Arguably, the pandemic wreaked the worst damage on the office and retail food groups. And within those two sectors, it might well be restaurants that now have the greatest ground to make up.
Nancy A. San Pedro, CPM®, has been standing side-by-side with retail tenants of all stripes throughout the depths of the pandemic, and has witnessed the changes they’re making in their leasing wants and needs as a result of the health crisis. The Los Angeles-based retail director of Equity Residential, AMO®, agrees that restaurants were initially the most beleaguered retail sector, but reports that post-COVID, the market is turning. In fact, “We’ve opened three new restaurants and plan to open three more” in coming months.
The retail market overall is indeed turning toward recovery, although, not surprisingly, San Pedro reports that recovery is market- and income-specific. Deloitte’s October 2021 Holiday Retail Survey reveals as much: “Average spend [is] up five percent YoY, boosted by a return to experiences (up 15 percent YoY), but gains are largely driven by high-income groups.” Those “experiences” include more restaurant activity.
Clearly the entire retail sector still has runway left before full recovery. “In my portfolio,” she says, the split between flourishing markets and those “that mimic what you’re hearing in the news is probably 50/50.”
Redefining the leasing expectation
“There’s a lot of chatter about tenants looking for bargain-basement pricing,” she continues. “I haven’t seen that.” What she is seeing is more landlord flexibility in respect to length of terms and how landlords generally are pricing, especially in the restaurant space.
“In triple-net or gross leases, the landlord’s income is guaranteed,” she explains. But more percentage rents, based in part on the gross sales of the tenant, are creeping into leasing conversations with restaurant tenants. “In those cases, the owner has to ride the wave with the tenant.”
That wave may also include less space. “The total square footage is changing,” San Pedro says. “What was a 3,000-square-foot dine-in restaurant might now shrink to 1,800 or 1,500 feet.” The COVID-induced trend toward third-party deliveries and away from dining-in is one of the drivers of that trend.
Not surprisingly, she’s also hearing requests for landlords to take on more of the construction work, requests that are easier to fulfill if the lease term is longer or it’s second-generation space – a space already used as a restaurant. A potential tenant looking at a first-gen restaurant on less than a three-year term, “isn’t ideal because my out-of-pocket is so high,” with the costs of modifications. On second-gen space, however, where the store is kitchen-ready, “I’d be willing to consider a two-year term for the right operator on the likelihood that they’ll renew.” If not, at least the upfront out-of-pocket wasn’t so steep.
There are two cases that counter the trend toward smaller footprints, however. First are those tenants who are asking for COVID-friendly spaces and opt to spread out for better social distancing rather than removing potentially income-producing tables, especially where outdoor dining is readily available. The other exception comes in the growing trend toward so-called commissary kitchens, where a variety of styles and brands can be found under one roof. “In those cases,” she says, “it’s not uncommon to see 5,000 square feet and up.” We’ll have more on that shortly.
The tech dynamic
One of the lessons that came out of the pandemic was the importance of technology in both operations and leasing. San Pedro explains that Equity was already “on that train” in their leasing protocols long before COVID struck, with innovations such as electronic signatures and virtual tours. “Now everyone is doing it,” she says. And yes, while virtual tours come in handy in the early stages of leasing conversations, “at some point, tenants need to come in and kick the tires.”
More than virtual changes, San Pedro reports that physical changes, beyond the expansion or contraction of footprints, are the order of the post-COVID day. As just one example, curbside pick-up makes designated parking spaces a must-have and, therefore, can be subject to a lease amendment, especially in dense urban markets where parking is precious. A Grubhub driver “can’t circle the block waiting for a parking space,” she says. “People want their food.”
The future of retail and restaurant leasing
In all, San Pedro is optimistic about the future for retail and the restaurant sector specifically. Yes, it’s different, but media hype distorts the true picture. Acknowledging the regional pockets of sluggishness, overall, “I am not seeing the doom and gloom.” What she is seeing is change.
“Some models didn’t survive the pandemic, and that’s unfortunate,” she says. “But I’m also seeing new models emerge,” such as the above-mentioned commissary kitchens and ghost kitchens such as Gorillas (a growing delivery service with a 10-minute guarantee). “Before, I might have had a 15,000-square-foot space that I didn’t know what to do with.” Today, such spaces open pathways for new market entrants.
“It’s a nice thing to see,” she concludes. “It’s a nice re-use of large-box spaces, and it gives me hope for the future.”