Dilemma: Should I let commercial tenant expand?

Question

6 unit, 1 commercial space, 5 apartments. 3 units in front, 3 in back. The commercial space is rented to a restaurant on the first floor. Owner of restaurant wants to break through to the apartment in the back of his restaurant and expand his business. He wants to expand so he can get a liquor license. His restaurant is very delicious, the ambiance is beautiful, but his success is less than stellar because he feels his lack of liquor license is a problem. However, he always pays his rent. If I don't allow this expansion, his business will go under and I'll have an empty storefront to deal with. For the record, I've had about 10 different businesses in there that have all failed or moved on and I'm left with an empty storefront. This current tenant is from the neighborhood and is committed to making this work. But not sure if I want to deal with a liquor license and what that could bring to the property. Im not sure what to do. Opinions?

Joel Owens · Answer

I had over a decade in the food business in all facets before getting into commercial real estate.

Food is low margin which is why he wants the liquor license. The main meal you have next to nothing for margin and it is a draw for the restaurant. The tea,coke,etc. has high margin along with appetizers and desserts.

If customers are being cheapo and just using coupons for the main meal and getting waters you might as well close down the place as there is no money to be made.

Bottled beer drinks have low margins, followed by draft, followed by highest margins with custom liquor drinks. Even if he expands with a liquor license he has to have expensive taps and systems with computers to monitor any waste or his high margins go down to nothing.

Does the tenant disclose annual and monthly sales per the lease? Are they using a POS system to track everything? If not they desperately need one. If sales are not disclosed per the lease you need to make that  a requirement for looking at allowing an expansion and liquor license.

When I sell triple net retail we look at sales to rent ratio. For a restaurant optimal is 8% or under sales ratio. So if rent is 100,000 a year all in including CAM we want to see 1,200,000 in sales. Once you add in food and labor you need that margin. If rent to sales is getting into the 10 to 12% ratio that is starting to enter the danger zone. Most bars need to generate 150 a sq ft in sales to break even.

I enjoy watching Jon Taffer from the show Bar Rescue on television. This guy does consulting and has turned around about 1 thousand bar/restaurants over decades of time.

If your rent is too high for the tenant you could amend the lease to be a base rent plus a percentage above a certain sales volume so when they do good you get more rent. Additionally you could require your tenant to post a deposit to cover the improvements on the property which is non-refundable. If equipment is paid off you could lien the equipment as collateral etc.

No legal advice given.

Jeff Kehl · Answer

@Nancy Curran To me this would be a simple decision. Restaurants/Bars are a terrible business with a high failure rate. Apartments are a very reliable business. I would rather the restaurant go out of business and convert the space to another apartment.

Max T. · Answer

Make him get the license first, then let him expand. In my city these licenses are expensive and hard to get. There is a limited number. The process often falls through.

Furthermore he could get the license and see how that affects his business before expanding. Maybe getting the license will improve business, maybe not. I wouldn't eliminate an income producing rental unit until I knew for sure.

Karen Bickford · Answer

I would let him. He is likely right that lack of a liquor license is affecting his business. If the food is good he is committed and from the area I think it makes sense.

A tiny little pizza joint in my bedroom community got a full liquor license and the place is a mob scene so the liquor license definitely helped.

Liquor licenses to take time to get there is a process you have to go through so not sure what that timeline would look like.

If the 10 businesses that have been in the space before have failed and he doesn't he will likely fail as well and be number 11. OTH  if his restaurant takes off he will be there in definitely and you will always be able to get a good rent. Unless of course he does so well he needs to leave to expand again.

Account Closed · Answer

I wish this tenant all the best, but will there be parking issues if the restaurant takes off? On the other hand, If this one tanks you'll have both an empty storefront and former apartment. Go the other way and convert the store to living space/workshop for some artist. Some locations are just cursed. Good luck.

Brandon T. · Answer

It looks like you already have some solid info here but I'll throw in some additional thoughts/experience that may help with your decision:

I've never rented to a restaurant but I have about 8 years of experience with bars/restaurants and I rent to other types of businesses that I perceive as lower risk. My intro to business was a casual fine dining restaurant that we eventually expanded into a high end night club and music venue. We shared a wall with a retail store and a wall with higher end apartments.

We had a liquor license from the beginning. We also hosted a happy hour and had a gentleman who's a bit of a local celebrity play a grand piano while folks mingled, and the business closed at 10pm. This went on for about a year without a single complaint from tenants next door. Many of the tenants became regular guests.

Once we expanded to a nightclub with a DJ we began closing at 2am, at that point we'd receive a complaint from a tenant about the loud vibrating bass maybe once every other week, but the folks complaining were regulars in the business and thought it was worth one or too loud nights for the advantages of living next door to a trendy restaurant/bar/club. The music venue portion of the business was underground so we didn't get any complaints at all from that.

As long as the business knows how to control their guests there should be few issues from having a liquor license.

With that being said, I don't think you mentioned the hours of operation or type of restaurant it is, but that would affect the impact a liquor license would have on sales as well.

A small neighborhood restaurant, open for lunch and dinner, that adds a bar might see a bump in profit but probably not anything substantial. If he's planning to extend business hours as well then that could be a different story. Our liquor sales for lunch and dinner during the week were minimal, and on a weekend rarely exceeded 3k-5k unless there was a corporate function or special event. But after 10pm, with entertainment, we could easily beat those numbers at just one of the 4 bars, and again off of a cover charge.

You may also want to consider if he's had a liquor license in the past or his knowledge of that industry. A liquor license isn't a magic bullet for a break even business, plenty of liquor serving establishments fail every year.

Also, I'm not sure if you have other commercial properties where the businesses do well and this one is just cursed, but if you've had 10 businesses go under in that building you may want to consider tweeking the screening process. After having a tenant business fail in one of our properties early on we started requiring a business plan and a resume from prospective tenants to help us predict whether they'd be successful or not.

If I were making the same decision as you, especially with a business as high risk as a restaurant, I'd reach out to someone like @Joel Owens who seems to have a lot of experience or someone with experience in a similar type of restaurant and ask for predictors of success/failure in that particular industry. Find out what they would look for in a business that they were considering investing in, then see if your tenant makes the cut.

Asking that tenant to submit some sort of business plan to you for the expansion as well as a P&L and basic projections would seem mandatory as well.

Good luck, hope that helps!

John Meyers · Answer

I do a lot of rentals and find that renters are not crazy about having a restaurant or bar below them.

Case in point, I rent condos above a bar in Chicago (ironically, Edison Park's "Curragh") and renters complain about the rowdy partiers and, therefore, never renew their leases after a year. There is really nothing you can do about drunk people yelling outside your building at midnight.

Today, I was trying to rent a 3 bedroom apartment in Lincoln Park and the biggest complaint is that it is above a nicely updated Chinese restaurant. -- I don't know if the renters were concerned about smell or noise but it definitely turned them away and I decided to drop that listing because its going to be too difficult to rent.

As far as resale, I think that an accounting office, etc is much more easy to manage and buyers will appreciate that they won't need to deal with the higher rental turnover that a restaurant or bar would bring. -- Lastly, restaurants and bars can have a hard time staying in business and once that build-out is complete, you are sort of stuck with it.

Good luck!

Nancy Curran · Answer

@Mark Creason, yes it's in the first ward and I and the proprietor both have good relationships with Moreno. So, that is set. I know how not to work with the Chicago government. So, I don't need help there. Now, I'm not incurring any costs. He is going to break through the back of his restaurant, into the back apartment. Everything he does, and always does, is on him. Of course, because I have eyes, I know that people live above establishments. But, is a restaurant/bar a hindrance as opposed to an accounting office that closes up at 6 at night? Do people have experience with tenants saying "I love the place but I would never live above a restaurant/bar"?  I'm not sure if it will add significant value to the building or not. Does a first floor restaurant/bar and 4 apartments sound better than a storefront with 5 apartments when I sell?

Mark Creason · Answer

I did ask where the property is located, which you have not answered.  I assume it is in Chicago, but what neighborhood.  Maybe Humboldt Park.  If it was, have you talked to Proco.  I brought up the Hooters as an example of how not to work within the city.  They opened a restaurant without a full liquor license.  The restaurant did poorly until they rectified that situation, which took years.

As for a typical Chicago building, they are usually long and narrow.  Assuming this to be the case, is it going to require a full remodel to make the restaurant work?  Who is going to pay these costs?  Will you be paying the tenant improvements?  Will it add significant value to this space?  I would think you would have to move the kitchen to the back of the property.  As for whether people would still rent above a property like this, it is extremely common for apartments to be above retail space on Western, Kedzie, Division, Damen, North, etc.  Wicker Park, Bucktown and Humboldt Park have a lot of space similar to what you may have.  Parking in these types of neighborhoods is not that important as people walk or take Uber to get around.

Good luck with your decision.

Jailen Holt · Answer

Your agreement should state that if the tenant does move out, he is responsible for restoring the property to how it was before his modifications.Since he will be utilizing more of your space, you also would have the right to charge a higher rent (typically his current rent + the cost of rent that the vacant unit was going for). I think the surrounding tenants might enjoy the added features of his business. You could do a survey beforehand to support this assumption. If his business is successful, you both will more than likely reap the benefits long term.

Best of luck to you both!

Dilemma: Should I let commercial tenant expand?

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