Restaurant Lease Considerations

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In the business of buying and selling restaurant locations, as in the business of restaurant management, one of the most important ingredients for success is a lease that works to the advantage of all concerned parties. Anything less usually means something other than circumstances where everyone can be a winner.

Who are the concerned parties that we are speaking of and what would be their principal concerns with the restaurant lease?

THE PROPERTY OWNER: The landlord has many of the same concerns as the restaurant tenant, only the landlord views these concerns from a different perspective - that of the investor and/or manager of the property. Quality of tenant, length of lease, uses permitted, the process of assignment, rental rates and charges for operating expenses and the rate of return would be right at the top of the landlord's priorities.

THE RESTAURANT OWNER: Since the vast majority of urban restaurants are tenants, one can assume that the lease should also be a matter of highest priority to the restaurant owner: For the restaurant owner, the principal issues would be the level of rent and rent increases, the issue of minimum vs. percentage rent, the length of the lease term and the availability of renewal options, the ability to assign or sublet, uses permitted and operating hours. Economic issues should be at the top of the restaurant operator's lease priorities.

THE RESTAURANT BROKER: The ability to sell a restaurant business is greatly affected by the restaurant lease. Thus, the real estate broker also has lease concerns including the length of term left and available option periods, the rental rate, uses permitted, tenant qualifications and the ability to assign or sublet.

The property owner, the restaurant owner and the restaurant broker are all impacted by some of the realities that exist in today's flourishing restaurant marketplace including:

The average life span of most restaurant concepts, including those of many multi-unit operators, is five years or less.
The cost of rent should not exceed six percent of sales unless the landlord has made above average contributions to tenant improvements or the restaurant concept is capable of lowering operating costs to offset the higher rent.
At some point in the term of the lease, the restaurant business will be for sale.

Better lease situations permit the building owner to earn a fair rate of return and to have a tenant that strengthens the value of the property. Restaurant industry rules of thumb generally look for the landlord to be comfortable with a ten to eleven percent capitalization rate. Since the average life span of a restaurant concept is so short, the landlord should be prepared for and provide for a lease assignment mechanism.

Since the restaurant operator needs to make money to stay in business, the costs of the lease must stay within the six percent of sales guidelines. When the lease costs begin to exceed that level, it usually is a good indicator that the business is getting into financial difficulty. The restaurant operator also needs enough time on the lease to recapture the investment in the business. Savvy restaurant buyers look at the lease before they consider any other aspects of a restaurant business they wish to purchase.

The restaurant broker is concerned about the ability of the current tenant to assign or sublet the leased space and the qualifications that will be put on the new tenant. While most leases provide for fair and equitable lease assignment, some are so restrictive as to make it almost impossible to sell the business. The length of time left on the lease impacts on the value of the business and the ease with which the business may be sold. Anything less than three or four years is usually a bad investment for a buyer and can make it very hard to sell the business unless there are renewal options available or the landlord has indicated a willingness to extend the lease or to issue a new lease to the restaurant buyer.

The restaurant broker is also concerned with lease rate and looks for situations where the lease is at or below the current market rate for the area where the restaurant is located to create a good value for the buyer and a selling advantage for the current owner. Rates that exceed what good judgment says will work for most restaurants not only make it hard to sell the business but may also be creating a situation where the probability of failure on the part of the new restaurant business owner is unnecessarily high.

Please feel free to call us if you have any questions on this information.

We're happy to assist you.

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Tempe, AZ 85282
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