Use Due Diligence to Ensure Success with Restaurant Tenant

March 2, 2018
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Commercial property owners know that having a visible and successful restaurant is not only lucrative, but also can be an amenity that improves the image of the property and provides an essential service to residents and other tenants or occupants of an office building, shopping center, or mixed-use project, not to mention the local community. However, a large number of all new restaurants close after only one year of operation. And this rate greatly increases after three years. The success rates for national chain restaurants, or franchises, are only slightly better than the national average.

This means that property owners should approach restaurant leases with a fair amount of trepidation at the outset. But if you’re careful, a restaurant tenant can be advantageous. Here’s how the due diligence process can help you make the right decision.

You should weigh the pros and cons of leasing to a restaurant tenant before negotiations start. The key to this is performing careful due diligence before offering space. The short-term advantage of filling a vacant space and receiving rental income may not outweigh the long-term financial risk and operational disruption if the business fails—especially if a space has been improved in a way that fits a restaurant but will practically need to be overhauled for a different type of replacement tenant.

During the due diligence process, ask yourself two questions. First, is the space within the building or center suitable for the unique requirements that restaurants typically demand? Second, is the prospective tenant capable of performing from both an operational and financial standpoint over the term of the lease?

To answer both questions, prior to negotiating the lease with a restaurant tenant, make an honest assessment of the space and determine whether it’s suitable for a restaurant. Even if there is a market demand for a restaurant and the rent is satisfactory, it’s critical to consider several issues when making a space suitability assessment.

Your first step should be an analysis of any legal restrictions or other limitations that may inhibit or prevent the premises from being used as an eating establishment. This may include zoning restrictions such as a prohibition of the use or the requirement for a special exception or special use permit, higher parking ratios, drive-through lane limitations, or signage restrictions. Or there may be other laws or regulations that would frustrate the use, such as a prohibition on liquor licenses. Finally, you’ll need to confirm that there aren’t any restrictive easements or covenants that would prohibit a restaurant. For example, one industry-leading fast food chain frequently places such restrictions on record before selling a store location that has been closed.

For four more issues to consider and an explanation of the next steps you should take for a greenlighted tenant, see “Take Key Factors into Account Before Leasing to Restaurant Tenant,” available to subscribers here.