Navigating your way around the potential pitfalls embedded in a restaurant lease can be tricky. So, how to avoid them? By Kerryn Ramsey
A restaurant lease is one of the most significant contracts you can sign—ultimately it can make or break your restaurant. It’s also a key benchmark when evaluating the value of your restaurant, so it is vital to review and understand your lease before signing on the dotted line.
A lease, nothing more than a contract between a tenant and a landlord, gives the tenant the legal right to occupy premises. Setting out agreed terms of occupancy, it states conditions in writing concerning issues such as rent, repairs, insurance and the outcome when the building is sold or transferred.
It is important to read the fine print and receive advice from a solicitor and/or accountant. There is no standard commercial lease; everything is open to negotiation.
According to Bob Hamilton, co-owner of Era Bistro in South Brisbane with his son Brad, everything said should be notated, everything agreed signed. “Assume nothing and be as sceptical as possible,” he says.
He’s learned the hard way after his former restaurant, Circa, was closed due to redevelopment. “If you’re dealing with a developer, you should look out for everything. My experience with developers has been most unhappy,” admits Hamilton.
Despite this hurdle, he found his track record helped in negotiating a lease for Era. “Having a history of being successful put us in a stronger bargaining position.”
Price is right
The first step when negotiating a lease is to ascertain the market rent.
If your potential venue is on a restaurant strip or in a shopping centre, get advice from local restaurateurs and real estate agents. “Shop around,” says Hamilton. “Find out what the market rate is at the time. Restaurant owners are happy to talk about it.”
If your restaurant has little passing trade—such as a suburban café with few shops in sight—it is best to talk to a commercial broker who writes retail restaurant leases in the area.
After researching the rental market, take an average of the rents you’ve surveyed and use this number as a basis for negotiating with the landlord.
When renewing a lease, it’s worth capitalising on your past success as a tenant—such as paying your rent on time and keeping the premises maintained—as a tool to negotiate a favourable rent.
How else does a restaurateur know if the rent is fair? “You just have to work out your percentage,” says Graham Bolton, co-owner of Char Char Bull with his wife Rhonda in Fremantle, Western Australia. “Most people advise that a restaurant shouldn’t pay above 8 per cent of takings in rent. In your negotiation stage, be mindful of what you consider budgeted takings against the cost of the actual rent.
“This figure can vary dramatically, subject to the value of the location. If it’s a location that doesn’t require any marketing, a person will pay a higher rent,” Bolton says.
Tony Eldred, founder of Eldred Hospitality in Melbourne, says: “Many restaurant owners are too optimistic and sign leases they can’t deliver.” His advice? Review worst-case scenarios so you have a picture of the potential financial impact during the leasing agreement.
Several cost factors can affect a leasing agreement. Potential restaurant owners need to ask the landlord a multitude of questions, including:
- Does the property have the correct zoning requirements?
- How often will the rent agreement be reviewed?
- How will the rent increases be calculated?
- Are there any restrictions on the hours you can access the property? Is it possible to change opening hours?
Bond is another cost to wear when setting up. Landlords will charge a bond as part of the lease agreement, and the cost can be as high as three months’ rent.
Dru Gillan, solicitor of the Restaurant & Catering NSW Legal Practice, points out another cost to watch: “In retail space pricing, there can be several layers of administration between the purchasers (restaurateurs) and the sellers (landlords). The landlord often has real estate agents who earn commissions for selling the space, and their solicitors are hovering. The potential buyer is at a disadvantage when forced to make a quick decision. This is to be avoided at all costs.”
Gillan also says a restaurateur should restrict the escalation charges—expenses incurred by the landlord, such as increased property taxes and property and business insurance—for later years. Though you may be asked, says Gillan, you do not have to agree to share these costs.
According to Bolton, add-on property costs and rates are usually separate from rent, “but sometimes these variables can be as much as the rent itself.’’
Bob Hamilton prefers to negotiate a complete figure, except for electricity and gas. “Then I know exactly where I’m going, particularly in Queensland, where we have enormous costs such as water bill increases. My rental here is a gross figure, and I feel comfortable with that.”
Before signing the lease, other costs, including repair and maintenance, can be imposed on the tenant, shared with the landlord or paid in full by the landlord. When the lease ends, ensure you know in what standard it is to be returned. Also, who pays for council rates, security, legal fees and cleaning?
Signage issues also need to be assessed. Does the signage affect other leasees, and does it fit in with the look of the area? “A lot of properties have advertising budgets,” says Bolton. “In the lease, you may have to contribute to a shopping centre promotion even though it may not be applicable to the restaurant. This can be an expensive add-on.”
There are various insurance options—public liability, building, glass—to consider. You also need to know if you have to make payments toward your landlord’s insurance as well as your own.
Be clear about the contents of the rent, which can include heating, air conditioning, security, cleaning and parking. The tenant will also often have to buy the utilities from the landlord. Be sure you have a right to audit the utility bill.
The duration of a lease can be a defining factor in the success or failure of a restaurant.
Most restaurateurs want a longer lease coupled with a reasonable rent review, which offers security and gives the business an opportunity to grow. The restaurateur needs a renewal option to extend the lease if required.
“Some people prefer straight leases, continuing for about 10 years,” says Bolton. “My preference would be a three-year lease plus two four-year options.”
The lease must be long enough to establish your business, but not so long that you can’t move or close the doors. Hamilton says: “I like the longest lease I can get,” he says. “I would never look at anything less than seven years and at least another five-year option, but get as many as you can.”
According to Eldred, lease increases need to be addressed. “At some restaurants, rent goes way over inflation —it can be more than 10 per cent a year.”
He notes some leases state the rent doesn’t rise, but the property isn’t maintained. “If the restaurant owner has to pay for deterioration, the costs can escalate severely,” he says.
The ‘make good’ provision
Perhaps the biggest trap restaurateurs fall into is not taking into account what happens when the lease expires. All leases contain a ‘make good’ provision that requires the tenant to return the premises to the landlord in a similar state as at the start of the lease.
Before signing a lease, do a detailed report on the state of the premises.
Bolton is wary regarding the ‘make good’ provision since he closed Sails Seafood Restaurant in Fremantle recently. “It had been a successful business for 18 years, but the landlord wanted a significant amount of money spent on the premises. It was a very expensive exercise.”
Gillan notes some tenants have discovered on leaving the premises they were required to remove everything, including the fit-out. “These additional costs ranged between $25,000 and $65,000 for some restaurants,” he says.
“Where it is agreed that the fit-out can be left, this should be documented.’’
Hamilton shudders over the ‘make good’ provision, commenting: “My advice? Get a good lawyer and read everything yourself. Query your lawyer, the developer and the landlord. When you’re comfortable, make it signed, sealed and delivered.”