In the first quarter of 2009, a franchisee struggling financially for more than a year because of lower sales and high fixed costs hired a restructuring firm to examine two restaurants that had become a drain on the company's cash flow. Both locations had seen a drop in sales of $150,000 per year and the franchisee was contemplating bankruptcy. But instead of closing the restaurants or pursuing bankruptcy, the restructuring firm renegotiated the leases on both restaurant sites, saving $3 million and helping the company stay afloat.
The arrangement was also a win for the landlord. If the restaurant had filed for bankruptcy, the property owner would have taken a major loss from the termination of the leases — much larger than the loss of reducing the rent to a level that was more realistic for the restaurants.
Occupancy costs are typically the third-largest expense behind food and labor, and restaurants have traditionally focused on cutting costs associated with the “big two.” But with the continued ripple effects of the economic downturn on consumers, there's often little else to trim. In planning for 2010 and beyond, consider lease renegotiations. When requesting a rent reduction, here are some basic best practices:
Determine whether a lease renegotiation is necessary. Examine the occupancy costs relative to sales. This varies by restaurant, but if this figure is more than 10 percent, it will be challenging to get an acceptable return on that restaurant; eight percent is a more manageable ratio. Additionally, if more than 50 percent of a restaurant's EBITDAR (the R stands for rent) is dedicated to occupancy costs, restructuring can be a good strategy.
Pick your battles. Restaurants with multiple locations shouldn't renegotiate every lease. Analyze financials to determine which locations are losing money or are less profitable. Illustrating that a location is losing money is one of the most powerful arguments you can make to a landlord when requesting a rent decrease.
Don't send out a generic request to landlords. Build a case tailored to a specific location by creating a written, fact-based explanation about why you should be given a lease restructure. Include information about whether the location is losing money, whether the occupancy cost is greater than eight percent of sales, and whether you may have to close the location without a restructure. Be prepared to share the financials with the landlord; this is not a bluffing game.
Find a win-win situation. Landlords will only choose to restructure a lease because they believe that it's in their best interest. You can ask landlords to lower the base rent while adding a percentage that is tied to a sales increase. You can also ask for a rent reduction while giving the landlord the option to reclaim the space on an agreed-upon date to help assuage concerns that the landlord will be stuck with a below-market rate lease for an extended period.
Be proactive. Call the landlord to introduce yourself and describe your situation. Then send a written proposal before following up by phone or email. Also make yourself available since some issues may require an in-person conversation.
Don't be tempted by rent deferrals. Negotiate a real solution because many of the issues facing the restaurant industry — such as an oversaturation of restaurants and an aging population that eats out less — are not short-term problems.
Consult a third party, such as a restructuring firm, for assistance because restructuring can be a time-consuming process that requires timely negotiation. If a company has 100 properties and 100 leases, this could mean dealing with 90 to 100 different landlords. Restructuring firms can also help you raise the stakes if you aren't getting a response from the landlord.
Gary Graves is a principal at the financial restructuring firm Huntley, Mullaney, Spargo & Sullivan. He brings more than 15 years of turnaround experience in both Fortune 500 and private-equity settings. Contact him at email@example.com or (630) 513-0600.