Tips for Drafting and Negotiating Restaurant Leases
As restaurants gain popularity as the flashy new anchor tenants in real estate developments, a number of restaurant-specific lease concepts will arise in lease negotiations for a well-planned restaurant space. The importance of certain concepts have been heightened as the development of mixed-use properties has accelerated. Being aware of these concepts and thoroughly contemplating them during lease negotiations will add clarity and certainty when the Lease is turned over to property management after opening night.
Scrubbers are increasing in popularity, both as a landlord requirement and a requirement per applicable codes and ordinances. A “scrubber” is a piece of equipment which filters odors out of hood exhaust generated by restaurant operators. As developers have moved toward constructing office and residential components on top of street-level retail, scrubbers have become more commonplace. Without a scrubber, a restaurant user at street level might jeopardize the ease with which a landlord can lease or sell multi-family or office constructed above retail. Suddenly those fancy balconies aren’t as much of a selling point as originally envisioned. Scrubbers can be costly to install and maintain, so if you’re doing a deal with a first-time restaurateur, be sure that they’ve priced one into their budget. Also, from a property management perspective, scrubbers should be treated similarly to HVAC units. Tenants should be required to maintain service contracts and provide evidence thereof to their landlords.
2. Grease Traps.
Grease traps are nothing new, but as food halls and restaurant-heavy mixed use projects become more common, it’s important to be sure that your Lease form correctly contemplates how grease trap repair, maintenance and invoicing will work in the real world. A typical form Lease will place repair and maintenance obligations on the tenant, but, increasingly, landlords are constructing communal grease traps which service all or a portion of a development. For a communal grease trap, the repair and maintenance obligation should be on the landlord, with the costs thereof being equitably apportioned among the grease trap users. This is typically accomplished as a proportion, with the cost being allocated based upon a restaurant’s square footage relative to the square footage of all restaurant users connecting to the communal grease trap.
It’s important for landlords and property managers to have a firm understanding of the capitalization structure of their restaurant tenants. This is a material point as security deposits, guaranties, and letters of credit are negotiated. The financing structure also impacts property managers. Once a Lease is signed, restaurant operators will often apply for funding from traditional and SBA lenders. In connection with that financing, lenders will typically require the landlord to enter into a landlord lien waiver or a landlord lien subordination agreement. In such an agreement, the landlord acknowledges that the lender has a lien right to certain restaurant collateral which is superior to the lien interests of the landlord. If a restaurant defaults on its lease obligations, a restaurant lender will attempt to foreclose upon its lien to obtain legal possession of the collateral which, likely (at least partially), secured the lender’s loan to the restaurant. The landlord can often negotiate a number of safeguards to protect its interests if a lender attempts to foreclose, but lenders will likely require a priority position. That’s something that landlords just have to stomach to make a restaurant deal happen. Lenders will typically agree not to disturb the day-to-day operations of a property as they take back their collateral, including the waiver of the ability to conduct an auction or sale from the restaurant space, which can be particularly disruptive to the aesthetic and day-to-day operations of high-end developments.
4. Franchisor Riders.
A restaurant franchisor will almost certainly require the landlord to enter into an agreement which grants the franchisor certain rights in the event of a default by the franchisee-operator. Franchisors invest significant resources into identifying and securing sites, and if a franchisee-operator isn’t living up to its obligations or expectations, the franchisor will want the ability to take back the space and either operate the restaurant or assign the Lease to another, better-qualified, operator. These franchisor riders are typically attached to the back of the Lease, but owners and property managers should be aware of their obligations to provide notice to the franchisor following a default by the franchisee/tenant under the Lease. Failure to provide notice to the franchisor and an opportunity to cure the default can create liability to the franchisor that no landlord would want to take on. And, the presence of a franchisor’s rider, doesn’t mean that it’s any less important in prudently managing the day-to-day operations of a property featuring restaurant uses.