2010 August: The Time is NOW

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2010 August: The Time is NOWBack during the good ole days of 2006, one of the top complaints among owners of expanding restaurant chains was finding top-tier locations at reasonable cost. Not only were the best spaces taken, but buildout costs were expensive and finding good contractors was challenging.

Fast forward to today. The restaurant industry is reeling with chains and independents failing or shuttering underperforming locations. Same store sales fell precipitously in recent years, forcing many restaurants to re-engineer their menu with “value offerings” to entice the public to open their wallets. Bank financing has dried up, with financiers running away when they hear anything with the name “restaurant” in it.

You’d think it was the end of the world for restaurants. Instead, today offers an unprecedented opportunity for pizzerias with the right concept looking to expand.

There are some obvious reasons. The downturn in the commercial real estate market and failure of retail chains has forced landlords to lower rents quite markedly in some markets. According to CoStar, a commercial real estate information fi rm, the most recent data available showed that the national average asking retail rental rate fell 4 percent to $16.94 per square foot at the end of the third quarter of 2009 from a year earlier. And the decimation is expected to continue as Reis, another provider of commercial real estate market information, predicts that the vacancy rate will continue to climb throughout the end of this year, while effective rents will further slip another 1.4 percent.

Even traditional high-cost cities have seen rents fall. Numero 28 Pizzeria co-owner Rolando Biamonte has expanded to three locations in New York City over the last two years. “Greater space availability and falling rents have made it easier for us to bring our gourmet pizza to more locations,” says Biamonte. The company recently opened a location in the East Village to complement an existing West Village location.

Weaker operators, saddled with poor management, significant debt loads or high occupancy costs are being pushed out of business — resulting in less competition. Some failed restaurant locations are leaving suitable space and equipment. This is the strategy Vinny Williams, co-owner of Massachusettsbased Rose and Vicki’s, often employs when looking for new locations.

“We’ve been able to acquire restaurant equipment vacated by previous tenants from banks for pennies on the dollar,” says Williams. He and his partner just opened their fourth location in a former freestanding sandwich and pizza restaurant.

Lower rents lead to lower breakeven points, providing new restaurants with greater pricing flexibility and fewer required customer visits to prosper. “It certainly gave us more breathing room,” adds Williams. The annual rent on his most recent location is $40,000 less than what the previous tenant was paying. Some owners have even received free rent. And lots of it, in fact.

“On one of our leases, we received a year of free rent on a 5-year lease containing two additional five-year options,” says to Brian Ognian, vice president of development for Hungry Howie’s Pizza. The company has even been approached by landlords offering incentives for them to leave existing locations and reopen nearby. “In all the years, I’ve never seen anything quite like this before.”

While some concepts are negotiating lower rents, some chains are using these troubled times to move their brand up-market. This is exactly what the Marietta, Georgia-based Stevi B’s pizza buffet chain is doing. According to Matt Loney, president, three years ago a company the size of Stevi B’s could never get into prime, top-tier locations since space was often gobbled up by larger chains. “The downturn has afforded our company the chance to get into Class A locations at former Class B prices,” says Loney. The downturn has led Stevi B’s to plan aggressive growth with eight additional locations projected to open in 2010 to add to the current 35 locations they operate today. “We’ve even repositioned our brand to take advantage of these opportunities,” says Loney, who has been busy adjusting the company’s concept to take advantage of these new upper scale markets.

“We’ve been able to serve a whole new clientele with our latest locations”.

Landlords, in addition to offering lower rents, have increased tenant improvement allowances. Charlie Morrison, president of 360-unit Pizza Inn, has seen this phenomenon in Texas.

“I’ve seen tenant improvements steadily increase from $20 to $30 per square foot three years ago to $30 to $50 per square foot today,” says Morrison. “If you’re selective about opportunities, you’ll find them”.

Loney has also seen an increase in tenant improvement allowances. “Landlords know that traditional financing has dried up,” he says. He has seen landlords with strong capital backing increase tenant improvement funding to reduce the chain’s initial investment in new locations.

Sometimes the opposite occurs with TI allowances because landlords themselves lose access to capital. When they can’t fund tenant improvements, landlords are forced to drastically slash rents to entice tenants to pay for their own tenant improvements. Morrison saw rents at one retail shopping plaza fall below $10 per square foot from $25 per square foot four years ago because the landlord could no longer fund tenant improvements.

The drop in construction activity has been a boon for some pizza owners. According to Ognian from Hungry Howie’s Pizza, with unemployment in the construction industry in a state of depression, general contractors are lowering prices because their costs are dropping due to greater availability of subcontractors.

“Our contractors have been very aggressive and cooperative in lowering investment costs,” says Ognian. “The lower upfront investment is allowing some of our multi-unit operators a chance to open additional locations sooner than anticipated.”

Contractors aren’t the only vendors Ognian has seen getting aggressive on price. “We’ve been able to hire a design fi rm to help augment our brand that frankly was out of reach a few years ago,” adds Ognian.

Just remember that good times don’t last forever — but neither do bad ones. Expanding pizzeria operators are getting well-positioned for the next upturn, whether the good times return in six months or six years. ?

Timothy Howes is a business consultant and an Assistant Professor of Management at Johnson and Wales University in Providence, Rhode Island.