Real Estate

The Restaurant Rent Problem

It stands to reason that a business that’s not allowed to operate as designed – or at all – will struggle to pay its bills. Since the onset of COVID-19, countless businesses in the United States – restaurants, bars, coffee shops, retailers, theaters, and gyms, among others – have been trapped in this nightmare.

Relief momentarily seemed to be on the way, as states reopened for business after roughly two months of near-total shutdown, with Datex Property Solutions reporting that national chain retailers paid an admittedly less-than-stellar 68% of June rent, up from 58% in May. In the restaurant world, Burger King and Dave & Buster’s both actually paid 100% of June rent, compared to just 63% and 67%, respectively, in May. Credit for this was due primarily to a widespread push to reopen the economy, as well as the federal government’s Paycheck Protection Program loans, and rent reduction/deferral agreements already negotiated between businesses and landlords.

Exacerbating an already extremely complicated situation is the fact that, four months into the pandemic, the country not only remains mired in the first wave, but the crisis has intensified, resulting in rollbacks of reopening guidelines across the country. Major cities and states have once again closed indoor dining, with New York delaying the reopening of dining rooms, in the words of Governor Andrew Cuomo “until the facts change and it is prudent to open”. Given the surges in new COVID cases in numerous regions nationwide, it’s highly unlikely that restrictions will be fully lifted for some time, with some areas perhaps increasing restrictions in the short term. Thus, it’s exceedingly possible that landlords will see rent collections fall once again in July and August.

In fact, this extremely challenging environment, which has already pushed a number of high-profile victims – NPC International (a 1,200-unit Pizza Hut and Wendy’s franchisee), Chuck E. Cheese, Garden Fresh Restaurants, Le Pain Quotidien (US), Cosí, CraftWorks Holdings, Sonic franchisee SD Holdings, Houilhan’s, and Bar Louie – into bankruptcy and threatens an overwhelming majority of independent restaurants, claimed another in recent days. On July 30, California-based casual dining chain California Pizza Kitchen (CPK), which operates about 200 restaurants, facing more than $400 million in debt and dwindling cash, became the latest household name to seek bankruptcy protection.

Owned by Golden Gate Capital and members of the company’s management team, CPK was burdened by a considerable debt load and unprofitable locations prior to coronavirus, and, as of 2019, had reportedly been seeking a buyer. The current climate proved too much. Negative cash flow of $18.9 million between March and June, a 40% drop in sales in the last week of June resulted in months of unpaid leases and ultimately forced the company into a restructuring.

Against this backdrop, restaurant owners have been locked in constant negotiations with landlords, over how best to address the issue of owed rent in a near-zero revenue environment. The fate of thousands of small businesses – employers of millions and providers of character to many communities – hangs in the balance. For most of these establishments, barring direct aid to the industry and in the absence of mutually acceptable deals with landlords, simply foregoing payment of rent may seem like the only path to survival.

A survey from early July, conducted by The Hospitality Alliance, polled 509 restaurants, bars, and clubs in New York, reaffirming the bleak situation in which the industry finds itself. Just 19.8% of respondents reported paying June 2020 rent in full, with 36% saying they’d paid none at all. Of the 31.5% who expected to pay “some” June rent, 90% expected to pay half (55%) or less than half (35%). Looking deeper, barely a quarter (26.5%) said that their landlords had waived any rent, while just two in five reported deferrals.

One in ten said they’d renegotiated their leases, but, rather alarmingly, just 27.7% claimed that any such negotiations were held “in good faith.” On a slightly more positive note, further up the east coast, in Massachusetts, about half of members of the state’s Restaurant and Retailers Associations said that landlords have been unwilling to adjust rents.

From a legal standpoint, many restaurant operators believed that this type of a pandemic would be deemed a force majeure event, superseding their obligation to pay rent, or transferring those obligations to their business interruption policies. However, most businesses have harshly learned that force majeure provisions exclude claims brought about by a virus.

In the midst of near-constant accounts of the struggles faced by these businesses, it’s worth keeping in mind that they are part of a larger ecosystem, in which landlords seeking rents payments have financial obligations of their own – namely mortgages and property taxes — and, in many cases, investors, to whom accountability is owed. In an industry that the National Restaurant Association estimates could lose as much as $240 billion by year-end, empathy and cooperation are more important than ever. As idealistic as it sounds, rather than viewing one another as adversaries, for restaurant owners and landlords to view one another as partners – and not adversaries – could prove vital to the survival of both parties’ businesses.

In such a collaborative arrangement, it will be incumbent on landlords to make the effort to understand the challenges accompanying their tenants’ businesses, from forced closures to the need to pivot to delivery- and takeaway-centric business model with essentially zero notice, to the impact of third-party delivery services on profits.

In a similar vein, restaurant owners must maintain open lines of communication with their landlords, educating them about the true extent of the crisis’ impact on business, and providing updates as to the performance of the business, and honest assessments of the operating environment going forward, amid social distancing and occupancy restrictions.

Whether rents are deferred, temporarily reduced or leases are renegotiated altogether, either at a lower figure or, perhaps, basing rent on a percentage of sales instead of a fixed amount, honest and reasonable communication is going to be vital in arriving at agreements that will enable restaurant owners to continue battling to save their restaurants while allowing the owners of buildings in which those restaurants sit to meet their own obligations.

In many cases, these agreements will be tailored to address the needs of the tenant and landlord in question. Variables must be considered: What is the restaurant’s pre-pandemic baseline performance? How leveraged is each respective party? Is there a larger office or residential element to the development in which the restaurant is located that eases the burden on this particular location? How well has the business adapted to “pandemic normal” – meaning how deftly has it shifted to a delivery- and takeaway-centric model, and how well is it capitalizing on available outdoor spaces? And finally, the trillion-dollar question: at what point can business reasonably be expected to return to normal?

Simply ignoring landlords or blindly threatening tenants with an eviction will not lead to a resolution, and will likely damage both sides. In this unfathomable moment, in which both sides need one another more than ever, survival will only come with understanding and communication.

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