In Defence of Landlords

Article originally published by MCA.

When restaurants are hit with rising food costs, staff wages, business rates and rents, resentment towards landlords inevitably rises. Restaurant businesses need a break, and have few other places to look – the economics of international supply chains are too nebulous to influence, it is hard to begrudge employees a small pay rise against the backdrop of rising living costs and the weakened pound, and everyone is tired of grumbling about politicians. As a round of rent reviews are the last straw for a number of eateries, the stereotype of the greedy landlord returns.

What is often forgotten is that commercial property companies, just like restaurant chains, are under pressure to deliver growth for shareholders. It is not simply a case of lining their pockets every time a rent review comes around, they need to hit targets like any other business. The pressure is mounting in the property world too – if the eating out market has reached saturation, who will fill this new swathe of vacancies? And how will they counter challenging valuation deficits? Many of the major players such as Land Securities and British Land have reported accounting returns below the level of inflation for 2017, compared with c.14% in 2016 – a pattern that mirrors the P&Ls of many restaurant chains right now. Whilst they aren’t exactly going out of business any time soon, they are likely to be feeling restaurants’ pain.

The situation has been created by several factors, including aggressive demand from restaurant chains themselves, often bidding each other up to secure a ‘top’ site. It takes a lot of justification and foresight for a landlord not to take the highest bidder. There should be a mutual responsibility between landlords and tenants to do their due diligence on whether rent-levels are sustainable, and to stress-test revenue and EBITDA projections. That is something we specifically model for new developments or restaurants that we work with, but all too often, this step is skipped or overlooked, leading to closures that are costly and painful for restaurants and landlords alike.

Establishing rent levels is where the problem often begins, but once rent reviews come around, there are other factors at play, such as maintaining rental levels that are fair to all tenants. If a restaurant is struggling and the landlord reduces the rent by a significant amount, is it fair for the successful café next door to pay more? In addition, when other rents are set according to comparables in the area, any reduction sets an unwelcome precedent for the next set of renewals. Maintaining and increasing asset value is one of the key performance drivers for the property industry. This is what makes rent renegotiations so difficult.

A long term Client of ours recently undertook a round of reviews where, as well as using comparable evidence (some which had levels just north of £100 per ft2), they also took into consideration (with the intelligence provided by the JLL Foodservice Team) P&L sense checks to ensure sustainability. As a result, the Landlord pitched the rent reviews at a lower (but, critically, affordable) level to ensure they didn’t “kill the golden goose”. They still achieved big increases but have ensured that tenants are still reaping decent contributions from their units. The ability to do this accurately stems largely from the tool kit of median rent reviews, and transparency on tenant turnovers, which in part was put down to the legacy of our involvement when the scheme was set up over 20 years ago.

This challenge is reflected in other areas as well, such as building a development around what the consumer wants. Retail leaders recognise the demand for variety and change, and can see the intrinsic attraction of pop-up units and rotating tenants. However, given the nature of these offers, they provide little direct asset value. Our clients also recognise the value of the “halo” that a strong set of restaurants can deliver in terms of driving footfall, dwell times, spend and, where applicable, residential value, but attributing a finite sum to this is very difficult. The most forward thinking developers are likely to be the ones that succeed. We have seen this work very well with Trinity Kitchen, for example, which was the first development of its kind in a UK shopping centre. The rental model was entirely different, and in many ways, higher risk, but the benefits in centre footfall and brand perceptions speak for themselves. Similarly, what Shaftesbury did with Kingly Court in Soho took considerable vision and gave them the flexibility to work with more experimental, socially responsible and original brands – a strategy that has done them a lot of favours, both financial and reputational.

As the retail and restaurant property landscape rapidly shifts, landlords and tenants will find a better balance. At the end of the day, it is in both parties’ interest for consumers to eat out more, which means establishing a rent level than enables restaurants to charge ‘affordable’ prices. In the short-term, we foresee a healthy turnover of tired concepts as the property market holds out, and then a boom of innovation as a new wave of brands swoop into vacated, rent-adjusted units. Timing may well be everything.

 

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