I wanted to share a new way I'm approaching mix-use real estate.  I know a lot of investors shy away from this asset class but there's currently a revenue opportunity partnering with quality restaurant operators for those with well-located commercial real estate. 

Background: I purchased a building with a high-visibility corner space last used as a restaurant. The property also includes nine apartments and a second commercial space leased to a credit tenant. As I began marketing the 3,100 SF restaurant space, it became clear that hospitality financing remains tight and operators are pushing far more of the cost burden onto landlords than a standard white box delivery.

My original pro-forma budgeted $200,000 ($150,000 for white box plus $50,000 towards tenant enhancements) with an expected rent of $4,800/month. However, vetted operators wanted roughly $400,000 toward their fit out plus a liquor license valued at $160,000 & year 1 rent concessions. Over a $360,000 dollar increase from what I had underwritten.

Seeing this as an industry-wide issue, I reached out to an attorney who focuses his practice on representing landlords in restaurant lease negotiations. He noted a growing trend of partnership arrangements where landlords with marketable real estate fund the upfront cost and share in revenue after rent. Given the strength of the location, I began evaluating that structure.

Solution: Instead of a traditional lease, I partnered with established operators who will earn a management fee and a performance-based share of profits after rent, while the real estate entity wholly owns the business, equipment, and captures most of the revenue. The total project cost through opening is $800,000, broken out as follows:

-$150,000 white box
-$160,000 liquor license
-$110,000 sprinkler system and new hood
-$106,000 kitchen and bar equipment
-$140,000 fit out
-$40,000 tables and chairs
-$90,000 critical-path items to opening

I was already prepared to invest $200,000 towards fit out for a proven operator. The liquor license is a transferable asset being purchased in a depressed market, and the sprinkler and hood upgrades increased occupancy from 84 to 112—a meaningful long-term improvement. That left $330,000 of additional cost I viewed as the "at risk capital" although equipment carries value, even depreciated and therefore this risk capital is using a conservative approach.

Our willingness to cover all expenses attracted several highly qualified restaurateurs. Under the partnership terms, ownership entity collects $9,500 NNN rent, the operators collect a management fee and the liquor license and increased occupancy related expenses are repaid using a 7- year amortization schedule to real estate partnership. Thereafter there's a revenue share. Using conservative year 1 figures, the real estate partnership is expected to receive approximately $130,000 on top of the $9,500 NNN Rent and nearly $40,0000 amortized repayment of certain cost outlays just from this one commercial space. The real estate partnership will also benefit from the buildings increased value using the expected income approach valuation method. Its important to note the rent is not manipulated in this case to increase the real estate value. The rent was calculated using industry accepted operating expense allocations intended to allow the restaurant to operate sustainably.

A helpful wrinkle is that roughly half of the building’s total rent comes from the residential units, which makes financing straightforward with better leverage. The current construction loan will cover $300,000 of these costs and upon refinance $600,000 of the associated costs will be rolled into the loan. 

Takeaway: Landlords of well-situated real estate with marketable restaurant space have significant negotiation leverage, and this model seems replicable as long as hospitality financing remains tight. I am already amending permits at another property to house a 250-seat indoor/outdoor beer garden with apartment conversions above. 

Here's the ingredients I look for that make this model work:

- Location, Location, Location

- Partner with accomplished and high character operators

 -Understand your market and take a conservative approach to selecting the dining concept. Do not reinvent the wheel.

 -Ability to sell liquor, beer and wine is critical 

 -Focus on buildings with meaningful rental income derived from other units, preferably from residential use. This helps financing