, Fla.-based eBrands, a 13-unit diversified dinnerhouse operator known for its fine-dining seafood concept, Aquaknox, in the Venetian hotel in Las Vegas, and its joint-venture partnership with celebrity chef David Burke.
The first step is figuring out what kind of lease is best for the business, Robinson says, adding that he believes landlords are entitled to higher rents when the tenant’s business is doing well. He notes that the mechanics of the lease can make all the difference between a bad and a good relationship with a landlord.
“We look at the landlord as a partner because in my opinion it does no one any good if we fail,” he says, noting that the company gets 15 solicitations weekly to lease somewhere.
“Personally, I like fixed-rate leases with a minimum first term of 10 years and two five-year options, so that you are looking at 20 years and are able to protect yourself.
“But those kinds of deals are getting harder to find, and if you do find them, the landlord is putting in an escalator of 2 percent to 3 percent a year. But what happens if one year business is off by $1 million? You are in the crapper.”
Hayback says GGP typically assigns leases that are a combination of fixed rate with a percentage of the gross included.
With average unit volumes topping $10 million, the 125-unit Cheesecake Factory is treated as an anchor tenant by shopping mall developers, which is an advantage in lease negotiations, says Howard Gordon, vice president of marketing for the Calabasas Hills, Calif.-based company.
“Shopping mall owners know that we can change the behavior of shoppers,” he says. “Before we arrive at a mall, most consumers went shopping first and then decided to eat afterwards. With Cheesecake, they go to eat first, because we are a destination, and then shop.”
Nick Lillo, a former hotel foodservice executive turned real-estate consultant, predicts that many independent operators are going to vanish in the years to come. Lillo became a top leasing agent for Simon Property Group, a real estate company with more than 320 properties and malls worldwide, where he worked with brands like Legal Sea Foods, Cheesecake Factory, P.F. Chang’s, California Pizza Kitchen, Champps and other dinnerhouse players.
Now a principal and co-founder of Siegel/Lillo & Associates in Carmel, Ind., a leasehold negotiating consultancy, Lillo says that current market conditions do not bode well for independent operators who find themselves having to negotiate their incumbency at a coveted location.
He notes that unlike retailers, many of which have even eliminated managers’ offices to maximize showroom space, restaurants must dedicate nearly a third of their footprints for kitchen and food inventory storage, so only two-thirds of a restaurant’s space is devoted to generating income.
“So when these guys are asking for market-rate rents, independents are going to have to figure out a way to generate more dollars on a sales-per-square-foot basis,” he says. “Fair market value doesn’t play well for moms and pops, and so they are and will get priced out of the market.
“A retailer doesn’t have that problem because the whole footprint is sales space and the inventory lasts longer. And yet, when it comes to the length of a customer visit, we know that the restaurant visit is a far longer visit and that has value to the property owner or shopping mall.”
Meanwhile, May of San Domenico NY says he and his landlord met in person a few weeks ago and he was offered tentative terms for a smaller rent increase to $750,000, up from $300,000. The landlord also said he would help the restaurant expand its dining room, which would add more seats to help pay the higher rent rate.
“I wouldn’t call it a breakthrough, and it’s not in ink, but at least we are talking,” May says. “I’m optimistic we’ll hit the right numbers.”