Investment Analysis

Restaurant Re-use

A menu of options exists for redeveloping food-use retail spaces.

By Michael Spilky |

Most owners of retail properties have restaurant tenants. Whether they are located on an end cap, inline, or on a free-standing outparcel, these restaurants make up an integral component of the retail investment landscape. Savvy property owners recognize that restaurant tenants and transactions require special attention and consideration — at times quite different from other, more-traditional shop spaces.

This notion is nothing new; however, several factors, including recent economic challenges and changes in consumer behavior and tastes, are forcing landlords to once again reinvent and reposition their properties due to unexpected vacancies.

Determine Best Use

Depending on the circumstances, property owners may be faced with leasing former restaurant spaces to another restaurant, converting an existing restaurant building to retail, or converting a retail building to a restaurant use.

In any of these scenarios, the first move is to consult with a local broker to determine the property’s value and best use. The value of a vacant restaurant facility is determined primarily by its location, supply and demand, quality of the existing tenant mix, available non-competing co-tenant menus in a shopping center, and the overall delivery condition.

If the above factors and market data indicate that the highest and best use for the site is to re-lease it to another restaurant tenant, then the next step is to better understand the existing restaurant building’s physical and mechanical condition. In most cases, these improvements are a valuable asset to a replacement restaurant tenant and a landlord will want to maintain the facility in the most intact, visibly turnkey condition possible.

The most valuable mechanical improvements involve plumbing, electrical, venting, and a grease trap. Other fixtures that are of equal value are walk-in coolers, kitchen hoods, sinks, stainless kitchen fixtures, and bar equipment. Age of improvements may play a role in their usability: For example, older grease interceptors may not meet today’s code. Any large-scale building modifications will trigger permits that will require code upgrades.

Maintenance of the restaurant while it’s closed requires periodically running the plumbing, such as flushing toilets and running water through drains; cracking open all doors on any walk-in coolers or other refrigeration equipment; detailing the facility; and removing all food. It’s also important to maintain the power, so that dark areas are easily lit for tenant showings.

A landlord with an extremely well-located vacant restaurant building in a high-demand area is likely in the best position. Basic financial considerations for a landlord trying to re-lease a former restaurant facility consist of a tenant improvement contribution, rent relief during construction, and brokerage commissions, all of which are standard in any new retail lease negotiation. In the best scenarios, landlords may be able to increase rents due to delivery of a restaurant facility with significant improvements including salvageable furniture and equipment.

Redevelopment Options

On the flip side, restaurants built as specific prototypes have limited re-use potential. For example, an older El Torito that was built as a very large Mexican hacienda will not be functional for many other restaurant brands. Other restaurants that are difficult to convert include bi-level Bucca di Beppo buildings and older Black Angus restaurants.

When sites are located in prime high-demand retail corridors, it may be profitable for a landlord to redevelop the property. In most cases, capitalizing on the restaurant entitlements will typically make the most economic sense. Options include converting the structure to a multitenant building or keeping it as a single-tenant restaurant by way of a new ground lease or build-to-suit. In either case, landlords may face considerable financial implications, including construction downtime and expectations for delivery condition; thus, an investment analysis should be the first step before going forward.

Pad Site Considerations

In the case of inline or end-cap sites of former restaurants, a good rule of thumb is for a landlord to maintain and make use of previous restaurant improvements and entitlements and lease the site to another food use. It rarely makes financial sense to convert a restaurant facility to a non-food retail space. The only caveat to this would be if the vacant space was required to assemble a larger space for a retail lease.

However, the opposite is true for pad sites: Landlords may be able to take advantage of a pad site currently occupied by retail and convert the site to a restaurant. Recently, countless numbers of Blockbuster pads with great visibility in shopping centers have been converted to either single-tenant or multitenant restaurants.

Some benefits of this conversion may be higher rents, shorter lease-up periods, and upside from percentage rent. There is a growing market for fast-casual restaurants that occupy smaller footprints; they traditionally can afford a higher per-square-foot rent, allowing for this type of reposition to pencil out.

Growing national brands in this segment are Panera Bread, Chipotle Mexican Grill, Five Guys Burger and Fries, and Rubio’s Fresh Mexican Grill, as well as many regional brands. Traditionally, tenants will require delivery of a space in a vanilla condition with plumbing, gas, electrical, venting, and a grease interceptor installed.

In this challenging economy, landlords should monitor tenants carefully and realize when a restaurant tenant is struggling or on the brink of bankruptcy. A landlord with failing tenants should start working with a broker early to grasp the current market demand for a location. Once educated about the market, the landlord will have a better understanding of what type of investment decisions may make the best economic sense for the property.

Michael Spilky is president of Location Matters, a San Diego-based commercial real estate brokerage firm focused on retail and the restaurant industry. Contact him at mike.spilky@locationmattersinc.com.