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Post-COVID-19 Pandemic Outlook — Restaurant Leases | Baker Donelson

As businesses begin to emerge from the COVID-19 pandemic, retail and restaurant leasing are showing strong growth. US retail vacancy fell to 6.1 percent in the second quarter of 2022, the lowest level in at least 15 years, while asking rents for US malls in the quarter were 16 percent more than five years ago, according to real estate services firm Cushman. & Wakefield. Most developers choose to renovate outdated malls rather than build new ones.1 The development of parcels or pads in rebuilt malls, which cater to national restaurant brands, also saw uninterrupted growth during the pandemic. Drive-thru restaurants have performed particularly strongly.

Ground leases are typically used in single-tenant or shopping center transactions. Prospective restaurant tenants should always conduct site due diligence, including reviewing all applicable recorded documents affecting the proposed use, as well as assessing the impact of cross-access and parking rights-of-way , transmission costs and signaling restrictions. The lead times and significant capital expenditures involved with inspecting the proposed site, such as conducting a new survey, Phase I environmental assessment, and property condition reporting for existing improvements, if applicable, as well as the determination of rights and permits necessary for the development and intended use of the restaurant: may be obtained require contingencies and termination rights not typically seen in online retail leases.

Sophisticated and experienced restaurant operators typically address many of the issues facing this development at the letter of intent (LOI) stage. However, regardless of how detailed an LOI may be, important issues will be resolved during the lease negotiation.

These issues are especially important in restaurant leases:

  • term – An initial term of 10 to 15 years with additional five-year options is typical.
  • Permitted use – Tenants desire flexibility in use and concept, while landlords seek to maintain their preferred mix of retailers by limiting each tenant’s permitted use. If alcohol is to be served on the leased premises, the availability of a liquor license and any applicable restrictions should be investigated.
  • Restrictive/Exclusive Use Agreement – Typically at the LOI stage, restaurant developers will seek restrictions on the rest of the owner’s property to have the exclusive right to a certain restaurant segment (eg quick service pizza, Italian or French bistro) . Crafting exclusives that give the landlord the necessary flexibility to lease the rest of the mall, while being narrow enough to protect the tenant’s desired exclusive use, requires skilled negotiation and drafting by attorneys. An instrument, such as a memorandum of lease memorializing the exclusive use covenant and restricted territory, may need to be filed after the lease is executed to alert potential competitors.
  • Inspection, entitlement and permit periods: contingencies – Government liens, physical inspection of leased premises, zoning, building permits, traffic lanes and outdoor living areas are all elements that require tenant due diligence and a significant capital expenditure that will not normally be incurred until full execution. leasing Tenants should seek sufficient inspection, right and permit periods to conduct their due diligence with the ability to exit the lease if the desired development and use cannot be achieved.
  • Construction of Improvements and Signage – Restaurants with a prototype store and signage package must seek landlord approval during lease negotiation. Tenants must also confirm whether third-party approval is required for the proposed construction and signage, with the lease contingent on their receipt and the landlord’s promise to assist. The extension of public services to leased premises – who is responsible and who pays for it – should be negotiated during the LOI stage.
  • Construction period and start date of the rental – Tenants typically build the improvements located on a leased lot and often seek to condition the lease start date until construction is completed so that tenants have enough time to staff and stock the location. Landlords typically require tenants to start and finish construction within set deadlines. Tenants often seek automatic extensions of construction periods if certain events occur. These arrangements are heavily negotiated and require an experienced hand to lead the process.
  • Continuous operations – Landlords will request a going concern covenant (this is more important if there is a percentage rental component) within “normal business hours”, which should be defined in the lease. National/regional credit restaurant tenants may be able to limit their continuing operations obligations to something less than the full term of the lease; however, landlords often require the right to repossess the premises and reimbursement of any unamortized construction allowance provided to the tenant if operations cease.
  • Parking – Restaurants require more parking than other commercial uses, which can cause problems during lease negotiations. Applicable easement agreements and covenants, conditions and restrictions, and existing leases should be reviewed to determine whether exclusive parking spaces may be granted (eg, for “to-go” service, Uber Eats or “on the edge”). The number of designated parking spaces is typically negotiated at the LOI stage and must be identified on a site plan attached to the final lease.
  • Driving lanes – About 57 percent of customers at fast-food hamburger restaurants use drive-thru, compared to 40 percent at quick-service Mexican restaurants and 38 percent at fast-food chicken restaurants, according to The NPD Group.2 Obtaining the necessary rights and permits to build the desired number of traffic lanes is critical to the economic viability of many restaurant concepts.
  • Outdoor seating – An exclusive outdoor seating/patio area will usually be negotiated in the LOI. Tenants typically do not pay rent for outdoor seating, but are responsible for insurance, maintenance and landlord indemnity. Complaints from neighboring tenants due to excessive noise, odors and impaired access to other premises are concerns that landlords seek to address in the lease.

1 Kate King, “Retail real estate is enjoying its biggest renaissance in years, Wall Street Journal (Oct. 4, 2022, 1:24 PM ET), https://www.wsj.com/articles/retail-real-estate-is-enjoying-its-biggest-revival-in-years-11664875802.

2 Steve McDonnell, “What percentage of drive-thru sales come from fast food restaurants?” Houston Chroniclehttps://smallbusiness.chron.com/percentage-sales-drive-through-windows-fast-food-restaurants-75713.html.