Inflation and unemployment are two of the most critical indicators that economists and policymakers monitor when discussing the economy's health. Though the two are not directly related, research has shown that they do, in fact, strongly impact each other. The Phillips Curve hypothesizes this relationship between inflation and unemployment, stating that when inflation is high, unemployment is low.
Policymakers face a severe issue as a result of this relationship. While low unemployment may appear to be beneficial to the economy and people, an unemployment rate that is too low may cause inflation to rise. However, if the government takes action to reduce inflation, it may minimize unemployment and cause a recession. This inverse relationship between inflation and unemployment can affect several aspects of commercial real estate, primarily the restaurant industry.
Restaurants Affected By Inflation
Many restaurant operators entered 2022 with an eagerness to expand, but that changed when the economic landscape caused their focus to shift toward maintaining current operations. Entering into 2023, operators are being forced to balance rapidly rising costs with maintaining consumer demand for their products.
Operators have been combating rising costs by mixing up menu prices in three ways:
- 1. Dynamic pricing—increasing menu prices during high-traffic times and decreasing them during low traffic
- 2. Barbell Menu Pricing—increasing menu prices on the highest and lowest demanded menu items while leaving the middle items untouched
- 3. Removal of Discount Specials and Deals
According to recent data, over the last two quarters of 2022, full-service menu prices rose on average by 8.8 percent, while quick-service menu prices rose on average by 7.7 percent. Year-over-year menu price hikes ranged from six to 13 percent in Q3 of 2022. Data from Revenue Management solutions shows that price increases beyond 10-13 percent had a noticeable impact on overall foot traffic.
Well-known restaurant's percentage price increases last two quarters of 2022:
- Applebee's—7 percent
- Chili's—9 percent
- McDonald's—10 percent
- IHOP—11 percent
- Chipotle—13 percent
Understanding the Needs of Consumers During High Inflation
Inflation exceeded 7.5 percent in 2022 but has begun to slow in recent months. With this in mind, consumers have had to adapt to higher grocery, gas, and living expenses. These higher prices have made consumers feel the need to search for cheaper food options. More affordable food options tend to be from restaurants that offer fast service, which explains why internet searches for quick-service and fast-casual concepts were up 10 percent in Q3 2022 compared to Q2 2022 and up eight percent year over year.
During the last week of September 2022, visits to full-service restaurants were down 18.2 percent compared to the same week in 2019 and down six percent compared to 2021. Comparatively, quick-serves saw only a 7.1 percent decline from 2019 during that same week and a 0.7 percent increase from 2021.
Year-over-year sales growth for quick service and fast casual restaurants was up 5.2 percent in October 2022. However, year-over-year guest traffic growth has been negative for the past eight months. If traffic isn't driving sales growth, what is? Sales are being driven by an increase in average check size which was up to 9 percent in October 2022. Additionally, the increase in menu prices has resulted in an increase in sales.
Average check growth does not take into account the fact that operators are raising prices. For example, if IHOP, which raised prices 11 percent year-over-year in October, experienced an average check growth of nine percent, after adjusting for price hikes, net check purchase volume per check is down 2 percent. This difference between average check growth and year-over-year sales growth is most likely attributed to a decrease in consumer demand or a decrease in the total volume purchased per check.
While menu prices have been increasing across the board, grocery prices have also been growing:
On average, food-at-home prices have increased by 13.5 percent.
On average, food away from home has increased by only 8.0 percent.
This difference has allowed a steady demand for restaurants to be maintained. However, the lack of workers readily available hinders operators from being able to take full advantage of the growing demand.
Unemployment in the Restaurant Industry
During the six months between October 2021 and March 2022, total monthly unfilled job openings in the restaurant sector exceeded total monthly hires on average by 500,000. Eighty-one percent of operators say that they are short at least one position. At the same time, servers and dishwashers (full-service positions) remain in the highest demand.
Filling open roles is not the only struggle for restaurants; retaining employees has become increasingly difficult in the full-service restaurant industry. Historically, the average turnover rate for restaurants is 23 percent. Recently, full-service restaurants are approaching turnover rates of up to 32 percent.
Restaurants are forced to operate with fewer workers, which results in a reduction in operating hours. The average U.S. restaurant is now open 6.4 hours less (7.5 percent) per week compared to three years ago. Casual dining chains closed on average 9 hours per week compared to three years ago. Most dramatically, Denny's and IHOP reduced their hours by 30.1 and 17.1, respectively. Conversely, some quick-service restaurants, such as Wendy's, have expanded their hours to offer additional menu items.
Operators have begun outsourcing their labor needs to their suppliers by ordering premade foods that require less in-house labor to prepare for consumers. When operators outsource food preparation to save on labor costs, the ultimate trade-off is the quality of food delivered to consumers. How long will customers continue to pay higher prices for food of less quality/freshness?
Important Considerations for Restaurant Operators in 2023
In 2022, inflation drove up costs across food, beverages, and labor, which will likely continue in 2023. Combined with continued economic instability and the need for new strategies to deal with the sector's ongoing workforce shortages, continued viability in 2023 will require tight management and wise investments.
Restaurant operators and investors should think critically about the rising risks associated with restaurant properties as investments. If a location is underperforming, it is wise to get the property evaluated by professionals to identify if these risks are relevant to the property.
If nearing the end of a lease term, restaurant operators will begin to view the option periods not as an extension of their term but as another place where they can cut costs and improve their bottom line. Strong guarantees are more important than ever. As restaurant margins shrink, large and small operators should start consolidating their operations into their most profitable locations.
Tucker Brock is an investment sales specialist at Matthews, focusing on the disposition and acquisition of single tenant net lease investment properties nationwide, specifically Applebee’s and IHOP tenants. His strong ability to cultivate and maintain relationships with the industry’s leading private clients, developers, private equity firms and REITs make him an asset to every transaction. Tucker prioritizes his clients, ensuring they are in the best position for long-term investment growth and profitability. He leverages his extensive background in the casual dining sector and his myriad of clientele to assist his clients in achieving all their goals. Tucker prides himself on putting his clients first and always doing right by everyone he works with.
Serving as a Market Leader, Keegan Mulcahy manages the growth and development of the San Diego office. He delivers industry-leading support and actively recruits and trains agents in the market. In his role as Market Leader, Keegan reviews opportunities to expand product types and service lines while ensuring clients receive the highest-level service through his mentorship of agents within the San Diego office.