By: Craig T. Watrous
In commercial real estate leasing, restaurants present a unique and particularly complex array of issues for landlords and tenants to consider. Due to the nature of restaurant operations, a restaurant’s use of commercial space often requires expensive tenant build-outs, city and local permits, special use considerations, ADA compliance, heavy traffic, specialized systems, and new equipment. There are often enormous upfront costs which have to be spent to get the space up and ready for the restaurant to open. The result is a game of risk and cost shifting between the landlord and the tenant. For landlords, restaurant leases can be very lucrative and also very risky. For tenants, the terms of the lease can shave away the razor thin profit margins that make or break the business. For these reasons restaurant leases are often heavily negotiated, complex documents that shouldn’t be taken lightly. This article attempts to summarize some of the key issues that both landlords and tenants should consider when negotiating their restaurant leases. Rather than take sides, we’ve tried to highlight areas in the restaurant lease that both the property owner and the restaurateur should consider. Of course the list isn’t exhaustive but hopefully it provides food for thought.
The Liquor License
Many restaurants not only want a liquor license but depend on it for their revenue stream and to bring in traffic to the restaurant. The main question that needs to be addressed is can a liquor license be obtained for the premises? If the restaurant’s success depends on getting a liquor license for the premises, then the lease should be contingent upon the issuance of that license. This benefits both the tenant and the landlord. The last thing a landlord wants is to have a tenant who is doomed for failure. Similarly liquor sales often mean increased traffic to the premises which may directly benefit the landlord’s other tenants, potentially increasing the value of the real estate. Some factors to consider if the lease is contingent upon the tenant getting a liquor license:
The Certificate of Occupancy
For properties that have been used in the past as a restaurant this is less of a concern. For new builds or properties that haven’t held restaurants before, the certificate of occupancy may not be a sure thing. Some things to verify/discuss:
The Restaurant’s Equipment – Title and Sales Tax Issues
If the tenant is bringing its own equipment then the lease should expressly spell out what items are considered fixtures and which are not. Does the space already have restaurant equipment in it that the tenant will be permitted to use? If so, then the parties need to consider the related title and tax issues.
The HVAC equipment for restaurants is significantly more robust than what’s needed for a typical commercial property. The tenant should have a qualified contractor review the space to inspect the condition, quality, and number of HVAC units and determine if they will be adequate for the restaurant’s needs.
Often overlooked, some restaurants need specialized hot water heating units. The following factors should be considered:
Fire Systems and Sprinklers
Restaurants need special fire and sprinkler systems.
Restaurants are generally large consumers of electricity. The tenant needs to be sure that the electrical systems at the premises will meet its needs. The landlord needs to make sure that the tenant is responsible for its fair share of its electrical use.
The parties need to confirm that the gas services to the premises is adequate for the restaurant’s needs. If more gas lines are required, allocation of the costs needs to be established. As stated above, if the gas isn’t separately metered then the lease should spell out how the tenant’s gas usage will be appropriately allocated to the tenant.
If the premises are stand alone, then this is an easier issue to deal with. If the premises are part of a larger building then the issue can become significantly more complex.
Sewer Lines and Grease Traps
Both the common sewer lines and the lines leading from the tenant’s space need to be assessed.
Miscellaneous Systems in the Premises
The tenant and landlord should closely assess the suitability of the remaining systems servicing the premises:
Bathrooms and Other Access Issues
The ADA has to be considered. Because a restaurant is a “place of public accommodation” it’s subject to the ADA’s access requirements. Bathrooms always come up because they’re expensive and often not up to code. Another main item to be reviewed is the entrance to the restaurant. For older buildings this can be an issue. An allocation of ADA responsibilities needs to be made in the lease.
Restaurants need signage. Similarly, landlords want to ensure that the tenant is able to draw patrons while protecting the appearance of the property. If the premises are part of a larger building there may be some restrictions on sign placement, size and style. If the premises are older the tenant may want to install new signs.
Term of the Lease and Renewals
Restaurant leases often have longer terms than other commercial leases. For landlords, because so much cost is put into the space prior to the lease, a longer term helps to recapture some of the upfront costs. For tenants its always location, location, location. If that location works, the tenant will want a longer term and lease extensions to lock it in. Of course, when things are going well both parties will want the lease to continue, but considerations should be put in place regarding not only the initial term but also renewals and extensions. While the tenant may want automatic extensions, the landlord should consider putting in provisions that protect it from getting locked into a long term relationship with a problematic tenant. If the tenant has had defaults in the past, the landlord may want discretion over future renewals.
Security Deposit and Personal Guaranty
It’s well known that restaurants regularly fail. Keep in mind, most restaurant equipment is leased, so when a business goes south often a landlord’s best hope of recovery is to go after the tenant’s security deposit. Thought needs to be put into how much deposit is reasonable while still working within the restaurant’s initial operating capital needs. Does the landlord want to require a personal guaranty from one or all of the restaurant’s principals?
The parking can make or break a restaurant. However, it’s not just the parking for the restaurant’s patrons that needs to be considered but also parking for the restaurant’s employees. For property owners, if other tenants use a development’s parking facilities, they need to be careful that the restaurant doesn’t monopolize the lot.
Ambiguities in leases lead to great lawsuits. A standard, off-the-shelf form, likely won’t address the particular needs and concerns of the restaurateur and property owner. It’s worthwhile for both parties to spend extra time upfront negotiating lease terms and putting the details in writing. We hope this article has been helpful.
(Mallon Lonnquist Morris & Watrous, PLLC, is a business, employment, real estate, and litigation law firm. Craig T. Watrous is a Colorado real estate attorney and partner at MLMW, based in Denver, Colorado. Craig regularly represents clients on both sides of restaurant leases. Craig can be reached at email@example.com and (303) 722-2165.)