Picking a profitable location for a restaurant or any business is a complex and challenging process. Numerous details need careful investigation to increase the likelihood that your new restaurant or business location will be profitable.
During my three-decade career in commercial real estate site selection, I identified five general areas of research that need to be conducted in order to maximize the probability that a business at a specific location will be profitable.
Acumen at evaluating real estate opportunities increases as a business matures and gains the benefit of sales experience in a variety of business locations.
Who are your best customers?
The business owner must define the prime customers to whom a product or service will be sold. “Targeted customers” for a new business for which actual demographics are not known can be based on the owner’s assumptions. For an established business, a variety of demographic data can be generated by the business about its clientele or by using the services of an outside research organization.
Employment, educational levels, income per capita, eat/drink sales per capita, age, retail sales per capita, and population growth trends data are readily available from government agencies and provide an accurate overview of the economic viability and demographic compatibility of each trade area being evaluated.
Is there too much competition?
Having selected a trade area that in the judgment of the owner contains an adequate number of customers with targeted demographics, it is essential to estimate the gross potential sales within the trade area for the product or service the business plans to offer. These projections can utilize estimated sales per capita for a similar or identical product in other markets or on a national basis.
Once the potential sales for the trade area have been calculated for the sales category, the sales of competitive businesses operating in a trade area must be estimated and subtracted from the trade area’s total sales potential. The amount remaining would be the sales available to support your new business within a specific competitive niche.
What attracts customers into the area?
Major regional retailers, specialty retailers, entertainment facilities, hospitality services, offices, medical buildings, multi-family and single-family residences, sports venues, churches, major transportation corridors, schools and tourism offerings attract potential customers to the vicinity of your proposed new location. If a business relies on impulse buyers (as opposed to destination businesses marketing specialty purchase items), having a diverse number of traffic generators ensures that an adequate customer count will be in the vicinity of your business during the week (in all day parts) and on the weekends.
More traffic generators generally translate into higher customer counts. A large variety and number of traffic generators will generally extend the length of high-volume sales hours and increase the number of table turns per shift. Obviously, more customers translate into more sales and higher profitability.
What size and type of real estate does my business need?
Once a trade area has been identified that contains an adequate number of “high opportunity customers” for your business category, an acceptable amount of direct competition and a large number of traffic generators, the next step is to locate a real estate property that is physically adequate for operation of the planned business.
Potential real estate properties in the trade area are investigated to determine size, zoning, allowed building area and height, signage, parking, utilities, access, visibility to vehicular traffic, landscaping, mandated governmental requirements, and licenses/permits required to construct improvements and operate on the property.
Normally an environmental audit, topographic survey, soils analysis and title check are initiated to ensure that there are no irregularities that would limit or restrict use of the property for your intended use. Much of this due diligence is completed by licensed engineers and real estate attorneys as well as the real estate site selector.
The primary issues are good visibility to vehicular traffic, adequate size, easy access and ample parking.
Can I pay the occupancy cost and make a profit?
Even if an exceptional trade area is selected and several real estate properties are identified within the trade area that meet the business owner’s site criteria, in the final analysis, the occupancy cost for the real estate property (rent, debt service, taxes, utility fees, land costs, insurance, construction costs, etc.) must be a reasonable percentage of the gross sales generated by a restaurant or business at the location.
If the annual occupancy cost as a percentage of annual gross sales is too high, the business will either fail or be marginally profitable. Neither of these options are good outcomes, especially when the significant management effort and capital costs invested to develop a new business location are considered.
Obviously, the goal is to identify and acquire a high volume and very profitable business location.
Downturn creates opportunity
You can take advantage of market conditions to expand your business. Adversity creates opportunities for successful food service operators. In a recessionary economic environment, profitable restaurants can heavy-up advertising to obtain a larger share of their respective market niche, recruit better management and service staff from their competitors and obtain “high opportunity” real estate properties at less cost.
An economic downturn will cause marginally profitable and unprofitable restaurants to re-evaluate their options. Many will either shut the door or consider closing under certain conditions. Restaurant locations in highly desirable markets might not even be available had it not been for a soft economy. By the time a new location is acquired and redeveloped for a new restaurant concept, market conditions may already be improving. That’s ideal timing for opening a new restaurant.
Trade area analysis
Successful multi-unit restaurant operators always prepare a comprehensive development plan for each market they serve. Targeted trade areas – previously identified as highly compatible with the expanding restaurant’s demographic profile – should be visited on a regular basis. Closed restaurants are obvious; underachieving restaurants can easily be identified by an experienced food-service manager. Visiting with restaurant managers in a trade area can provide good feedback on general business conditions and evoke street talk about existing food operators.
Restaurants that may be closing do not want the word out on the street. Rumors about possible closure can be devastating – employees may immediately seek new jobs, suppliers may tighten credit terms and customer counts may decline further.
Both the restaurant owner and the potential buyer benefit by keeping a potential sale and purchase of a restaurant highly confidential. Buyers should reassure an owner of their desire to negotiate in a confidential manner.
The value of restaurant locations in the same trade area can vary significantly. Value is comprised of several components:
Land – The property may be owned by the restaurateur or ground-leased from a landlord. If the property is leased, the business terms of the lease must be immediately evaluated. The prime lease controls the right to sublease, and the business and financial terms of any sublease agreement. Frequently, the value of a leasehold exceeds the rents being paid. Under a long-term lease, the rent for a property is often below market rates.
Building – Improvements are either owned by the restaurant or leased from the landlord.
Fixtures, Furniture, Equipment – FF&E are normally owned by the restaurant, but may be subject to a lien from a lendor or the landlord.
Good Will – Generally, there is little good will value for a low-volume or unprofitable restaurant. Successful restaurants, however, may sell at a premium price.
To determine the value of the fee simple interest (owned property) or leasehold interest (leased property), I would suggest engaging a competent local, licensed appraiser or commercial real estate broker to consult with you in ascertaining market value.
The real estate transaction should be structured to allow both parties (buyer and seller) to mutually benefit from the agreement. In most cases, the greater benefit accrues to the buyer who is taking the current operator out of an unprofitable venue.
Business reversals force weak food-service operations to exit the market and allow new business concepts, market trends and consumer demands to emerge. The consumer, in the end, benefits from higher quality, greater variety and more cost-efficient products and services.
Accelerating your restaurant’s expansion plans when market conditions are weak is a good business practice.
Ed Lane is chief executive of Lane Consultants Inc., a commercial real estate services firm based in Lexington, and publisher of The Lane Report.