Buying a Restaurant

Typically, restaurants will be listed for three (or more) times their EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) or, in the simplest of terms, their ‘cash throw-off’. Be sure that the seller has kept good books, preferably with a CPA. Ask for a recent Profit and Loss (P&L) statement. 

For a Restaurant that does $2M in sales; ‘all in’ rent should be between 7% to 10% of gross sales. COGS should be around 30%, EBITDA should be between 15% to 20%. 

Of course there are other factors to consider: Business debt, personnel and training, brand image and awareness, location, rental rates, equipment condition, Franchisor and/or Landlord qualification, COGS (Cost of Goods sold), inventory value, comparables in the market, and others.

Be sure to have a contractor do a thorough inspection of the premises and report any issues in writing. Have a food service company come out to and take an equipment inventory and condition assessment. You can sometimes get this service gratis if you are willing to consider purchasing any necessary replacements from the vendor (at a competitive price of course). Sit down with your bank, CPA, attorney, and business broker to review all aspects of the business deal including the lease (pay close attention to the assignment clause and any hidden approvals or fees associated with transferring ownership).

 

Percentage Rent and Breakpoints

Sometimes Landlords ask for percentage rent. I often get asked what is percentage rent, immediately followed by the question how to calculate a natural breakpoint. 

Basically, percentage rent is a way for the Landlord to share in the success of your business. The idea is that they receive a negotiated amount of additional rent if you hit a negotiated milestone in sales. Lots of use of the word ‘negotiated’ here because there are several variables. 

There are two ways that Landlords establish the threshold above which they receive ‘percentage rent’. One way is a natural break calculation. Here, the amount that you’ll pay in additional rent is a function of your base rent. I’ll work through an example below. The second way to establish the threshold is an unnatural break. Here, the Landlord an you just agree on a sales volume. 

Lets work through an example of a natural break and an unnatural break. 

Natural Breakpoint Example: Lets say your paying a base rent of $25 psf on a 4,000-sf space. You annual rent in this scenario is $100,000.  The Landlord has proposed percentage rent at 5% above natural break. So $100,000/0.05 = $2M. This means your natural breakpoint is $2M in sales. The Landlord will reap 5% of anything you make above that $2M mark. If you make $2,200,000 in annual sales, the Landlord will be owned $10,000 from you in additional rent. Heres how I calculated that: $2,200,000(your sales) – $2,000,000 (natural break) = $200,000 (0.05) = $10,000.

Unnatural Breakpoint Example: Using the same example $25 psf on a 4,000-sf space. In this example the Landlord want 5% over an unnatural breakpoint of $1.8M. Here, the Landlord has set a breakpoint that is not tied to the base rent – he can set it as high or as low as he needs to make his ROI work for him.  Lets say you made the same $2,200,000 in annual sales. The Landlord would get $20,000 in additional rent. Here’s how I calculated that: $2,200,000(your sales) – $1,800,000 (unnatural break) = $400,000 (0.05) = $20,000.

The concept of percentage rent is usually in the favor of the Landlord. I’ve seen it used by an experienced broker to reduce the base rent. The key to percentage rent is to put that ‘carrot’ of a breakpoint as high as you can so that when you do hit it, your sales are so strong the additional payout doesn’t have an impact on your operation.

How Much Should I Be Paying In Rent?

I often get asked ‘How much should I be paying in rent?’. The rule of thumb for a restaurant is based on your projected sales. Your all in rent ceiling should be no more than 6% to 8% of your gross sales. 

An example of this is as follows:

Lets say you have a 3,500-sf space at an all in rent of $20 psf. Your annual rent for this space is $70,000. Lets also say that your restaurant is projected to do $1,000,000 in annual sales. Your rent ceiling would be equal to $1,000,000 (8%) or $80,000 per year. In this example, the proposed rent is lower than the rule of thumb, so judging by industry standards and assuming your operating your restaurant efficiently, this rent rate is manageable.

Annual CAM Increases

Recently, I received a call from a franchisee who was upset about his CAM (Common Area Maintenance) increases. For a 4200-sf restaurant endcap on the edge of town, the franchisee was paying around $6 psf in CAM charges. The $6 psf CAM charge reflected a recent 5% increase. His question: “What can I do to get my CAM charge down?”

“Yikes”, I said. Not because of the CAM rate (this is actually a very decent CAM rate), or the CAM increase,  but the fact that he wanted a reprieve in CAM costs. CAM is notoriously difficult to negotiate down, especially once you’ve signed the lease. “You’ll have better luck negotiating a lower base rent”, I told him. I needed more information about his situation. 

The franchisee told me that the property had just been flipped. “What are your neighbors paying in base rent and in CAM?” I asked. He wasn’t sure, but he made an effort to go find out. In the meantime, I called a broker I knew in the community and asked her what the comparables were for his area. “Even in an endcap, he’s paying about $1.50 psf over market”, the broker told me. 

With this information and the intel from the adjacent tenants in the shopping center, the franchisee was able to negotiate a lower base rent rate. How is it possible to lower your rent rate after you’ve signed a lease? You need to communicate with the Landlord. If you’re feeling a pinch for whatever reason, communicate that to their team. You don’t get anything if you don’t ask!