The lousy economy could mean good news for chains with cash to expand.
We’re like a buzzard,” says Mike Lassiter. He’s talking about the real estate strategy he’s employing with Rising Roll Gourmet, a 13-unit, fast-casual sandwich concept based in Atlanta. “A lot of companies that were very aggressive in site selection during the last few years ended up overpaying for sites. So we’re circling, looking for opportunities in the key markets we want to be in, because we think some of those sites are going to come back on the market.”
Indeed, Rising Roll is taking over an Atlanta site that was shuttered by another fast-casual concept. The landlord has come down about 20 percent on lease rates in order to get the space filled, according to Lassiter. In general, he says, “landlords are more willing to do realistic deals, as opposed to the more overpriced deals they were doing a few years ago.”
And Rising Roll isn’t alone. Other chains with expansion plans and, critically, access to financing, see the current slowdown in commercial real estate—and retail space in particular—as an opportunity to get good deals where other chains have faltered.
“It’s a good time for the strong to expand and the good concepts to go forward,” says Tom Prakas of The Prakas Group, a Boca Raton, Florida, real estate firm that specializes in restaurants and nightclubs. “While there are still some centers that are very strong, lots of landlords are definitely in a deal-making mood.”
Still, not every chain is getting in on the action. Prakas says he has trouble convincing clients to put money on the table these days, a scenario he likens to stock market investors’ well-documented tendency to buy when the market is doing well—rather than buying low and profiting on the upside.
Indeed, the overall economy doesn’t present reassuring signs to soothe a nervous operator’s fears. Consumer confidence is down, reaching its fifth-lowest reading ever in June; meanwhile, inflation made its biggest annual jump since 1991. The housing market continues to struggle and U.S. employers cut jobs for the sixth straight month.
Those factors are reflected in commercial real estate figures. Investment in commercial real estate is declining, according to Jed Smith of the National Association of Realtors, due to the credit crunch resulting from the subprime mortgage crisis and general uncertainty about the economy. Transaction volume in Los Angeles, for example, is down 85 percent over the same period last year, according to Smith. Baltimore is down 92 percent and Cincinnati is down 82 percent. Some markets are seeing slightly more activity, with transaction volume in Stamford, Connecticut, and Manhattan down 11 percent and 35 percent, respectively.
At the same time, Smith says, rent gains across the United States are slowing and vacancy rates are rising. The national retail vacancy rate increased from 9.2 percent in the fourth quarter of 2007 to 9.7 percent today. As a result, “the edge in negotiations is moving toward the tenant,” says Smith.
That sentiment is echoed by Tim Mosbacher, vice president of real estate for Noodles & Company, the Colorado-based, fast-casual concept. “I wouldn’t say the tables have completely turned in favor of the buyer or tenant, but the situation has definitely improved,” says Mosbacher, who is overseeing launches for 20 to 25 additional units this year. “Prices have leveled off, and we’re making some headway in landlord contributions toward tenant improvements. I think they’re willing to contribute extra cash so they can keep lease rates where they expected them to be,” he adds.
In addition to the cash for set-up costs, Noodles & Company has been offered lease terms of $2 to $3 a square foot lower than the going rate in some locations. As a result, like Rising Roll, the firm is going ahead with its expansion plans. Mosbacher says the chain is “very realistic” about the economy, but that company executives don’t see any reason to pull back. That philosophy is unusual among operators these days, according to Marty Kotis, a North Carolina commercial broker who is president of the Council of International Restaurant Real Estate Brokers. Kotis says many restaurants—and retailers in general—are delaying expansion plans until 2009 or even 2010.
As a result, Kotis says opportunities exist for chains with a solid understanding of the business cycle and deep enough pockets to weather potentially poor performance in the short term. “If you find a location you like, you might have to eat your sales for 18 months or two years. So maybe you take the real estate and sit on it for 18 months,” he says. “Or maybe you work out a deal with the landlord and pay half rent for the next 12 months; they get to lease the space, but you don’t have to eat the entire cost.”
Another option is going the build-to-suit route. “Developers like myself are wheeling and dealing more,” says Kotis. “For the right concept, we’ll give them pretty much all the money they need to open their doors, since we’re well funded and have access to capital that an operator may not have.”
The commercial real estate market tends to lag behind the residential market by about a year, according to Smith of the National Association of Realtors, which is projecting improvements in the housing market by late this year and into 2009. So, if the commercial market follows a year later, prices will rise—and landlords and sellers lose interest in negotiating—late next year and into 2010. In the interim, store closings at Starbucks and other concepts mean that many solid sites are likely to come on the market.
Still, cautions broker Tom Prakas, don’t snap up a site just because it’s cheap. Conduct your normal due diligence, including traffic studies and searches for comparable transactions. “The only difference now is that you can hold out for your best deal,” he says. “You make your money when you sign a lease or buy a property. Then, when the economy does turn around, you’re going to say, this was a great deal.”