So you want to buy a restaurant. Having sold more than 350 restaurants in the past 5 years I’ve seen my share of sad stories in the restaurant business. Every day I get calls from restaurant owners whose dreams of owning and running a restaurant have been crushed by the recent weak economy. The restaurant business is financially rewarding if one approaches it as a business and not a personal dream to be fulfilled. Don’t get me wrong. It is the dream that gets one to the point of considering buying a restaurant. But one must wake-up and put there reality hat on before jumping into the fire.
The biggest mistake I see buyers/tenants make is they focus an enormous amount of effort on trying to find a so called AAA location. In other words, to most buyer/tenants location, location, location is all they care about as though that’s going to make their restaurant a winner. We’ll this broker disagrees.
Why do I disagree? Let’s take an example. Let say there is a space in a so-called AAA location where there are 3,000 Sq. Ft. and the rent is $9,000 a month or $3 Sq. Ft. and then there is another space of equal square footage but perhaps a B location and the rent is $4,500 a month. Let’s assume for argument sake the parking and quality of the facility is the same and the B center is not a dump location, perhaps just a little older and perhaps dated.
I’m sure all of us can name dozens of very successful restaurants located in less than a AAA location. One of the most famous one is La Super Rica in Santa Barbara made popular by Juliet Childs. If you haven’t been there, you must go. It is a Mexican restaurant – not like any other and definitely not anything like traditional Mexican – where the building is 400 Sq. Ft. with a large covered patio. It sits on a corner location in a not so good part of Santa Barbara – if there is such a thing since the homes around the restaurant are worn-out and probably cost $500,000 – and the restaurant is about a mile off the freeway. I’d say this is at best a C location.
But this restaurant I estimate does no less than $10,000 a day. That’s 400 Sq. Ft.. That’s 5 employees. And no credit cards please. Can you say profits!
Another great success story is a steak place called Jocko’s in Nipomo California. This famous steakhouse started out as a local bar in the 1950’s. The owner put a BBQ pit outside the restaurant and started tossing steaks and whatnot over oak wood. Some 50 years later these folks do no less than 650 lbs. of beef a weekday and could reach 850 lbs on a weekend and that’s just the beef because they also serve chicken and pork. There is no less than a one hour wait to get into the restaurant to experience the wonderful meats – I know a secret on how to get served fast, call me. The lady who owns the place – the daughter of the original founder – is as sweet of a person as one can meet. The restaurant is probably 4,000 Sq. Ft. and frankly looks worn-out – although I believe they’ve been doing upgrades lately. It is in a small town with a population of 1,000 and one mile off the 101 freeway. Certainly, this is not a AAA location.
All of us know these kinds of success stories. There are many factors playing into why each of them is successful – primarily quality and value – but nevertheless, they defy the notion that a restaurant must be in a AAA location to be successful.
During this economic down-turn we’ve seen 10’s of thousands of restaurants across the U.S. close their doors. The primary reason, they had little volume to support the rent they were paying.
There are rules of thumbs one must use when considering opening a restaurant as it applies to whether the restaurant can support the rent. The one I like using is simple and known as the rent factor – the percent of rent as a percent of gross revenues or sale. This factor should be maintained at about the 6% range in order to have a good return on your investment. I feel for franchises such as Subway and Quiznos the rent factors should be in the 4-5% range because the franchise fees are pricey with these franchises. In other words, if a restaurant has gross sales (excluding sales tax) of $100,000 a month, then the rent should be $6,000 a month or 6% of the gross sale.
Working it backwards, if a landlord wants to charge $5,000 a month for rent, then ask yourself can the restaurant of your dreams generate sales of $83,000 a month ($5,000 divided by 6%) in order to provide a fair return? Most of the time the answer is no and the tenant should walk away.
So back to why I think a AAA location is over rated. In my earlier example of the 3,000 Sq. Ft. AAA restaurant location with monthly rent of $9,000 and the other B restaurant location with monthly rent of $4,500 a month I’d rather see the additional $4,500 a month be poured into advertising and marketing campaigns than in rent. I’d rather see the owner get aggressive with marketing and advertising for the first year and build the following and then cut back on that expense as the crowds begin to form.
Why do I like to see this, because it lowers the breakeven point from $150,000 ($9,000 divided by 6%) a month under the AAA location to $75,000 ($4,500 divide by 6%) for the B location. Wouldn’t you agree that doing $75,000 a month is much more doable than $150,000 a month?
And there is great upside when a crowd has been developed because if one does generate $150,000 in the B location, the rent factor is now 3% and one should be dropping no less than 20% net profit. One can cut-back on the market and advertising on the B location when the crowd has been developed, but in the AAA location, the rent will always be there.
And this brings me to another point. When selling a restaurant, it is much easier to sell a restaurant with a reasonable rent than one with AAA rent, therefore reducing your risks of having to make rent payment in the future.
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