Fast Food Tenant Leases (Absolute Net Lease)

[Gene H.]

Hello -

A friend that's part of an investment group owns an absolute net leased property occupied/leased by a national fast food chain operated by a franchisee that operates ~150 restaurants under several different entities. Issue is that the store is underperforming and the current tenant/franchisee is selling the business along with ~80 of their other stores and assigning the lease to another operator. They are allowed to assign their lease under the contract.

The would be new operator/assignee is larger than the current tenant and one of the largest fast food franchisees in the world in terms of stores operated and their properties sell at strong cap rates. If this franchisee assumes the lease, it should be a positive.

Issue is that they have asked my friend for a rent reduction as the rent to sales ratio for that particular store is low. They have threatened to create a new entity and throw my friends store into that entity rather than putting the store in the larger/stronger credit entity. I assume they would declare bankruptcy on the new entity and close my friends store down.

My questions for this situation are: 

1. Is it common for fast food tenants that are assigning leases to ask landlords for rent reductions?

2. Can the new tenant/assignee stop making rent payments at any point in time and/or declare bankruptcy without having their larger/stronger credit entity be liable in any sort of way?

3. The current lease has a personal guarantee provided by the owner/president of the franchisee/current tenant however this expires soon. There is also a guarantee that is substantially longer provided by 3 entities owned by the owner/presidents holdco. These entities also operate fast food restaurants. Issue is my friend does not know whether or not the restaurants held by the entities will be sold off in the same transaction or another. If they are sold off, would the guarantee still stand? If not, how would it be possible to ensure a similar guarantee?

4. What is the best way for my friend to protect himself?

Any input would be greatly appreciated. Thank you very much in advance!

[Joel Owens]

Gene it sounds like the lease was not set up optimally when originally created.

A commercial real estate attorney familiar with retail and business litigation should be able to properly evaluate the situation and make recommendations.

Does the tenant per the lease have to disclose sales,business financials, and ongoing personal?

If it does not now is the time to request it for any rent reduction considerations. You have to know what is the current rent to sales ratio for health.

Generally on restaurants it is 10% rent to health. So take base rent plus cam ( landlord insurance policy, property taxes, any admin or management fee ) and that amount should not go above 10% of annual sales.

So if rent is 100,000 all in you want to see location sales at 1,000,000 or higher. If rent percentage is above 10% the restaurant is starting to go in the danger zone as you add in food and labor and returns are minimal.

Look at current sales versus the brand's average. Is it at,below, or above market nationally?

A good attorney will not just give a blanket reduction. You can manipulate returns by altering the lease. You might could reduce rent but add in percentage rent above certain sales hurdles. So rent is XX 1,000,000 and below sales but any sales above 1 million there is a 5% kicker, So 1,050,000 would be 50,000 X .05 = 2,500 bonus rent to landlord that year. 100,000 would be 5,000 etc.

This scenario gives the landlord back extra return when the business turns around instead of a blanket reduction that only benefits the tenant. You would need to require that financials provided are certified and audited when presented to the landlord. This does not include annual rent increases that are part of the lease. If franchisee and not large corporate then you want increases each year in primary term. So maybe rent reduces initially but you increase rent by 2.5 or 3% annually instead of the current 1.5 for example to get a blended cap rate return over time to the same point. Which concept is it? For fast food many of them are starting to use kiosks and automating to save money versus pay high labor costs.

Is the site desirable? Maybe the tenant that is there is struggling because of the brand,poor management, over saturation for food type, and not the location. Maybe another brand that has a lower cap rate resale value and is more desirable would want the location.

Before negotiating with the current tenant you need to know how weak the lease is in your favor and the strength of the site for other options. You also need to know if there is alternative sites the tenant could move to or are they just blowing smoke. An astute tenant sometimes tries to take advantage of a less knowledgable owner to put things in their favor.

If a tenant is really struggling then the owner has to try and meet in the middle for solutions that work for both parties.

No legal advice given.