Deal Driven

We often hear that a restaurant company’s expansion is “deal driven.” What exactly does that mean? In too many instances, it means site selection was determined when a landlord offered a hefty allowance on one or more properties. The restaurant company jumped on the allowance, instead of relying on high-quality site metrics. I’m amazed each time I see it happen, because it’s a mistake that is very difficult to overcome. It affects operations for the term of the lease.

It’s easy to understand the reasoning. Restaurants are capital intensive; cash is king for a small growth company. If a new restaurant can be opened with a reduced cash outlay, it must be a good deal. The cash-on-cash return will be huge – right?

Wrong. While high landlord allowances require a smaller initial cash outlay, such deals almost always come with high rents. And, high rents raise the break-even hurdle, resulting in a highly leveraged P&L. That means the restaurant company needs to generate high sales just to stay in business. Here’s the ironic twist: high landlord allowances never generate high sales, but high-quality sites do.

The amount of landlord allowance is a finance decision, not a real estate decision. A solid real estate strategy differentiates between the two. Sites should be evaluated on the basis of potential, merit and capability to generate sales – independent of the deal structure. For our partners, we create a new store pro forma analysis using a return on invested capital approach. If the unfinanced returns meet the company’s hurdle, then the question can be asked, “How much cash outlay will this potential site require?”