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jack in the box under construction.jpg Photo courtesy of Alicia Kelso
A Jack in the Box restaurant under construction in Louisville, Ky.

How restaurant companies are navigating a messy real estate market

High demand and costs, coupled with low inventory and construction/permitting delays, have created development bottlenecks for many companies itching to grow.

The restaurant real estate market has been a bit messy as of late, to say the least. Demand is high. Inventory – especially for table stakes drive-thru locations – is low. Costs are astronomical. Construction, supplies, permits are painfully slow.  As Portillo’s CEO Michael Osanloo described during his company’s most recent earnings call, “It’s sort of whatever the military acronym is for SNAFU – Situation Normal All Messed Up. We continue to face delays in all kinds of last-minute things. I think we have reconciled ourselves to this is a new normal.”

Still, concepts that survived or thrived through the pandemic are itching to grow and most have dry powder to do so. As such, we’re starting to catch some glimpses of how they’re adjusting their strategies to navigate the "new normal" – from a bigger focus on conversions to smaller buildouts to the creation of value engineering programs to good, old-fashioned patience. Chipotle has even started calling cities to “make sure Chipotle is at the top of their work list.”  

For Portillo’s, the adjustments mean building timeline “cushions” around the things that are uncontrollable, “so you’re not disappointed with budgeting, timelines, etc.” Osanloo said. Cava is also adding what executives call timeline “buffers,” which they said will help create a robust pipeline and an opportunity to open more restaurants this year than the company originally planned.

“Our real estate team has been building increased buffers into the pipeline to ensure we are insulated from potential delays in equipment availability, permitting and inspections,” CEO Brett Schulman recently told analysts.

Cheesecake Factory is taking this same approach, increasing its “funnel” to have more sites in the pipeline to ensure targets are still met next year. The company has also strategically pushed back some openings to Q1 to wait out some of the delays. Chipotle is also focused on building a robust pipeline. That way, as CFO Jack Hartung recently explained, the pipeline keeps getting bigger as the timelines extend.

“We’ve also challenged our teams to take a look at what is causing some of the delays. What can we do from a mix standpoint? Are there simpler deals we can go after that would shorten the timeline? Can we work with developers?” he said.

To navigate this environment, Darden has become a bit more selective with its sites, CEO Rick Cardenas recently told analysts.

“We’ve turned down a few (projects) because costs are a little higher than what we wanted them to be. What we’ve done in the past, we’ve been able to get back to those same projects at the costs that are more reasonable,” he said. “We’re willing to wait a little to get the costs more inline.”

As delays continue to be a major hindrance, some brands are turning more attention toward conversions. Fat Brands plans to selectively convert existing Smokey Bones locations to enhance growth of the Twin Peaks system, for instance, and Dine Brands’ IHOP and Applebee’s are also both focused on conversions. IHOP president Jay Johns recently told analysts that conversions are typically 30-40% cheaper than new builds and permitting typically goes a little faster as well. Applebee’s president Tony Moralejo said three of the chain’s last four openings were conversions and have generated higher AUVs than the system average.

“Our franchisees recognize the benefit of conversions, including shorter construction timelines for openings,” he said.

Applebee’s is also focused on a new, smaller prototype – created in the throes of the pandemic – that Moralejo called “more economical” for the system.

“Collectively, these strategies should drive net new unit growth,” he said. “That’s still the goal.”

Meanwhile, Chuy’s approach to the challenging environment is to buy some of its properties to control both the land and development. CFO Jon Howie told analysts that build-out costs are about 40% higher than they were pre-pandemic.

“What we’re doing to combat this is, given that our cash situation gives us a little flexibility, is buying a lot of our properties,” he said. “Then in the future, when the cap rates come back down, doing a sales leaseback to recapture some of that cost and increase the overall (return on investment) and get it to those cash-on-cash returns.” About half of what Chuy’s is opening in 2024 include such purchases.

Dutch Bros., Potbelly and Jack in the Box executives also recently touched on their real estate strategy shifts to navigate roadblocks. Dutch Bros.’ Christine Barone said her company’s new approach is underpinned by three key elements – widening its initial reach as it enters new markets to allow more brand building opportunities; shifting back to build-to-suit leases, which she said requires a lower upfront cash commitment; and developing new prototypes to efficiently penetrate new markets.  A new prototype with a smaller dining room, called Crave, is central to Jack in the Box’s strategy as well. To support development of these new units, Jack in the Box is leaning in on what it calls a “value engineering” program aimed at reducing costs. CEO Darin Harris recently said the payback target is under 5 years, regardless of the current higher costs to build.

And, for Potbelly, CEO Bob Wright recently told analysts the company is trying to “outrun delays through execution” and has put two leaders into place to do so – one with development execution responsibilities (construction, site selection, etc.) and one that oversees franchising development and relationships specifically. This brings the team closer to the work, he said.

“One of the reasons you get in trouble with permitting is you didn’t do the hard work of evaluating the site the right way before you started. We have a requirement to do that before you sign the lease, so we don’t get surprised by finding out you didn’t have the right power feed, or I couldn’t put a grease trap in where I thought I could. Not only do we know it so we don’t get delays, we know it so the franchisee can negotiate a better lease with the landlord because of those barriers,” Wright said.

Potbelly also leverages engineering firms and architects that provide franchisees with drawings to help make the permitting process easier.

“We’ve outrun those potential barriers by out operating them,” Wright said.

What’s next?

New strategies aside, the question remains ‘will things lighten up a bit in 2024?’ That’s the anticipation. Emily Durham, senior vice president, Food and Beverage Advisory at JLL, said supply chain improvements should ease some of the development challenges the industry has experienced throughout the past several years. The supply chain delays, she adds, have been a big issue when trying to get deals done under terms which allow the tenant to avoid paying “dark rent.”

“On the tenant side, we’ll commit to doing our part – preparing the plans to submit for permits within a certain number of days. I know municipalities are trying to go digital for the permitting process in the hopes of shortening the duration to get permits, but that remains to be seen,” Durham said.

If such a bottleneck were to ease, the development picture could look wildly different next year.

“Hopefully, the municipalities will get a little better and we will be able to see permitting start to increase at a little bit faster pace,” Cheesecake Factory President David Gordon recently said. “Because at this point, that’s really the only thing slowing us down.”

Contact Alicia Kelso at [email protected]

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