Scores Of Restaurants Are Likely To Close For Good, Reshaping The Retail Market
The restaurant industry is preparing for a long, uphill battle.
With government relief measures not working for many restaurant businesses and takeout service not providing sustainable revenue, industry leaders expect this crisis will lead to the permanent closure of a large number of restaurants.
The restaurant closures will come not only from those that are unable to reopen after the mandated shutdown, but those that try to resume business and are unable to turn a profit, experts say.
Social distancing guidelines and slower consumer spending could cut top-line revenues in half, restaurant owners told Bisnow, and in an industry with already slim margins, that will not be enough for many businesses to survive.
Industry experts predict it could take between 12 and 18 months for restaurant demand to return to normal, and by that time, a significant number of restaurants will be wiped out. Brokers expect the wave of closings will increase the retail vacancy rate and shift market dynamics in the tenants’ favor. This could bring down rents in the long run as landlords look to fill empty spaces, creating new opportunities for well-positioned restaurateurs to expand.
“There are restaurants that are closed that aren’t paying rent right now, so who knows how many of those are going to reopen?” said Tom Papadopoulos, a broker who represents restaurants and landlords in the D.C. area.
“When they reopen, sales will be probably 50% of their typical sales," he said. "I think it’s going to stay that way for a while, and the second phase will be even more restaurants will close by the end of the year.”
Not Like Flipping A Switch
Reopening a restaurant will require owners to keep the business alive during the shutdown by paying rent and other bills — or by reaching deferral agreements with landlords and lenders — but the act of reopening will come with its own significant costs.
Restaurant owners will have to restock kitchens, buy personal protection equipment and sanitation matetials and re-train staff with new social distancing procedures that will likely be required to open.
Streetsense Managing Director Jay Coldren, whose firm released a “Relaunch Toolkit” for restaurant owners Monday, estimated reopening would cost between $15K and $30K, depending on the size of the operation.
Coldren, who manages Streetsense’s restaurant practice, said the larger challenge beyond the cost of reopening will be the ability to make a restaurant profitable again. Streetsense has been working with restaurants to redesign spaces to create 6 feet of distance between customers, and he said it will likely lead to a 50% to 60% drop in capacity.
“The real issue is preserving whatever available capital you have for the long run,” Coldren said. “We’re looking at a 12- to 18-month return to normal. People aren’t going to come back all at once, and with social distancing, the cash flow is going to be very different. It could be cut in half.”
Nationally, 41% of restaurant owners said the slow return of customers will be the biggest challenge in reopening, according to a survey released this month by the Independent Restaurant Coalition and the James Beard Foundation.
“You’re opening just to break even at best until things normalize,” said Eastbanc principal Philippe Lanier, whose firm owns a large D.C. retail portfolio and who also invests in several restaurant businesses. “There’s not a lot of reason to stay open other than your sheer love for the industry, because you want to try to preserve and recover maybe by the end of next year.”
Geoff Dawson, co-owner of six D.C.-area bars and restaurants, said he would be ”shocked” if business is back to normal by September. He said he expects restaurant revenues will be closer to 50% of their normal levels. With profit margins already in the single digits before the crisis, he said that will not be enough to sustain many businesses.
Big Chief, a bar Dawson co-owned in Ivy City, had already been struggling and was forced to close permanently because of the crisis, he said. Fado Irish Pub, a popular haunt in Chinatown, announced this week it won't reopen.
To prevent more closures, Dawson hopes landlords will reach agreements with restaurant operators to offer flexibility on rent even after the businesses reopen. He said landlords could change restaurants’ rent payments to a percentage of monthly revenues, allowing them to start off with lower expenses and ramp back up as business returns to normal.
“As we come back, that could work because that will give us a chance to grow with whatever business returns, and we’ll be able to sustain it,” Dawson said. “If we return within striking distance of 100%, then we’re back.”
Papadopoulos said the revenue-sharing model would be the “logical” way to handle rent payments for the first six to 12 months after in-house service returns. Landlords that don’t offer flexibility will have a hard time replacing a tenant.
“The restaurateur can say, ‘Here were my sales in ‘19, this is what I’m doing now and this is what we can afford to pay,’” Papadopoulos said. “If the landlord says ‘OK get out, I’ll re-lease the space,’ that's going to be time and money, and who knows how many people are going to stand in line to open restaurants?”
Lanier said Eastbanc has been understanding about restaurants that are unable to pay rent in the near-term, but he said he is unable to make any commitments on long-term lease amendments because each deal involves multiple partners and lenders that need to be part of the discussion.
“There are scenarios where I envision the partnership says that’s what we have to do,” Lanier said of offering long-term flexibility on rent payments for restaurants.
Even before the crisis, some industry experts saw D.C.’s restaurant industry as oversaturated, having added hundreds of new dining spots in recent years. The District had 2,457 eating and drinking establishments as of 2018, according to the National Restaurant Association, and the industry employed over 65,000 people as of last year.
“We’ve been on a massive tear of openings throughout Washington and there’s a depth issue of how many restaurants can we support,” Miller Walker Retail Real Estate principal Bill Miller said. “We’re going to have some guys that weren’t doing well go out of business.”
Restaurant sales taxes comprised 31% of the city’s $1.6B in sales tax revenue in Fiscal Year 2019, according to D.C. Chief Financial Officer Jeffrey DeWitt. In a revenue forecast presentation last week, DeWitt projected D.C. would lose $395M in sales tax revenue in Fiscal Year 2020 because of the restaurant and hospitality sector shutdown.
His projections assume that some businesses will be allowed to reopen this summer with social distancing restrictions, and he expects the city will reach its “new normal” by spring or summer of next year.
Monday, exactly six weeks after Mayor Muriel Bowser halted in-house restaurant service, she announced the launch of the ReOpen DC Advisory Group. The group consists of several committees, including a Restaurants and Food Retailers committee, a Retail and Small Business committee and a Real Estate and Construction committee.
The restaurant committee, including celebrity chef José Andrés, Busboys and Poets owner Andy Shallal, Restaurant Association of Metropolitan Washington CEO Kathy Hollinger and several other community members, will recommend strategies for safely opening food-service businesses.
Similar groups have been formed in other parts of the country, and President Donald Trump's Great American Economic Revival Industry Groups, announced earlier this month, include a food and beverage group made up of executives from restaurant chains and some acclaimed chefs, including Wolfgang Puck and Thomas Keller.
The Coming Correction
The depth of the city’s restaurant closures remains to be seen, but brokers agree it will significantly increase the vacancy rate and change the dynamics of the retail real estate market.
The retail vacancy rate in the D.C. area stood around 6.2% as of August, according to Dochter & Alexander Retail Advisors' latest market report. Dochter & Alexander principal Matt Alexander said a vacancy rate increase is “inevitable,” but it is difficult to predict how much vacant space will return to the market.
“There will be a certain percentage of restaurants that are not able to reopen, whether they can’t sustain through this or their performance was softer before this happened and it’s something they’re not going to be able to recover from,” Alexander said. “We’re going to see supply come back to the market.”
Rents in the restaurant industry are driven by a combination of the market’s vacancy rate and the amount of sales a business can expect to bring in, CBRE Executive Vice President Michael Zacharia said.
“With the expected influx of vacancy from this, I do think we’ll see rent come down, at least in the near term,” Zacharia said. “If every table is 6 feet away and restaurants have half the amount of customers, that is going to have a direct correlation for how much rent these restaurants can pay to be sustainable.”
Some restaurant owners in recent years have attributed their closures to D.C. landlords seeking higher rents than they could afford. But brokers say developers of new projects were offering generous deals to bring in restaurants as anchor tenants that could help the lease-up of their buildings. Whether in the form of lower rents or tenant improvement allowances, these deals represented a softening of the market, and retail brokers expect that trend to accelerate.
“These landlords were making better deals for the restaurant operators, and rents were being more reasonable to some extent, and landlords were putting more dollars into spaces,” Papadopoulos said. “That was already happening, and now that’s going to have to continue to happen with even better numbers for some of these tenants.”
Across the retail industry, a shift toward online ordering has led to a drop in demand for brick-and-mortar spaces that was already causing rents to come down, Lanier said.
“There’s a natural transition of tenants leaving and coming with vacancy in between and rents being adjusted along the way,” Lanier said. “This does not make that easier. I do think this will put pressure on rents, but I think that was already happening.”
Coldren said he expects to see well-capitalized restaurateurs with large portfolios begin to expand next year by opening in locations where less fortunate business owners had to close.
“Landlords are going to be stuck with fully built-out restaurants they have nothing to do with,” Coldren said. “The multi-unit restaurateurs that survive are going to pick up additional locations pretty easily, and come spring, you’re going to see a bunch of renovations as seasoned restaurateurs pick up stores in locations that have closed down.”
Neighborhood Retail Group CEO Bethany Kazaba said she is representing an operator who owns several D.C.-area restaurants and is looking to expand in an Alexandria space where the current tenant is unlikely to renew its lease.
“There are going to be so many opportunities that come from second-generation restaurant spaces,” Kazaba said. “There are going to be good opportunities for people that really want to open.”
She said she expects landlords in the near-term will try to maintain the same rental rate they had pre-crisis, but she thinks they will be forced to bring the rate down in the coming months.
“Early in this, unfortunately, the landlord is going to try to replace the rent,” Kazaba said. "I think give it 60 days, maybe 180 days, if the space is still available, you will begin to see the correction."
Dawson said he hopes landlords will see this market shift coming and offer more flexibility to keep their existing tenants from closing down.
“Say all of the landlords kick us out, we have back rent we can’t pay, we leave and then go prey on empty spaces that are available where we can get a better deal,” he said. “They’re not going to be able to charge what they were prior to this with a crippled economy, so there’s not a very good reason for them to play hardball.”