Have you been offered a new hospitality space?

The flurry of building projects being completed in our major cities has quite a sting in it’s tail for the hospitality industry. In my travels I’m seeing cafes, delis and restaurants being included in nearly every substantial new building in the quest to create satisfying work and living space for the tenants and purchasers of the new real estate.

On the surface this seems like a logical, welcome development that will provide convenience, colour, movement and atmosphere at street level to what would otherwise be fairly sterile concrete structures. The occupants of the new buildings certainly benefit, but do the hospitality operators?

For Lease

There are many properties aiming for a hospitality operator

Too many hospitality businesses in our big cities

I’m not so sure they do. We are now facing a serious oversupply of hospitality businesses in our major cities, especially in the middle and upper market levels. Every new business that opens for trade incrementally dilutes a market that has not seen real growth for some time. Put simply, there are too few customers, and too many businesses. This oversupply situation artificially holds the prices you can charge for goods and services down to levels that I now consider unsustainable.

Most of theses new spaces are being offered to operators as leaseholds, at ‘current market value’. What that usually means is that the spaces are being offered at a price that few hospitality operators can really afford to pay. You have to sell an awful lot of food and beverage to be able to afford to pay a rent of $500 per square metre — let alone $1200 per square metre, as we have recently observed being asked.

Office lunch

Are there enough people around to give you a decent trade?

The other tenants in a building probably won’t give you break even trade

The local population in these new building projects is usually fairly low — mostly way too low to support the hospitality businesses being established at street level. This means that if the business is to prosper there has to be either sufficient population to support it within walking distance; or convenient, inexpensive car parking close by. If adjacent buildings all have their own hospitality spaces, we end up with a situation similar to the island that Lewis Carrol described, ‘where the inhabitants made a precarious living taking in each other’s washing’.

Run the numbers

Hospitality businesses usually only trade for a small number of hours in every 24 hour cycle, during ‘service periods’. They also have a relatively low average transaction value, which normally falls between the range of $5 – $60. Customers can take up a lot of expensive space in the process — in cafes and restaurants particularly, a customer will occupy up to 2 square metres of floor space. To make matters worse average occupancy of seats can be as low as 30%. So what?

Well, all these facts can be established for any proposed business concept and extrapolated to calculate the potential ‘yield’ from that particular concept. This should be established in a feasibility study, but few operators bother; most seem to prefer to work on emotional judgement and the opinion of Uncle Jimmy who once had a cafe.

Lease

It’s very hard to get out of a lease once signed.

It’s hard to get out of a lease

Operators who don’t do their homework properly and leap into these ‘opportunities’ now often find themselves sandwiched between the opposing economic forces of low income and very high rent. Profit is then non-existent or negative, and the business has to be propped-up or subsidised in some way by the operator or their family.

The way commercial leases are structured there are substantial penalties attached to breaking a lease if you are in trouble. The threat of these penalties tends to make people hold on way longer than they should in a non-performing business, often to the point where they lose everything. The modern trend of banks requiring Director’s Guarantees and second mortgages on any business loans pretty much ensures this.

Avoid getting screwed

We’re watching with mounting disquiet as a procession of people seeking a new opportunity march like financial lemmings into unsustainable projects. Some of the leases I’ve seen are horrific — all to benefit of the landlord and not much for the operator. Take two recent examples, for instance: An operator signed a substantial lease for a restaurant in a new project which had a specified completion date. The restaurateur had an expensive new team ready to go, but the project is now going to be eight months late. The operator wears the cost.

In another example, we were asked to assist with tenanting a restaurant in a new project. When I inspected the site I became aware that the surrounding area would be a major construction zone for a further eighteen months. When I raised the issue with the property developer and declined to be involved unless there was compensation written into the lease, I was accused of being ‘commercially naive’.

Caveat EmptorLet the buyer beware . . .

Caveat emptor — ‘let the buyer beware’ — the legal maxim that has governed these matters from Roman times, no longer seems to be serving us too well. It may be appropriate in matters of retail trade and simple transactions, but it fails badly where a large well-heeled corporation is dealing with a small commercially innocent, independent business operator.

The answer? I hate to impose more regulation, but that is one solution. Another is for property developers to offer these sites as freeholds rather than leaseholds. At least the operator would have a second bite at the cherry — if operating profit fails, there is still the capital gain on the real estate which would tend to offset the business losses.

Ultimately, if property owners want stable hospitality operators tenanting their buildings as a necessary service to their occupants, they might have to bite the bullet and accept a lower return from these spaces. Pigs might fly, too.