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Fri 20th Feb 2015 - Friday Opinion |
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Subjects: The squeeze on weaker restaurant operators, global restaurant investment, Rooney Anand and minimum pricing
Authors: Richard Negus, James Hacon and Martyn Cornell
As rents climb, the weakest will go to the – increasingly expensive – wall. By Richard Negus
Last year was a record-breaking one in the restaurant industry, with Hardens Restaurant Guide confirming some 148 new additions to London’s restaurant scene alone, a third higher than the previous record, set back in 2006. The sector also experienced unprecedented merger and acquisition activity, with the likes of PizzaExpress, Gondola, Strada, TGI Friday’s and Prezzo all changing owners. The activity is forecast to continue. But how sustainable is this restaurant property activity?
Allegra Strategies confirm that there are some 326,000 outlets contributing to the UK food service and hospitality market. The number of restaurants that provide full waiter/waitress service and that fall within planning use class A3 is approximately 32,000, although the exact number is difficult to calculate, because of the blurring of boundaries between restaurants, pubs, cafes, coffee shops, delis, sandwich shops, takeaway restaurants, drive-through restaurants and quick service restaurants. All, to varying degrees, provide food which can be eaten on the premises. However the focus of this article with be on restaurants falling within Use Class A3.
There are believed to be around 6,000 restaurants in Greater London – around one to every 580 households – and the capital continues to be the driving force of the sector. It is where consumer demand and competition are greatest, and the result is a city with the most diverse and exciting variety and quality of restaurant offerings, probably better than any other city in the world. It is also the location where, generally speaking, concepts and brands need to succeed before consideration can be given to national/international expansion.
By my own and very approximate calculation, some ten restaurants have opened every week during the past ten years. To put this in perspective, at the same time, approximately 30 public houses (mostly wet-led “boozers”) have been closing every week, evidence of the shift from pure pub drinking to eating out. It will come as no surprise therefore that it is the continued growth of eating out in the UK which is fuelling the increasing number of restaurants, as restaurateurs seek to capitalise on growing consumer demand. The requirement for expansion is from a mixture of new entrants, independent operators, small restaurant groups, the branded chains and overseas operators, and the demand is stronger now than it has ever been.
The problem is that, to a point, the restaurateurs are all looking for the same thing. They wish to be located around High Streets in populous towns, on out-of -town retail and leisure parks, in shopping centres and at travel hubs (railway stations, airports, and so on). They generally require space for a minimum of 100 covers (seats), which typically amounts to a total floor area (to include ancillary/back of house areas) of 3,500 sq ft. There will be plenty of examples of restaurants with only 60 covers and also of restaurants with 200-plus covers or more, but it is the branded operators which are driving new restaurant openings, with the likes of the Restaurant Group (owner of Frankie & Bennie's and Chiquito), Nando’s, Prezzo, PizzaExpress, Five Guys, McDonald's, Wagamama, Bella Italia, and many more, each looking to expand their stable by 20 to 50 new restaurants in 2015 and the same again in 2016.
The restaurant market, for reasons of supply and demand, is dominated by leasehold property. Accordingly there are two principal ways for operators to secure restaurant premises, namely directly from a landlord on a new lease or to purchase an existing restaurant premises. In London there is a shortage of new development leisure schemes, and hence acquisitive restaurateurs will have to persuade an existing occupier to vacate their premises by offering them some financial incentive, or “premium".
Persuading owners of profitable restaurants to give up their businesses does not come cheap and to purchase prime sites in London can require significant premiums. In recent months operators such as Five Guys, Caffe Concerto and McDonald's have paid £1m-plus premiums to secure premises in the West End of London. The premium is paid to the tenant and not to the landlord, although the landlord will inevitably benefit at the next rent review (restaurant leases generally provide for the rent to be reviewed every five years, and upwards only) and use the evidence of the substantial premium as increased tenant demand and rising market rental values.
The value of the premium depends on whether the restaurant is being sold as a "going concern”, that is, with the restaurant continuing to trade as is, under the same name, et cetera, or 2) as a “property" with the benefit of the fixtures, fittings, A3 planning use, licensing, etc. The value of a going concern will be affected by the actual trade of the business, whereas the value of a restaurant property will be driven by potential profits and be influenced by various factors such as location, property configuration and size, state of repair, condition of fixtures and fittings, and so on. A good example of the premium value for a prime going concern is Madison, One New Change, near St Paul's Cathedral in the City of London, where the leasehold restaurant is believed to have generated annual profits of £1m. It was acquired by D&D London Dining Group for something in the region of £4m in May 2014.
Where restaurants produce little or no profit, the calculation of premium by a multiple of profits is less appropriate and the calculation of the value has very little to do with the restaurant’s trade, but more to do with the potential trade under the style of operation proposed by the purchaser. The value or premium is therefore little more than "key money” and can vary from nothing (or even a reverse premium for the restaurateur tenant seeking to exit their liabilities under their lease) to £300,000 to £400,000. In absolute prime properties, that figure could exceed £2m for restaurant sites that will be stripped back to shell (removed of all fixtures, fittings, furniture and equipment) and then refitted at an additional cost of £1m, or more.
During 2014 AG&G sold some 20 of Strada’s "bottom end" restaurants as part of the restructure by Tragus (owner of Bella Italia, Cafe Rouge and Belgo) and the subsequent sale of the Strada group to Hugh Osmond’s Sun Capital. The restaurants were sold individually to a variety of branded operators and some private restaurateurs. Their locations were mainly in provincial towns across the UK and in some London suburbs. The restaurants were on the whole “tired” and mostly smaller than the 3,500 sq ft/100 covers desired by the multiple restaurateurs. No trading information was disclosed to prospective purchasers and the premiums represented what the buyers were prepared to pay to secure the sites (key money); none of the restaurants would continue to trade under the Strada name. The average premium paid for each restaurant was around £130,000, with the highest premiums being achieved in the London locations. An estimated £250,000 to £450,000 was spent by each purchaser refurbishing their restaurant.
What a purchaser can afford to pay for a restaurant will depend on how successful/profitable the purchaser believes the restaurant will be under their management/operation. It is the restaurant brands, with their consistency of offer and geographical knowledge of trading potential, that will be able to approach acquisitions with a degree of confidence and certainty. It goes without saying that the more successful brands can afford to outbid less successful operators. Purchasers will be aware that if the restaurant trades successfully the resulting value of the restaurant could be worth a multiple of around four times profits. However for the “branded” operators such as PizzaExpress, Nando’s, and so on, these purchasers will be aware that their company (brand) has the potential to be sold at a multiple of around ten times profits and this perhaps explains the financial justification for some growing restaurant chains offering substantial premiums and how they can outbid non-branded/independent restaurateurs.
Of the new acquisitive restaurateurs, the American chain Five Guys probably made the biggest impact on the sector in 2014, having grown to nearly 20 sites in 18 months and in the process securing three prime West End of London sites (Covent Garden, Argyll Street and Villiers Street) paying premiums in the region of £1.5m to £2.5m. Each site will have had another £1m-plus spent fitting the restaurant out. It may be questionable whether each Five Guys’ restaurant individually will be worth more than total of the premium paid and fit-out cost, however undoubtedly the potential of the “brand” will be worth considerably more than its constituent parts. Outside London, Five Guys has managed to persuade (bearing in mind it is a new and unproven operation to the UK) landlords of leisure/shopping centres to let it key sites, often by paying market-setting rents, which ultimately will affect all local restaurateurs as rent reviews approach and landlords use the new rental evidence to increase rents.
The shortage of supply in London, high premium values/rents and strong competition are driving some branded restaurateurs to look to suburban locations and out-of-town leisure schemes for expansion opportunities where competition is weaker and rents lower. However where rents were once £20 to 25 per sq ft, restaurateurs are being forced to pay rents of £35 to £40 per sq ft in some locations, which ultimately dilutes profits for existing businesses, not only through the increased competition, but as a result of increasing rental values and therefore increasing costs to businesses. It is all very well if restaurants continue to trade profitably. However a very serious risk with restaurant properties are the length of leases, often for terms of 20 and 25 years, which is considerably longer than all other commercial property (retail, industrial or offices) and is due to the length of time required by tenants to depreciate their substantial fit out costs compared to retail and office users. If restaurants do not trade successfully then the leases with “upward only reviews" can become a burden rather than an asset.
Pizza Hut came to the UK some 40 years ago and grew to 700 restaurants at one point. It opened sites in High Streets, shopping centres, retail and leisure parks across the country. Many of its High Street restaurants opened more than 20 years ago and with new local restaurant developments, some of Pizza Hut's High Street restaurants found themselves in secondary/tertiary locations. Just as restaurant tenants now are signing up to long leases, Pizza Hut had signed up to 25 and 30-year lease terms with rents pegged to retail rents and rent reviews every five years. Over the years, rents increased and as better-located competition diluted trade, many of Pizza Hut’s High Street stores (as opposed to out-of-town stores) became unprofitable. The Pizza Hut business suffered as a result and found it difficult to exit some leases that were too long in term for retailers and in locations too weak to appeal to the new wave of restaurateurs. Fortunately for Pizza Hut, many of these leases are now expiring and its liabilities ending.
The forecast for eating out is continued growth, and acquisitive and expanding restaurateurs are reaping the rewards. However, with some towns reaching saturation, it will only be the strongest that will survive, and over the coming years some of the smaller operators will fail. Judging by the multiple restaurateurs' acquisition plans and number of new entrants announcing intentions to open in the UK, 2015 will see no let-up in restaurant openings. If anything, the sector could see even more merger and acquisition activity as investors try to ride the crest of the restaurant market wave.
Richard Negus is a director at AG&G, the chartered surveyors and leisure property specialists and has 25 years experience of dealing with leisure property. During the past 12 years he has bought and sold nearly 500 restaurants
A view from the global restaurant investment forum by James HaconI am writing this from the very comfortable surrounds of the Dubai International Airport, surrounded by many international brands we would all recognise, awaiting my return flight to Heathrow. This flying visit was prompted by an invitation to speak at the Global Restaurant Investment Forum. The event, in its second year, brings together investors, restaurant brand owners and operators, with a spluttering of industry suppliers, over three days.
The considerable British contingent, arriving at the Conrad Dubai on the first day, met other delegates from across the world, including the Middle East, Asia Pacific, Europe, the United States and South America. With what we thought was going to be a gentle introduction to Dubai’s food scene, the group embarked on a concept tour, visiting some of Dubai’s newest and most talked-about outlets. These included D&A, Tortuga, Pierchic, Beach Canteen festival outlets, Perry & Blackwelders Original Smokehouse and the recent British transplant Coya. For most of the people I spoke to, the highlight of the day was Coya, with many of the other concepts seeming to not quite hit the mark on the food front; although the views of Pierchic were simply breath-taking.
With a day of concept touring under our belt’s the next two days were a blend of interviews, panel discussions, key notes and short presentations. Here are my highlights:
• The FT restaurant critic and author Nick Lander, of L’Escargot fame, talked about the lessons to be learnt from the world’s top 20 restaurateurs. One of his most interesting points was about UK diners being less willing to be challenged, preferring to go for comfort, with little to no risk or adventure in their dining choices.
• The founder of Culinary Edge, Aaron Noveshen, tackled the top trends from the US in record speed, with just 20 minutes on the clock. He talked about how hot-spot dining was providing a suitable replacement for the unsustainable demand for drive-through outlets by operators, with the staggering statistic that 20% of meals in the US are taken in the car! Other trends of particular interest included dining on demand, with food delivery in under five minutes on the West Coast, and "eatertainment", with a blend of high-quality dining and entertainment, including bowling and cinema.
• Going Local in Dubai focused on the growing opportunity for F&B operators in the UAE, with even bigger malls and more developments coming live soon. While the property consultants seemed confident of continuing success and growth, operators were a little more cautious, talking about displaced business from older to newer mall developments, and a lack of interest in "home grown" brands in preference for international franchises, and rent percentages often topping 40%. That said, a key takeaway from the conference for many of us from the UK was the staggering ebitda levels being achieved here.
• Celebrity chefs Todd English and Greg Malouf were in high spirits when interviewed, particularly Malouf, being extremely candid in his comments around moving to Dubai from Australia, the challenges he faced and his personal views around a lack of quality options of where to dine in the city.
• Chilango co-founders Eric Partaker and Dan Houghton shared the success from their recent Burrito Bond crowdfunding, talking about how they chose to take a debt raising option rather than equity.
• In a session titled "What not to do in restaurant design", panellists shared the importance of incorporating emotional connection points within new developments, how there is no such measure as "return-on-ego"; and that while important, food was the last thing that guests experience on the journey and its excellence cannot replace great decor and design.
• The managing director of Soho Hospitality, Rohit Sachdev shared the success of his two new concepts in Bangkok; Above Eleven, a roof top bar & restaurant turning over more than the hotel it sits on top of, and Charcoal, an Indian restaurant succeeding without a curry in sight. He talked of how he inspired his operations team by taking them on trips overseas as part of the development to source ingredients and how he has so far achieved payback on his capex within 18 months.
• Kim Rahbek of Sticks & Sushi talked briefly of the chain's success and growth in the London market after building the brand in Copenhagen, sharing its approach which is based on four pillars: brand, food, restaurant design and guest service, tied together by a commitment to quality.
Above all else, two things stood out to me. The first is the global respect for London as one of the international powerhouses of the restaurant industry. The second is the opportunity that exists for UK brands that want to franchise into the Middle East and beyond, with many partners actively seeking these opportunities; although a considerable amount of caution was shared by speakers around the importance of selecting the right partner and keeping a firm handle on the relationship.
It was an inspiring and very informative conference. I’ll definitely be going next year, and joining an even bigger British delegation, I hope.
James Hacon is managing director of Elliotts, the sector leading marketing, insights and PR agency
Why Rooney Anand is totally wrong to back minimum alcohol pricing, by Martyn Cornell I have written here before about what a terrible idea it is for the hospitality industry to concede any ground at all to its enemies. You may imagine, then, how I felt to see Rooney Anand, chief executive of Greene King, calling in the Daily Telegraph for minimum unit pricing for alcohol. The arguments for minimum unit pricing have been totally debunked, and Mr Anand should really have known he was talking rubbish – or his advisers should have told him. I cannot understand why he is using his position as boss of one of the largest brewers and pub operators in the country to promote the agenda of the neoprohibitionists, for whom minimum unit pricing is but a small step on the way to totally restricting the sale of alcohol.
“Binge drinking continues to adversely affect our nation,” Anand cried, insisting that we have a “growing culture of irresponsible drinking”. And yet, as Paul Chase, author of the excellent book Culture Wars and Moral Panic: The Story of Alcohol and Society, and regular contributor to this site, has pointed out on numerous occasions, this is simply not true. Since 2004 there has been an 18.9% fall in alcohol consumption per head and consumption is now at its lowest level this century. Violent crime linked to alcohol has fallen by 32% since 2004 and by 47% since 1995. Since 2005 the number of men officially “binge drinking” (a concept in any case based on dubious methodology and out-of-thin-air figures) has fallen by 17%; the number of women binge drinking has fallen by 23%; and binge drinking among 16 to 24-year-olds has fallen by 31% among men and by 34% among women. In 2012-13, alcohol consumption in England and Wales fell by 2.1% year-on-year, to its lowest level since 1990. Where is the evidence for a “growing culture of irresponsible drinking”? “When it is possible to walk into a shop and buy a bottle of beer for less than a bottle of water, it is no surprise that, as a nation, we are moving in the wrong direction in our relationship with and consumption of alcohol,” Anand asserts. So a fall of almost a fifth in alcohol consumption in the past ten years is a move in the wrong direction? Or did nobody tell the Greene King boss that alcohol consumption is dropping? Incidentally, that fall of nearly a fifth in alcohol consumption is actually far more than its proponents claimed would have been achieved by introducing minimum pricing. Oh, and it’s NOT possible to buy a bottle of beer for less than the price of a bottle of water, and never has been, unless you are talking about the most expensive designer water.
Anand goes on to claim that a 50p minimum unit price “could” reduce the costs to the NHS caused by alcoholic overindulgence by “as much as” £417m a year. Ignoring the two sets of weasel words there – “could” and “as much as”, the use of which sucks all the meaning out of his claim– it’s a pathetic claim anyway. £417m a year equals 31p per household per week. Big swing.
Next up, Anand references “a recent study by the University of Sheffield” which “indicated that minimum unit pricing” would have a larger positive impact on those in poverty, particularly high risk drinkers. Allegedly, minimum unit pricing “targets those prone to binge drinking, with their consumption expected to fall 7% through raising the price of approximately 30% of units sold to harmful drinkers.” But, again, as Paul Chase has pointed out, “the Sheffield minimum pricing model is based on absurd assumptions, such as the belief that heavy drinkers are much more price-sensitive than moderate drinkers, and assumptions made about the price-elasticity of demand for alcohol that are at odds with what economic research and common sense tell us about the relationship between price and consumption.” To fill that out: there is no evidence at all that making drink dearer for heavy, problem drinkers will stop them drinking as much as they already do. Indeed, it seems more than likely that what will happen is that heavy drinkers, faced with more expensive drink, will cut down on expenditure elsewhere – food, clothing, even shelter – in order to find the money to carry on drinking as much as ever.
Anand calls the failure to introduce a minimum pricing of alcohol in Scotland “disappointing”. But Scotland’s attempt to introduce minimum pricing hasn’t gone through because it is currently the subject of an investigation by the European Court of Justice, which is likely to give its decision on whether the proposal is legal, or breaks EU competition law, only at the end of 2015 or early in 2016. Expert betting is that minimum unit pricing will be ruled illegal.
It is hard not to assume that Anand is backing the idea of minimum unit pricing because he thinks that it makes him appear on the side of the “good guys”, despite being a producer of “demon alcohol”. Perhaps, too, he thinks that minimum unit pricing will hurt the supermarkets more than it will the brewers and pub owners, and for that reason it’s a Good Thing. But he really needs to think about who he is getting into bed with by promoting minimum unit pricing. These are people prepared to lie and distort to promote their aims – the claim that “up to” 35% of A&E admissions are “alcohol-related”, for example, which is completely made up, or the equally preposterous claim that “Alcohol misuse hands a hefty annual bill of £21bn to UK taxpayers”, which is, again, based on unverifiable plucked-out-of-the-air guesses and false reasoning. But the anti-alcohol lobby genuinely doesn’t care if its statistics aren’t true. It only wants to see its policies adopted, because it thinks it knows best what is good for all of us. To quote Paul Chase again: “Public discourse on alcohol is dominated by an absolutist, loony-left dominated, alcophobic public health movement that has become a vehicle for Big Business bashing.” Really, Rooney, do you think you should be promoting a policy these people want?
Martyn Cornell is managing editor of Propel Info
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