Leasing a commercial property for your restaurant allows you to get your business off the ground without buying a building. Restaurant leases typically run from five to 10 years and may include a series of industry-specific clauses. Onerous restaurant leases are a common cause of restaurant closures, so it is important to get the most favorable terms when you are renting a restaurant space.
A restaurant lease is a long-term, binding contract. You will absolutely need an attorney to review letters of intent and draft lease clauses. You don’t have to break the bank to find one. The Business Advisory Plan offered by legal services site LegalZoom is priced at $36 per month and gives you access to local business attorneys who can advise you on everything from your lease to your business structure. You can visit LegalZoom for more information.
1. Weigh the Benefits & Risks of Leasing
Your restaurant location will be the single most impactful decision you make when you are starting a restaurant. Some restaurant owners choose to buy a space when they find a good one, but the cost of buying commercial property can be prohibitively high for small restaurants. You can lease restaurant space at a much lower upfront cost.
Leases allow your restaurant the flexibility to move if the location isn’t right. Leasing typically saves you money you would otherwise spend on property taxes as well. It’s easier to move or close your business if you’re tired of running a restaurant at the end of your lease . If you decide to go with a commercial lease you want to consider the remaining steps we discuss below.
2. Understand Common Restaurant Lease Factors
Many unique phrases pop up in the course of discussing commercial leases in general. Our article How to Lease Commercial Real Estate: The Ultimate Guide contains a comprehensive list of them. Restaurant renting, however, has specific language that can be quite different from a traditional retail or office rental situation. It is important to understand these before negotiating a restaurant lease.
- Start date of rent: Many restaurant landlords will waive restaurant renting payments during your restaurant build-out. Typically you can get 60 to 90 days, or until you open for business, whichever comes first.
- Liquidated damages: If a landlord’s failure to make repairs delays your restaurant opening, they may owe you for your time and lost revenue.
- Liquor license contingency: If part of your restaurant business is tied to your ability to obtain licenses like a liquor license, you can note this in your lease. Then, if you are not approved for the necessary license, you can get out of the lease.
- Kick-Out Clause: This language allows you to terminate the lease if your gross sales fail to meet a pre-negotiated dollar amount by a set time.
- Sub-Lease Agreement: The ability to sub-lease to another tenant is useful. If your restaurant is struggling, you can find another business to take over the space from you.
- Exclusive use: If you are located in a shopping center or mall location, an exclusive use clause prevents the landlord from placing a similar tenant near your restaurant.
- Kiosk/ Food truck protection: Another concern for restaurants in shopping centers is direct competition from kiosks or food trucks. This is similar to the exclusive use clause, but directs language toward food trucks or kiosks being parked within a certain distance from your restaurant.
In addition to these terms, there are two major factors that you should know about before ending a conversation about restaurant leases. Clauses like burn-offs and percentage rent are common in most restaurant leases. They both have a lot of ins-and-outs to consider, so let’s explore them in more depth.
Restaurants—especially new ones—are widely considered to be a risky investment. That can make a property owner skittish about renting to a restaurant. So commercial landlords tend to request large security deposits or personal guarantees from you and any principal business partners. While this protects the landlord from your restaurant defaulting on the lease, it can increase your costs and negate any work you have done to separate your personal assets from your business.
Most restaurant leases split the difference by adding “burn-off” clauses to protect the landlord from defaults while limiting your personal obligations to a certain timeframe. For example, a Security Deposit Burn-off clause requires your landlord to return a portion of your security deposit after your restaurant has been a tenant in good standing for a certain amount of time, or when your restaurant reaches an agreed upon level of sales.
A Personal Guarantee Burn-off clause rolls back any personal guarantees that the original lease required of you or your business partners. A typical Personal Guarantee Burn-off clause terminates the personal guarantee after your restaurant has paid rent without defaulting for three years.
This term is the most important to understand. Most restaurant leases include language that entitles your landlord to a percentage of your “gross sales” as part of your monthly rent. The usual request is for 7% of your gross sales after you pass a set sales amount, ( $100,000, for example). These clauses are pretty universal, and nearly impossible to avoid. You and your attorney should still try to get it removed. If you can’t remove it, you should negotiate this clause heavily.
The importance of negotiating the percentage rent of a restaurant lease cannot be overstated. Sharing your sales information directly with your landlord (as a percentage rent clause essentially requires you do) will make it more difficult to negotiate favorable terms when it comes time to renew your lease. There is a reason that so many restaurants close at the five and 10 year points. These are typical times for rent re-negotiations.
Most percentage rent negotiations focus on the definition of the term “gross sales.” It may seem like a straightforward term, but there are ways to refine it:
- Subtract credit card processing fees: Restaurants pay 3-5% of most credit card transactions to payment processors and often never see these fees hit their bank account. This should be a straightforward adjustment to make.
- Ensure that refunds and discounts are excluded: Sales that were discounted or refunded should not be counted toward your gross revenue.
- Offer a dining discount: Offering your landlord and their property managers a dining discount is a gesture of goodwill. Combined with the strategy above, it can also help decrease the definition of your gross revenue.
- Tips and gratuities: Any tips or gratuities paid to your employees should stay out of your gross revenue calculations.
- Sales of furniture or equipment: If you sell some equipment that you don’t need—like an espresso machine or a load of glasses—these funds should not be counted as revenue.
Depending on your location, restaurant style, and attorney’s abilities you may find other ways to further define what should and shouldn’t be included in the gross revenue figure that is used to determine your percentage rent figure.
3. Get the Right Restaurant Lease Broker
There are three types of restaurant lease brokers: leasing agents, tenant brokers, and dual brokers. A leasing agent represents the property owner, or landlord, of a commercial building. He or she earns a commission based on the units they rent to businesses. Tenant brokers represent you in your search for the perfect restaurant location. Some states allow a third type of broker, a dual broker. A dual broker is a neutral broker who helps you and the landlord navigate the lease negotiation.
The best strategy for finding a lease that is favorable to your restaurant’s interests is to work with a tenant broker. You will have to pay their fees, but a tenant broker can translate lease conversations into plain language for you, and will offer you advice and guidance. Since leasing agents represent the landlord’s interests, they cannot recommend terms that would be more favorable to you. Dual brokers must remain neutral and cannot advise you directly, either.
In most cases, you can find a local tenant broker by doing an internet search for your location and the phrase “commercial real estate tenant broker.” A local broker will have local knowledge of good locations, and may have also negotiated leases with your prospective landlord on previous occasions.
Sometimes, especially in small markets, you may not be able to find a tenants’ broker. In this case, a business attorney is even more valuable. If you can find one that handles a lot of restaurant business clients, even better. You can search legal service websites like LegalZoom and IncFile, or ask other restaurant owners in your area for recommendations.
4. Work With an Attorney
Restaurant leases are 20 to 40 pages long. Unlike residential leases, commercial landlords are under no obligation to phrase them in conversational language that is easy to understand. The best strategy for securing a favorable commercial lease is to work with a business attorney. Any money that you spend on an attorney now will save you money and headaches in the future.
If your restaurant and operating budget are small, look for an attorney that will work with you on an hourly fee basis. Small restaurants that are owned by women, people of color, recent immigrants, or veterans may be able to find business attorneys via local legal aid organizations or law schools. You can find such resources in your area by checking the American Bar Association website.
You can also find a local attorney through asking fellow restaurant owners for recommendations. Legal services websites like LegalZoom and IncFile also maintain databases of attorneys that you can search by location and specialty.
5. Define Your Restaurant’s Needs
Defining your restaurant’s needs before you begin looking at spaces will help you and your broker move quickly when considering different spaces. Your specific needs will vary based on your restaurant type. There are some general features to consider when comparing restaurant spaces to rent:
- Square footage: Typically, the larger your square footage, the higher the rent will be. Also, a bigger location means your sales will need to be higher, since heating, cooling and other costs will also be more expensive. Determine the size you need, and stick to it.
- Use-ratios: Depending on your restaurant type, you will need varying amounts of space for your staff and your customers. Most full-service restaurants use 30-40% of their square footage for the kitchen, and 60-70% for dining space.
- Parking: If customers can’t park easily near your restaurant, they won’t dine with you. Make sure the space you are leasing comes with a designated parking area, or room for a valet stand.
- Drive-thru: Especially in the age of social distancing, drive-thru windows are priceless. If your concept needs drive-thru capabilities, ensure that the space has enough space to add one.
- Ventilation: This is a major consideration for your cooking equipment, fire safety plans, and for maintaining a sanitary environment for your customers and employees. If you have wood burning ovens or smoke-producing equipment, ventilation is doubly important.
- Entrances and exits: A best practice is to have separate entrances for your customers and employees. If you are considering space in a shopping center or mixed use building, you’ll also want to inquire about loading docks for suppliers and location of dumpsters for garbage disposal.
Did you know: Sales per square foot is a popular way to quantify a restaurant’s profitability. A good target for your restaurant’s sales per square foot is $150 to $250.
Create a list of features that your restaurant must have versus features that are simply nice to have. For example, a pizzeria must have a pizza oven (and the necessary ventilation for one). If you are developing a zero-waste restaurant concept, a designated place for recycling and composting materials would be a must-have. In either scenario, a horseshoe bar with track-lit cabinets might just be nice to have, though not necessary.
Defining your needs can also create opportunities for flexibility. Depending on how far you have developed your restaurant concept, you may prefer to re-conceptualize your business based on an available space. For example, suppose you find a great location with favorable lease terms and a flexible landlord, but it is 80% kitchen and only 20% dining room space. It might be worthwhile to re-conceptualize your full service pan-Latin restaurant as a quick-service, grab-and-go concept.
6. Remember Renovations
Renovations are common in restaurant spaces. The commercial property you are leasing may already be outfitted with a commercial kitchen. Or you may be the first restaurant tenant and need to install the necessary equipment yourself. Depending on what type of modifications are needed, you or the property owner will be responsible for paying for them. It is important to think about the renovations you need now, as well as future modifications you may need.
Capital Improvements are repairs or renovations that will forever change the property and increase its market value. Typically landlords pay for all capital improvements because the landlord will benefit from them even after your tenancy expires. Examples of capital improvements would be replacing roofs or updating the building’s plumbing or electrical systems.
Non-capital improvements are alterations to the space that are specific to your restaurant business. These are improvements that future tenants may not need or want. Non-capital improvements might be Italian glass light fixtures that compliment your Italian restaurant theme.
New Construction Spaces
In raw spaces, the landlord pays for any structural work that needs to be done. It is the landlord’s building after all. Water lines, electrical lines, and ventilation systems for the building fall under the landlord’s jurisdiction. Connecting your specific equipment, however, is usually at your expense. So, for example, the landlord covers the cost of installing main water lines, but you would pay to extend that water line to connect to your ice machine.
Did you know: New construction may also have impact fees affiliated with it. These are fees charged to a property developer by the city or county for new real estate developments. Some developers try to pass these costs on to tenants.
You may have plans to expand or shift your operation during the terms of your lease. For example, you may plan to start your business as a straightforward deli operation, then expand to catering in the next few years. In this case, you would want to expand the prep area of your kitchen and possibly add a separate entrance to load out large orders on rolling carts. Make sure that the space will be able to grow with your business before you sign on the dotted line.
A Note for Franchisees
If you are opening a franchise of a larger restaurant, you may be required by the franchisor to open your restaurant on a certain date. Your franchise agreement may include penalties for delays.
If this is the case, you need to ensure that any repairs your property owner is covering are tied to that same date or earlier. Your attorney should draft a clause in the lease agreement that ensures the property owner will be responsible for any penalties you incur due to their construction delays.
7. Avoid Binding Language in Your Letter of Intent
A Letter of Intent (LOI) is a letter that is written before the signing of a lease that memorializes the terms you and the property owner have discussed. A LOI can be drafted by you, the property owner, or either of your attorneys.
The wisest move is to have your attorney write the LOI. If negotiations fall through and you don’t continue with a lease agreement, the LOI could be considered legally binding in some places. Your attorney will ensure that your letter of intent is free of any binding language that could paint you into a corner.
If the property owner (or their attorney) drafts the LOI, have your attorney look it over before you sign. If there is any language that you feel is unclear, or suggests that you have agreed to something that you do not agree to—such as paying for certain repairs, or future rent increases—let the property owner know in writing. Your tone doesn’t need to be harsh, but it is important to record your disagreement over the terms in writing.
Remember, an LOI is part of the lease negotiation process. If there is anything about the LOI that you disagree with or understand differently, don’t sign it. Have your lawyer request adjustments. If the landlord gets impatient with you, remind yourself that it is better to lose a potential location than to be locked into an unfavorable restaurant lease.
Leasing a restaurant space has many advantages over buying a location. Leases cost much less upfront and allow your restaurant to be more flexible. Commercial leases are more involved than residential ones and do not come with the same degree of consumer protections. Negotiating terms with the landlord is an expected part of the lease process.
When you are pursuing a restaurant lease, it is imperative that you have an attorney on your side to negotiate favorable terms for your business. LegalZoom is the nation’s leading provider of online legal solutions. In addition to a searchable database of attorneys in your area, LegalZoom also offers a Business Advisory Plan for $36 per month. Visit LegalZoom to check out its full range of services.