Working With Your “Silent Partner” When Reopening Your RestaurantBy Kurt S. Kiess | April 30, 2020
A landlord is often referred to as the silent partner in a business. This silent partner does not normally share in a percentage of the income, but rather, receives a fixed, guaranteed payment—which we know as rent. With the recent COVID-19 mandated shutdown of the restaurant industry and the excessive financial hardship it has caused, now may be the time for restaurant and business owners to revisit the relationships they share with their silent partners. While the restaurant industry looks to regain its footing, is there a way in which the contractual terms binding landlord and tenant can be adjusted while still benefiting both parties?
Right now, as states and local municipalities look to begin gradually reopening the economy, it is generally assumed that a reduction of the capacity of restaurants, i.e., headcount, will be imposed. To meet these new spacing requirements, restaurants risk losing up to 50% of their seating capacity. In order to offset this consequential reduction in revenue, attentive restaurant owners are seeking to reduce as many of their variable costs as possible. They will bring back fewer employees for both front and back of the house. Some are considering a limited menu selection and limited hours of operation. However, the largest fixed cost for most restaurants is rent. Anticipating a return of approximately 50% of customers due to either a lack of demand or space reduction, some might make the argument that the value of their rented space is now only worth 50% of what it was prior to the shutdown—but few landlords would agree, as they surely have not seen a 50% reduction in their own fixed costs. So how do we go forward? Well, tenants and landlords now need to understand their true relationship as partners and could consider a relationship where profit-sharing can be a valuable alternative to rent for both parties.
Historically, many restaurants and retailers in mall-type settings have adopted a percentage of sales as additional rent, with tenants paying more rent to the landlord as sales increase. These arrangements are not commonly incorporated into leases for smaller, single-tenant locations. However, in today’s unprecedented circumstances, I recommend that an attempt be made to adopt this alternative to restaurant leases, i.e., reduced based rent along with a percentage of sales. The percentage needs to be studied, negotiated and fair. The restaurant owner is, in essence, asking the landlord to bet on the success of the venture, but the landlord’s incentive is that he may receive more in rent than under a standard lease. Keep in mind that landlords never want their retail space to be empty. Empty space reduces the value of other spaces rented by other tenants in large building settings, and in smaller settings, empty spaces do nothing to reduce the fixed costs of the landlord, resulting in greater financial pressure. Because the likelihood of a new tenant coming along and launching of a new restaurant during this exceptionally difficult time is low, landlords may not want to lose current tenants due to rent expense and therefore may be amenable to a discussing a change in rent structure rather than risk losing an established tenant.
As the industry weathers some of the toughest conditions any of us have seen in our lifetime, I recommend that restaurateurs and landlords work together as partners now in order to ensure their mutual success. Both parties may make less in the immediate future, but the alignment of long-term interests in the form of a true partnership will provide greater commercial and financial benefits for all in the long run.
About Kurt S. Kiess
Kurt S. Kiess, CPA, is a Partner at Marks Paneth LLP. He has a broad background in the audit and tax aspects of his profession. Mr. Kiess concentrates on serving clients in a variety of industries, including real estate, retail, insurance and manufacturing. With a public accounting background spanning more than 30 years, Mr. Kiess was a Partner at Marks Shron & Company when it combined with Paneth, Haber and Zimmerman LLP to form today's... READ MORE +