What to charge for a restaurant patio?

Question

Assuming going rates are NNN $1/sq foot for restaurant space, what is a fair price for the attached patio space? Small population makes comps with patios impossible. Local weather allows for patio use about half of the year.

Sq footage of restaurant is 1623.

Sq footage of patio is 671.

Thank you!

Sq footage of restaurant is 1623.

Sq footage of patio is 671.

Thank you!

Damon DiPlacido · Answer

From my experience, unless the space is in very high demand in A+ type real estate, the patio is available for tenant's use at no additional charge. Likely an easier "sell" to raise the base rate PSF on the 1,623 SF ever so slightly to include use of the patio.

Joel Owens · Answer

Whether you keep a tenant there are a ton of factors. I was in the restaurant business before getting into commercial real estate so know it extremely well.

Is there a personal guarantee on this lease? Does the guarantee ever go away in the primary term? For option renewals will there be leasing commissions owed? For market lease rates there are lots of factors. Is the tenant local, regional, or national in nature? Are current market rents for the space with the lease at, below, or above market rents? A common mistake I see is someone will list a space as rent is below market but actually for the box size of the space it is actually above market or market rent.

How is the space positioned? Is there a lot of visibility from the road, high traffic counts, great access in and out, plenty of parking or if urban core high walkability score? I have seen retail centers for instance where if it is turned sideways or building is situated behind another retail center then harder to rent and rents drop to fill it with lease up.

How good is the cross traffic from other sites to this tenant box space?

On keeping a tenant or getting rid of them sometimes it can be a blessing. If you know the tenant is struggling and might file BK it can sometimes be better to get them out now. If the tenant is struggling but the area has changed and now instead of all mom and pop tenants some regional and national tenants are interested you might could command much higher rents.

So in 2 ways or more the value could improve. You get higher rents and on top of that because tenant mix is stronger usually with national tenants you could then likely sell at a lower cap rate for a higher price point value. Example a retail center with all mom and pop tenants might be a 7.5 cap whereas national tenants with 10 year leases could trade at a 6.5 cap rate etc.

Retail has many nuances to it which can make things interesting on a daily basis. You might want to get a landlord rep broker to run a void analysis. This tends to show what type of tenant would optimally go in your space, the rents expected, type of lease structure, TI's average, leasing commissions average, attorneys fees to do the lease, etc. Depending on tenant type you are marketing to (national, regional, mom and pop), how much new development is ongoing versus existing vacant space, and box size type will play into how long it takes to lease a space and get rent going. This is why mom and pop I like for them to have some net worth so if business is failing and say remaining lease has 300k on it but they are worth 750k with personal guarantee then I have seen before early termination with the lease for 50k. The goal of the 50k is to cover TI,LC's, downtime of lost rent, attorneys fees, tenant rep broker commissions so when the space is released you are almost breakeven with the money. I typically would not put lot's of money into a space for a newer single user mom and pop tenant with hardly any net worth to speak of. Some landlords let those tenants in but do not want to spend any TI on them. They also do not usually want to pay tenant rep commissions on weak tenants upfront. Instead some landlords will give a nominal fee upfront to tenant rep broker for mom and pop tenants and then payout additional portion of the fee over time as the tenant performs.

Damon DiPlacido · Answer

It's hard for me to gauge what you should charge, as 1. most, if not all, the restaurant deals (20+ over the last 2 years) I do that involve a patio there's no additional charge for use of the patio, and 2. I don't know your market.  There's no exact science to it but like you said it's only usable about half the year (due to temperature, I presume) and then even when the weather is warm, it could be raining, so truly only available likely somewhat less than half the year - maybe an extra $0.15 - $0.20 psf/mo added to the $1 psf/mo sounds reasonable. Also on whether to retain the tenant or get a new one, it's almost always in your best interest to retain a tenant once you factor in loss of income b/c of vacancy period and then construction period for new tenant), legal fees, broker fees, etc.

Joel Owens · Answer

Some owners just do not charge for the patio and let the tenants have it as a bonus. Depends on what rent you are already getting inside. You could just have a base rent based on the total sq footage and then have a break point to pay additional rent above certain annual sales. Inflation rises each year generally and the menu's pricing usually keeps going up.

So for instance if there was 3% bonus to landlord in additional rent above 1,000,000 in annual sales and not adjusted for inflation it should be easier for tenant to hit that number each year as the burger meal goes from 7.00 to 7.25 to 7.50 etc.

Faye R. · Answer

Joel,

There is a personal guarantee but that isn’t worth anything. No leasing commissions. Tenant is local in nature. His primary business is production for grocery stores. He is working on taking it to the regional level.

The space is positioned in the pedestrian heart of a small town. (pop 6.5k) It has sufficient parking and good traffic counts. The community has a strong identity. It’s the third or fourth most expensive zip code out of the 18 in our county. Even if I could attract them, national chains in the core identity area wouldn’t be embraced by the community. We strongly value local and unique.

A recent feasibility study reports that the average retail rate for the county is $13sf/year. But it’s difficult to apply this to the individual cities.

There are only three other restaurant-ready spaces available rightnow. But they are all in a higher populated but less expensive city. Two are about $1sf but are twice the size. One is comparable in size and only .50sf but it’s in a bad location.  If variances in residential rents can be applied, my unit should be 20% higher than these. But that same idea would yield considerably more if I applied it to the closest neighboring town where I was paying $2.25sf for restaurant space and residential rates are  63% higher.

Great idea to offer fee payment over time, for mom and pop tenant placement. Thank you.

Will you explain this for me? I don’t understand:  “someone will list a space as rent is below market but actually for the box size of the space it is actually above market or market rent.”

Faye R. · Answer

Damon,

.10-.20/sq foot sounds reasonable to me also. Thanks. You’re right. It won’t attract a national tenant.

Damon DiPlacido · Answer

I stand by my statement, and based on the few details provided here, it's more than just likely this space would not be a fit for a national restaurant tenant (either as franchisee or corporate signed deal). $1 psf/mo NNN ($12 psf/yr) NNN speaks volumes about the location from a national restaurant chain perspective.

Faye R. · Answer

Thanks for the thoughts, Joel and Damon.  It's not typical in this area to get a percentage of income. I went into a lease extension negotiation meeting with the tenant feeling like a good guy for having cut him significant breaks on late fees and interest and also skipping annual increases for two years. He walked into it feeling like the original lease terms were not fair because he was responsible for upkeep and repairs. Also he was under the impression that I charged him 600/month more than the previous tenant.” (In reality it was a 260/month increase and I spent 35.5k on repairs and improvements before he took possession. But the conversation was so unexpected that I didn’t have the numbers with me.)

Part of me wants to tell him to hit the road. Current market rents appear to be higher than the 5% cap that his lease extension allows so it would be financially rewarding. But it feels important to attempt to justify the rent. He is a good guy with a residential tenant mentality whose business is struggling.  Also, it’s a small town. His story doesn’t serve the community.

As a former restaurateur, I know that the patio allows him to do considerably more business. As a real estate investor, if the rent is the same with or without it, the logical course of action would be to build over it. So there is clearly value to the patio, I just don’t know how to measure it. Any thoughts on a percentage to “ever so slightly raise the base rent?”

What to charge for a restaurant patio?

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