How much rent should I pay?

How much rent are you paying for your restaurant or cafe? Some of the figures I hear about in my travels make me shudder and wonder how some people manage to make any kind of profit. A fair proportion of this industry seem to be working hard for their landlords and not for themselves.

For Lease

There are many properties aiming for a hospitality operator

The prices charged for leasing or renting a property are dictated by the laws of supply and demand. As a rough rule of thumb we can assume that the higher the surrounding population density and the more grand the building, the higher the rent you will pay. In addition some locations attract a premium for such features as high pedestrian traffic, proximity to theatres, ease of parking, grandiose décor etc.

Landlord’s needs and yours are different

It’s a fair enough way to value real estate if you look at it from the perspective of the landlord, but if we consider the situation from a hospitality operator’s point of view, some complex difficulties arise that need to be considered before you sign a lease. If you don’t, you’ll find yourself trying to renegotiate the terms of your lease mid term, which can be quite difficult, if not impossible.

It seems like property developers and architects are putting restaurants and cafes in most of their new buildings. Quite a few of my clients have been approached to lease space in these new developments and have asked me to evaluate the proposals they’ve been given. Not many of them are very attractive.

No direct relationship between rent and your pricing

The essential problem is that there is no direct relationship between the rent you pay and the prices you can charge for your goods and services. Rents are dictated by real estate market forces and the prices you charge for your products and services are dictated by hospitality market forces — there is absolutely no connection. Another way of looking at it is to recognise that your customers don’t care if you are paying a high rent — that’s your problem — all they care about is their own perception of value for money which is dictated by their past experiences and what they can get for their money elsewhere, including out in the ‘burbs.

Surburban Restaurant

Cheaper rent usually means higher marketing costs to lure customers to you.

This leads to the situation where they can have a similar meal in a good suburban restaurant for half the price they can have the same experience in a CBD location. If you dine in the Sydney or Melbourne CBD area you’ll get a good idea of what I mean. The prices of food and beverage are getting to a level I call ‘interesting’. Main courses have commonly reached the $50+ mark in upper level establishments and entrees have reached the $25+. Diners would be forgiven for thinking they were buying shares in the business, but the astronomical rents being demanded by landlords necessitate pricing at these levels to maintain profitability.

I see the same pattern being repeated over and over. A new development is built and the better hospitality operators are approached one by one by the developer who wants the right mix of tenants in the building. The experienced operators reject the deal because the figures don’t stack up correctly. Eventually the projects are offered to less experienced operators because no one else will touch them. The less experienced operators then sign themselves up for punitive leases that effectively neutralise all profits both now and in the future.

At the extreme end of the scale I’ve seen ‘percentage of turnover’ leases as high as 18%. We know that you can’t make money at this level of rent unless you charge unsustainable prices, yet people always seem ready to queue up for the leap off the financial cliff. This is especially true of hospitality tenants in our larger shopping centres, who seem to establish and then go broke with alarming frequency.

Don’t settle for % of turnover rents

In general, I’m more keen on flat price rents than percentage rents because the flat rent gives you a good opportunity to make some serious money if you can get your income substantially higher than the figure you based your rent on in the first place. A percentage of turnover deal can often yield a substantial above-the-market windfall to the landlord if your income goes up — resulting most of your hard work and effort going into their pocket, not yours.

I had a clever client who took over run down tearooms on the Port Phillip Bay foreshore and negotiated a flat rate 21 year lease on the historic figures of his less-than-inspired predecessor. My client then proceeded to build the business to a turnover about ten times the previous level. To cut a long story short the rent ended-up amounting to less than one percent of their turnover — much to the landlord’s chagrin. That’s the way to do it, but believe me — it’s rare. It’s usually the landlord who has the upper hand.

The bottom line is that if your rent amounts to more than 8% of your turnover you may have a millstone around your neck. Ideally your rent should be about 5–6%. Rent plus marketing should not exceed 12%. The better your site, the less you have to spend on marketing and vice versa. There’s not much you can do about high rent if you’re on a percentage lease, except appeal for a rent reduction on the grounds that it’s not in the landlord’s interest to have an endless turnover of hospitality tenants. Good luck. If you’re clever enough to be on a fixed amount, work on your income. The more you take the smaller your rent percentage becomes.

Oh, and one last word . . . Don’t accept rent increases unless they are balanced by improvements to the property. Otherwise you’ll find yourself paying an escalating amount of money for a deteriorating premises.