Note that I have no experience in the restaurant industry, and these are my thoughts as pure outsider. If you’re looking for an opinion with hard facts backing it up, you’re not going to find it here.
Over the past couple of days, I have been seeing a lot of discussion about how COVID-19 is the beginning of the end for the restaurant and bar industry. It is no secret that currently, even after “reopening”, government enforced social distancing is causing restaurants to struggle. These requirements have drastically reduced the overall capacity of these venues. For example, a previously-200-person capacity restaurant is now a 50-person capacity restaurant. This kind of begs the question: are the property owners of these venues, who are renting the space to the businesses, still delivering the value that they are required to by their leases?
Real estate prices are complicated, and have many factors, however when it comes to restaurants, there are 2 main factors: Location, and capacity. When a restaurant is looking for a space, as far as I know, they are looking for these two factors.
Location is clearly important because it is directly correlated to the total available customer base: a “better” location is more accessible, has more traffic in the area, and therefore a larger set of potential customer.
Capacity is important because it dictates the bandwidth that a venue can handle at a given time., and thus the revenue that can be brought in. A 100-person capacity venue can generate approximately twice as much revenue as a 50-person capacity venue. The total square footage of the venue is only really import so far as that it directly impacts the capacity. Ie, typically, location being equal, a 10k sqft space will have a higher capacity than a 5k sqft space, and thus demands higher rent. If the capacity of the two spaces was equal, it is unclear that the larger space is that much more valuable.
This situation is being described as a reckoning for the restaurant and bar industry; as if they were foolish to open businesses that could not survive this, and that the business model is fundamentally flawed.
This is completely untrue. Restaurants and bars right now are failing because they are being held captive by leases which are failing to deliver on the premise of the original lease: a venue which had the characteristics of the location (ie, the foot traffic associated with a mall or busy downtown venue), and the capacity to serve the expected number of customers. The problem is not that the business is less valuable, but that the fair market value of the real estate has been drastically reduced. These businesses are being left holding the bag, paying rent at a rate that would be impossible for the landlord to replace with a new tenant. At a rate that will almost certainly lead to these businesses going under.
Evening assuming social distancing requirements continue, this doesn’t mean that I think that restaurants and bar activity will come to an end. I see two outcomes:
1) If property owners agree to modified rent schedules, and existing restaurants surviving through this. Unfortunately I do not see property owners accepting that, due to regulations, their space is not worth what it used to be. I do not see this happening.
2) If property owners do not agree to modify rent, and continue to value it at pre-pandemic levels, it is likely impractical for current restaurants, I expect us to see a slowing down as restaurants go out of business over the next couple years while existing leases expire. Property owners will have to lower prices at that time to a point which makes sense with the traffic and capacity that they are actually able to offer, which will start allowing business to practically begin opening physical locations again.
I want to drive home the fact that the main change in value created by these social distancing restrictions, although affecting restaurant’s cash flow, is not truly on the restaurant. The fact is that the fair market value of the real estate they are renting has changed, and the owners of the property, which were directly impacted, are currently insulated from these changes by their outstanding lease terms. This may be perfectly legal; I would be surprised if the explicit capacity of the space was stipulated in these restaurant leases, however I would not be surprised if the ability to use the space as intended was not stipulated.
Either way, it is not a short-coming of the restaurant business model, and market forces will correct for this in the long run. During this time, we may see an increase in the “cloud kitchen” model; building out a restaurant brand through delivery-only, from a low-cost kitchen located in a more industrial part of town until high-traffic, traditional restaurant space pricing adjusts.
I hope this was insightful, or at least entertaining. If you have any questions, don’t hesitate to shoot me an email, or follow me on twitter @nrmitchi