The glut of empty commercial real estate, particularly within urban markets, has already been front-and-center for the past two years, driving rent to stabilize. For instance, the amount of empty retail space in [New York City] climbed to 11 million square feet in 2017, double what it was in 2007.
For landlords, the pandemic only worsened an already precarious situation. In addition to the countless small retail and restaurant businesses that may be forced to permanently vacate their commercial spaces because they can no long afford them, a growing number of corporate chains is also beginning to prove unwilling or able to pay their rent. These store closures are sure to create an overhang of real estate inventory, leading to lower rent for the surviving chains.
Coming out of the pandemic, we anticipate that the accelerated rate of vacancy caused by the economic hardships facing the restaurant industry will lead to: (1) significantly reduced commercial rent; (2) an abundance of available spaces with key mechanical, electrical, and plumbing (MEP) infrastructure, plus furniture, fixtures, and equipment (FF&E) already in place; and (3) significant tenant improvement (TI) packages that will be made available by landlords who are anxious to fill their spaces.
Andy Peskoe, a leading industry attorney who runs the food, beverage, and hospitality group at Golenbock Eiseman Assor Bell & Peskoe LLP, says, “We are sure to see a reduction in total restaurants able to operate profitably, but we expect that alternative tenants [specifically retail] will be closing at a rate exceeding hospitality businesses. Thus, the need for forward-looking landlords to partner with their hospitality tenants to help them reopen and help them find a profitable model is critical. These restaurant tenants are the best possible rent payers: The space is already built out, and they will have a supportive returning clientele to help with reopening.”
Furthermore, our anecdotal conversations with general contractors suggest that the disruptions within the industry have caused slowdowns in restaurant construction. This, in turn, has compelled general and subcontractors to reduce their fees in order to win bids on sparse projects. The competition among general contractors for projects could ultimately lead to lower construction costs. COVID-19 may impact design and construction contracts in a variety of ways, including impacts to supply chains, contractor workforces, designer personnel, and the availability of government inspectors. Reduced rent and lower out-of-pocket buildout costs will help to improve the unit economics and ROICs of new unit development for brands that have the capital to expand.
Demand-Side Tailwinds: Fast Casual Set to Take Further Share from Other Restaurant Segments
The history of the restaurant industry has been a constant evolution of restaurant brands building better mousetraps (i.e. concepts) to better meet evolving consumer needs. When Steve Ells founded Chipotle nearly 30 years ago, he saw an opportunity to offer higher-quality food, prepared with classic cooking techniques. Customers had previously never had access to this, outside of full-service, dine-in restaurants.
However, in order to offer this elevated food at competitive prices to traditional quick-service restaurant brands, Ells had to do without servers, shrink the size of the store footprint, and send customers to the counter to place their orders. Within this new model, throughput became king. This required efficient make-lines, success across multiple dayparts (both lunch and dinner, in Chipotle’s case) and appealing to a broad base of customers across gender and age lines.
The labor and real estate savings spawned by this higher throughput could then be reinvested in providing higher-quality food to the customer at an affordable price. The impacts of COVID-19 will lead to further disruption, and the progressive fast casual segment is best positioned to adjust to this new environment and meet the needs of these consumers.
Demand-Side Tailwind 1: Fast Casual Set to Take Further Market Share from Traditional Quick-Service Restaurants
For generations, the quick-service segment has provided customers with a cheap alternative to cooking at home, essentially a home meal replacement service. At the turn of the 21st Century, coming-of-age millennials began seeking healthier alternatives to the quick-service restaurant food their parents fed them growing up. This was a key factor in the creation of fast casual restaurants, which provide fast but more wholesome food at a still-affordable price point, with a sub-$12 average check. Customers began trading up from traditional quick-service restaurant brands to this new segment of fast casual concepts.
The total dollars spent by millennials and Gen Z continues to grow versus other age groups, particularly within the restaurant category. We expect consumers from these generations to continue moving away from traditional quick-serve concepts and to further trade up to healthier fast casual alternatives in the years to come.