What is the outlook for the food and beverage industry now and what will it look like in the future once Covid-19 is behind us?
The California Restaurant Association (CRA) which is a statewide industry and is the definitive voice of the California foodservice industry projects that approximately thirty percent (30%) of all food & drinking establishments in California which total approximately 80,000 businesses will permanently not reopen. In some areas like San Francisco and downtown Los Angeles that number may go as high as forty percent (40%) or more of all food and beverage establishments permanently not reopening.
Irrespective of these negative projections there will continue to be a demand by customers for dining out and once the Pandemic is behind us restaurants and bars will continue to be a viable industry. People have cabin fever from being tied to their homes for many months, they enjoy eating different types of food other than what they cook at home and view dining out as an entertainment experience as well as satisfying their hunger.
Pending the success of eliminating the virus it is hard to project what the landscape will look like either short term or long term regarding any new operating restrictions implemented by the government. Such restrictions include distancing, wearing masks, sanitizing, disposable menus, taking temperatures of food service employees and having them wear masks and gloves, etc.
During Covid-19 who are the buyers and what are they buying?
As well as the pre Covid-19 group of experienced restaurant owners, managers and other restaurant employees this group is being augmented during Covid-19 by a new group of buyers. These buyers are coming from other industries with little or no restaurant experience who have been victims of job layoffs from industries that have been down sized and/or eliminated and their former jobs are gone now and possibly forever. These buyers are typically buying less challenging operationally oriented food service businesses such as yogurt stores, gelato and ice cream stores, coffee and bubble tea cafes, sandwich shops, breakfast & lunch businesses and pizza operations that include either a straight take-out and delivery model or a combination of dining in and take-out and delivery business.
Additionally, we are selling specialty restaurants (Italian, French, etc.) with full kitchens which can easily be run by an owner operator. We have also sold a few businesses that are small spaces with full kitchens that the buyers bought with the intent of doing solely take-out and delivery business. Bars continue to be in demand even though they are closed temporarily during Covid-19 and we have sold one bar during Covid-19 and will be closing another one shortly including the real estate, Also, buyers are looking for closed or open food and beverage businesses where the operator also owns the real estate so they can acquire the business plus the real estate. More of these real estate opportunities are becoming available as some of these building owners are in trouble financially as they have mortgages and other building expenses and are not receiving rental income from their tenants to service these costs at this time.
Additionally, lease opportunities of fully equipped food and beverage operations are becoming available as a number of food and beverage tenants have given back their keys to their landlords and relinquished their space. In these situations, little or no key money is required other than a security deposit by the new tenant with a new lease. If there is a hard liquor license involved the new tenant either purchases it from the former tenant at the fair market value or purchases their own liquor license from a third party and has it transferred into the proposed location.
What are buyers’ price and lease expectations during Covid-19?
Since I have been selling restaurants starting in 1995 the market has primarily been a sellers’ market which means the sellers had more leverage with buyers in selling their businesses and could be more aggressive in their pricing. The opposite of a sellers’ market is a buyer’s market which is when buyers have more control of the sales process and have leverage in pricing which is the situation today.
The following periods have been a buyer’s market:
1) 9/11/2001, when terrorists attacked the World Trade Center,
2) the Great Recession, from 2007 through 2009, and
3) the Pandemic period of Covid-19 which we are currently experiencing.
Consequently, buyers are expecting inexpensive prices for purchasing eating and drinking establishments and/or having the opportunity to take over vacated built out restaurant and bar spaces whose former tenants gave back the premises to their landlords. Additionally, new restaurant, bar and other foodservice tenants are negotiating more advantageous leases which is discussed further in the immediate section below.
How are new leases being negotiated during Covid-19?
In many situations the new tenant gets a certain amount of free rent and then the rent goes to half rent during the no dining in period and if in the future take-out, delivery and outside dining is eliminated then no rent for that period. Starting rent in some cases is a percentage of the market rent or a straight percentage of sales (usually percentage rent is in the 5% to 6% of sales range) for such time as dining in sales get back to some semblance of normality with operating restrictions being removed regarding distancing, masks, excess sanitizing, etc. in the future. Some deals that we get into contract between buyer and seller go away as a result of the landlord’s unreasonableness in working with the new tenant in terms of addressing the items indicated above.
For restaurant and bar sales during Covid-19, how are they being financed?
Pre Covid-19 the Small Business Administration (SBA) was active in financing profitable businesses up to eighty percent (80%) of the purchase price of the business and up to ninety percent (90%) of the purchase price of the building if the real estate was part of the transaction. Today SBA will not lend on a business that has been closed during the Pandemic or a business that is performing at a lower sales and profit history then the period before the Pandemic. SBA’s position today is that a business whose sales and profits have been negatively impacted by the Pandemic that are selling today that the business being sold must have a two (2) to three (3) year track record in the future with reasonable profits for SBA to be involved to finance the business by either taking out any seller financing as explained below and/or putting in place new financing.
Consequently, if the sale is other than all cash and financing is involved then the seller is required to provide the financing in the form of a seller carry back loan.
The terms of a seller carry back loan will vary between one (1) to five (5) years and could be structured as follows: 1) interest only (interest rates range from 2% to 7% annually), 2) amortized (write off the principal amount of the loan over a given period) over a short or long period with the principal balance due as a balloon payment if at the due date of the loan there is still a principal balance. These seller carry back loans are secured by a UCC1 security agreement recorded against all the assets of the business and are personally guaranteed by the principals of the entity purchasing the business.