Running a restaurant business is notoriously challenging. According to a frequently cited Ohio State University study, 60 percent of restaurants do not make it past the first year, and 80 percent fail by year five. In today’s competitive environment, even big-name chains aren’t immune, as evidenced by the high-profile bankruptcies this summer: Arizona franchisees of Carl’s Jr. restaurants as well as the nine-location, Scottsdale-based Z’Tejas Southwestern Grill.
Financial issues generally don’t arrive out of the blue. An operator suffering financial losses, to the point where they can’t sustain operations, is best served to look at different alternatives to continuing the operations – and to do so as early in the process as possible.
Here are some alternatives, involving real estate assets associated with these cases.
Restructure the Lease Rate and/or Duration of the Lease. If the troubled restauranteur leases its property, there may be an opportunity to renegotiate essential provisions which will enable the operator to achieve some relief and/or operational efficiency. Items that are commonly negotiated include the rental rate and the duration of the lease. Market value rental rates are still relatively low, and a vacant property is worth a lot less to a landlord, than an occupied one. The landlord may be willing to abate rent to allow for the restaurant to pay its creditors and the landlord may agree to accept a promissory note in the future for the abated rent.
Adjust CAM (common area maintenance) Charges. Many landlords have reduced or eliminated CAM charges for a period of time, to ensure the tenant’s success/occupancy.
Assign the Lease or Sublease. A restaurant owner may have the right to assign the lease. This may be to a better operator, or without restriction. The lease will guide the opportunity here, but whether or not the lease provides for this opportunity, a landlord may be willing to grant this request, to keep the space from going dark.
Recapitalize the Operations. There is a lot of capital available in the current marketplace, even for distressed borrowers. In addition, there are lots of opportunities to refinance – not just the real estate occupied by the restaurant, but the operation itself. Lines of credit and other financing devices can provide a cash infusion for a struggling operator.
Sale-Leaseback. For those who own the property that their restaurant occupies, they have an opportunity to recapitalize through sale leaseback or straight sale. Investors are hungry for these net lease properties, even with a distressed tenant. These transactions work in this manner: the owner (soon-to-be-tenant) sells off the real estate, and enters into a long-term lease, while keeping the operation in place, trading ownership for a lease interest. This gives the owner an opportunity to recapitalize, and achieve some operating capital. You may be thinking, “This operator/would-be-tenant is distressed and not functioning well, why would someone want to invest in that kind of deal?” The fact is the investor markets are still live – even for distressed deals with operators with less than stellar credit. The payback comes in terms of cap-rate adjusted returns. While cap rates might be 5-6 percent for a smooth-running operator, an investor might command as much as 8-10 percent for a deal in a distressed situation.
When Bankruptcy Is Inevitable
Clearly, it’s ideal for restaurants and related stakeholders to avoid bankruptcy. But even if bankruptcy is the end game, there are several alternatives to consider within those parameters:
- Reject the lease. For operators who don’t own the site, options include rejecting the lease and paying reduced damages pursuant to the Bankruptcy Code or reinstating back payments.
- Assume and/or Renegotiate the Terms of the Lease. Although this is best executed pre-bankruptcy, there still may be ways to assume or revise the lease. This is subject to Bankruptcy Court approval and the process is complicated, but it’s important to note that the time frame on such action is usually 120 days from the filing the bankruptcy petition.
- Liquidate the Assets. The last alternative, and one which is ideally avoided, is the liquidation of the assets. In the end, such a decision costs everybody money.
Professionals on the Restaurant Turnaround Team
The professionals on the restaurant turnaround team should include: a bankruptcy attorney, an accountant and a real estate broker.
Restaurants fail for a wide variety of reasons, from shifting consumer tastes and poor management to increased real estate, labor, and raw food costs. Even in a distressed situation, however, a restaurant operator needs to stay informed about the best options to keep the operation solvent or to maximize the return on an owner’s investment.
This article should not be considered or construed as legal advice on any fact or circumstance. You should consult your own attorney regarding your own personal situation or any legal question you may have.
Beth Jo Zeitzer, Esq. is the owner and designated broker of R.O.I. Properties, a full-service real estate brokerage firm focused on working with business owners, investors and property owners regarding the marketing and sale of commercial and residential properties, including restaurants, other retail, office, industrial, multi-family, hospitality, and land assets. She can be reached at (602) 319-1326 or firstname.lastname@example.org