Tommy Bahama's real estate hunt

The search for casual-restaurant chain Tommy Bahama's newest unit began way back in 1997.  Execs wanted something in an area with a year-round warm climate, which matched the company's beach-oriented profile. They wanted a tourist-rich, upscale community, and they wanted a big space—14,000 sq. ft. or so—to accommodate both the cafe and a store for the company's line of clothing and accessories.

While it obviously had no beach, Arizona hit all of the bullet points. So scouts combed various cities there for sites. Something in Scottsdale looked promising, but the landlord wouldn't budge on rent. The price was right at a Tucson site, but it looked out onto a parking lot. Deals in North Scottsdale and Phoenix were nixed due to problems with neighborhood organizations and sticky local government restrictions, a co-tenant mix that didn't complement the brand, and those high rents again.

As the search entered into and then exited the boom years, the Scottsdale site sat unoccupied. Restaurant division president W.C. Wells and Scottsdale broker Kim Craig revisited the landlord and, after almost a year of tense negotiations, hammered out a 10-year lease. Tommy Bahama's seventh cafe will open in November.

"We didn't feel the landlord understood the economics of the situation," says Craig. "Ultimately, both sides had to give in on certain points. It was a long, arduous process."

Should it have been? With the economy still finding its feet, conventional wisdom would have landlords rolling out the red carpet for a restaurant company that does $30 million a year. And doesn't a soft economy mean lots of out-of-business signs and empty stores, and breaks for those willing to rent them? And don't current conditions mean that many have scaled back on their growth, opening up the field for those who choose to do so?

You might think all of these things—and you'd be wrong. In fact, say insiders, the competition for the prime spots is as cutthroat as ever (or worse, some say), and real estate execs in all industry segments are reporting mounting frustration in their site searches. Listening to them, it can sound like the go-go late '90s never ended.

"It's the toughest it's been in 15 years," says Ed Williams, VP of development for casual chain Damon's Grill. "There's been an explosion of growth the last few years, with a huge influx of competitors that are willing to pay ridiculous rates."

He and his real estate colleagues offer no shortage of reasons why it's so tough. There are the record-low interest rates, which not only give landlords greater impetus to keep their prices high, but have also increased the number of competitors—restaurant and retail—vying for the good sites. Some point the finger at local governments' failure to loosen up an increasingly thick tangle of regulations, despite the need for economic stimulation. Then there are the ever-expansive ambitions of public companies, their growth mandates often oblivious to a down economy, keeping prices where they were during the boom years. And still others blame the boom years themselves, saying that real estate prices simply never sunk below the high-water marks they hit a few years ago.

While low interest rates are, of course, good for business, some execs these days are faulting them, too. Due to the low interest rates, they say, landlords are more likely to keep a property empty for the short-term than drop their prices just to fill the space, because the payments they're making to the bank are comparatively reasonable. "The cost to hold onto property is as low as it's been in many years," says Eric Lavanger, VP of franchise development at Dairy Queen. "With low carrying costs, landlords are happy to hang onto their dirt a little longer."

Others point out that the low interest rates—coupled with the recent waves of corporate downsizing—have increased the competition. How? There are (theoretically, at least) more former executives turning into entrepreneurs—either by opening restaurants or other retail businesses. And of course, they need locations.

That frustrates operators like Atlanta Bread CEO Jerry Couvaras, who's trying to carry out plans to open 50 units next year. "I predicted greater availability and cheaper prices, and it just hasn't happened," he says. "It's due in part to more people chasing the American dream and opening the stores they've always wanted to open."

And it's not just individual wildcats, either. Williams says the stiffest new competition for sites is coming from national drug store and bank chains, the latter of which he says are expanding aggressively after deciding that customers preferred banking face-to-face instead of online. "Since they'll pay the highest rates, the big drug stores and banks are the first choice for sites, followed by high-credit public restaurant companies like Darden," he says. "That's what we have to contend with."

Indeed, admittedly bad real estate deals earlier this year by both California Pizza Kitchen and Panera Bread suggest that there's still a considerable buy-now-ask-questions-later mindset among some public companies out there. CPK co-chairman Rick Rosenfield told Wall Street that former CEO Fred Hipp's departure was based on "poor real estate choices" amidst the company's "aggressive" expansion strategy, while Panera CEO Ron Shaich chastised a developer in the Dallas market for picking what the chief executive called "the wrong real estate." (Both companies chose not to comment for this feature.)

If it appears some developers are stuck in 2000, so too are prices. Some siting execs observe that while real estate prices shoot up in a boom economy, they're much slower to descend as the economy cools off. "Acquisition costs for a new property are based on historical records of similar properties that have been sold in the last 12-18 months," complains Craig. "Property valuation looks in the rear-view mirror, instead of looking at current and future trends."

And that mirror shows some prospective tenants waving fistfuls of dollars in landlords' faces. While landlords may suspect that the property is worth less than they're asking, they'll nonetheless keep the inflated price tag on it, say scouts. "They're reluctant to value their property for less than they paid for it," Craig adds, "so they'll name a high price, knowing that somebody will eventually pay it."

Making matters worse for real estate execs is what they say is a rise in often dealbreaking costs attached to building codes and governmental ordinances, as increasingly active citizen groups pressure their leaders to manage growth. One scout reports that the cost of opening a restaurant is about double what it was just a few years ago. Besides an increase in the cost of the real estate itself, there are elevated fees stemming from sewers and water. Another scout mentioned one building permit process he'd encountered. While not long ago it took a week or two to get the papers in order, the process can drag on for as long as 16 weeks. It all requires extra time and money that could be spent searching for new sites, he says. Adds Lavanger: "Cities are really tightening up their development and making it hard to grow. You need some degree of flexibility if you want to continue growing."

Such an ultra-tight market has, in turn, caused site scouts to make some significant adjustments to their search methods. Reacting to the tough market conditions, some have beefed up their searches with high-tech, cutting-edge tools. But others claim they've found success by returning to the old gumshoe methods. The best intelligence, they say, comes from simply getting out on the road and looking. Others believe that modifying their prototype as a response to a limited selection of property has helped them in the fight for space.

Wells, for one, is a big believer in lo-fi legwork. Prior to joining Tommy Bahama's, he was saddled with figuring out why an upscale seafood unit opened in a wealthy Portland, OR, neighborhood by an out-of-state company was underperforming. So he canvassed the area, polling 25 top-grossing restaurateurs, who told him all of the city's upscale seafood restaurants were on the water. His unit wasn't. "You can learn more from talking to people or just standing on a street corner watching them," learned Wells, "than you can from some site analysis book or program."

Other chains have again turned to the services of local middlemen who, though they add to the cost of finding a site, know the local market better than a far-away headquarters will. While the concept of using the local broker is anything but new, the challenges in the real estate market are so considerable, chains say, that the local guy is suddenly more in demand than before. Ask Dairy Queen, which has enlisted the aid of these scouts in order to locate sites for the 60 Grill & Chills (the chain's fast-casual concept) it hopes to open in 2004. "The brokers have a wealth of knowledge and experience in the local markets that we just don't have the time to get on our own," says Lavanger.

Difficult real-estate conditions also seem to have added impetus to the trend of chains scaling down their blueprints to fit into secondary and tertiary locales—something seen a few years ago when outfits like Applebee's and Krispy Kreme shrunk their basic footprints in order to groove with smaller markets than they had previously penetrated. Today, companies like Captain D's, Popeyes, and Damon's are following suit. Captain D's is, in fact, staking all future growth on the tactic: all 20 stores slated to open in 2004 will be the smaller size. "It's about reducing construction and land acquisition costs," says real estate VP Jeff Hammers.

The challenge, of course, lies in getting the stores to do comparable volumes as their bigger brothers. Hammers says his smaller units pull it off with increased carryout business, thanks to an operations system better suited for it. The smaller Damon's units, which the company debuted in May 2002 and will open three or four more in 2004, close the gap by doing an increased daypart business. "Depending on sales volumes," Damon's CEO Shannon Foust has stated in a release, "a smaller building can provide a better investment return in some markets."

And it well might. But given today's siting realities, some execs add that even if they do find what appears to be a desirable site, they may hedge their bets by signing a shorter-term lease than they would have in the past. After all, you just never know. As Church's real estate chief Wade Allen puts it: "You might think twice about setting up on a long-term investment, one that limits your exit capabilities."

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