How the Fast-Casual Boom Is Changing the Restaurant Real Estate Game

By Amy McKeever,

Competition is fierce for restaurant real estate all across the country.

But one type of restaurant space has proven particularly elusive: one with a small-ish footprint that's ideal for fast-casual dining.

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Everyone from national chains to locally owned fast-casuals to independent restaurateurs seeks out these types of spaces, ranging from about 1,500 to 2,500 square feet — imagine a Chipotle or a Chop't.

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Rebecca Schley | Flickr

In Portland, Oregon, where local fast-casual concepts like Lardo and Little Big Burger have sprung up in recent years, restaurateurs call the offices of the brokerage firm Urban Works three to four times a day asking for second-generation restaurant spaces about that same size.

The hunt is just as difficult in Washington, DC. Two years ago, when chef Mike Isabella was looking to expand his popular sandwich shop G, competition for restaurant spaces was so brutal he had to give up. He did ink a deal for another small-footprint concept at the DC airport, but that wasn't any easier; Isabella says he was one of 400 companies bidding to open there. And, he adds, there were even more airport deals that he'd bid on and lost. Last month, Nation's Restaurant News confirmed that the fast-casual boom has driven lease rates for these spaces to astounding levels nationwide. It's a landlord's market pretty much everywhere.

In New York, Julian Hitchcock, founder of New York's consulting and commercial brokerage firm the F+B Group, says that while independent restaurateurs are willing to pay high lease rates, the tricky part is finding a landlord to gamble on them: It's much safer to rely on a tested national chain with deep-pocketed backers instead.

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So how is a restaurateur supposed to navigate a landlord's market? A good start might be to figure out what that means, what landlords want from a tenant, and what other restaurateurs are doing to stay competitive.

Before you can compete in a landlord's market, it helps to know what you're dealing with. In many cities across the country, a major factor in rising lease rates is, of course, development and growth. Darren Tristano, president of the restaurant industry research firm Technomic, argues that cultural changes are also in play. Tristano says that the rise of delivery and takeaway has shifted dining out of the restaurant and into the home, prompting even full-service operators to look for smaller dining rooms.

Isabella's own restaurant empire has felt the intermingling effects of both shifts. Last year, he opened two full-service restaurants with smaller footprints in Ballston, Virginia (which, it should be noted, was a rather under-tapped market just outside of DC). But Isabella found it was harder to make money at those two concepts, Pepita and Yona.

While they're located in more affordable real estate, they come with a much higher overhead than a fast-casual restaurant — there's waitstaff to pay, for example. And they're surrounded by the likes of Subway, Sweetgreen, and the local sandwich chain Taylor Gourmet. People don't seem to have the time or inclination to dine out at lunch so much anymore, Isabella says, so they gravitate toward those chains that can get them in and out quickly.

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In order to compete, Isabella implemented an online ordering and takeout system during lunch hours. And at the nearby Kapnos Taverna — a mid-sized, full-service restaurant — he offers an express lunch menu that allows it to "turn and burn" much like a fast-casual would. "As a restaurateur, you have to adapt," he says.

And in a landlord's market, it seems restaurateurs particularly must adapt to having less space. Part of the rise of the smaller restaurant space, Tristano says, is that independents are being outpaced by fast-casuals anyway. Last year, according to a March Technomic report, fast-casual sales grew by 11.4 percent, almost double the rate of any other dining segment.

That's key. As the NRN report from the same month contends, the rise of Chipotle-ish fast-casuals has driven up rents even further by creating a huge demand for a limited number of restaurant spaces. In those smaller spaces, landlords can get more money per square foot than they could out of an 8,000-square-foot full-service restaurant space. As Isabella explains it, that's because restaurants can do a higher relative volume and therefore make bigger profits in that smaller amount of space, especially if they're fast-casual. Meanwhile, it's obviously still cheaper for restaurant owners to rent a place that's one-third the size of a normal restaurant.

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It's such an advantage on both sides that realtors in major dining cities are seeing landlords and developers chopping up those large full-service restaurants into two or three units. In DC, Thomas Papadopoulos, principal broker at Papadopoulos Properties, explains that this strategy not only allows a landlord to command more rent per square foot, but also reduces risk by relying on multiple tenants, rather than putting one tenant on the hook for the whole sum. This is also the strategy that's partly driving the food hall boom, Hitchcock says. "As rents increase, that's another nail in the coffin for full-service restaurants."

The intense competition for fast-casual-sized spaces actually discouraged Isabella from trying to expand his sandwich shop (though it did open a location in Nationals Park). But there's a cyclical nature to chefs jumping into the fast-casual scrum. Motivated by rising rents and rising labor costs (particularly in cities like New York, where minimum wages have increased), chefs are increasingly testing out small casual concepts that take less money to open and operate, and will keep their brand names in the news. The more that chefs succeed in fast-casual — particularly in food halls — the more that their peers seek to join them. If they can find the real estate.

So if landlords have all the power in restaurant real estate, what are they looking for in a tenant? It's important to start by noting that this varies by landlord, neighborhood, and type of project. A landlord seeking a restaurant operator for a small neighborhood condo building will have different priorities than a deep-pocketed developer looking for a restaurant to anchor a downtown retail complex.

Some landlords do have more than money in mind. If they have a space on the ground floor of a condo building or office complex, landlords look for tenants who are clean, fairly quiet, and don't emit any unappealing odors that would bother residents or fellow tenants. In a more residential neighborhood, full-service restaurants do well since dinner is more highly trafficked than lunch. But if there's a lunch crowd available in that residential neighborhood, a fast-casual might be even better since it reduces late-night noise.

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Some landlords are chasing after buzz. In New York, Hitchcock explains that landlords who own big buildings and therefore have a stake in the surrounding neighborhood often value the idea of culture-building through dining. He uses the Brookfield Place development as an example: developers looking to rebuild and reinvigorate the Financial District have courted popular concepts and restaurateurs — many of them local, like Black Seed Bagels, Blue Ribbon Sushi, and Parm — to entice diners into the area. While Dunkin' Donuts may be a national brand with excellent financials and a proven track record, Hitchcock says, it can't create a culture like an independent or local restaurant could.

If a landlord is willing to gamble on a local restaurateur — and if that buzz does indeed translate into success — an independent restaurant can ultimately be even more financially rewarding than a national chain. It assures the landlord of that restaurant's ability to keep paying rent, and it also would make the landlord's other properties in the neighborhood more desirable.

What the neighborhood wants for itself matters to landlords, too, but only to an extent. "Everybody would like to have a utopia of restaurants in their ground-floor spaces," says Brian Greeley, a vice president at Portland's brokerage firm Urban Works. But that's not always possible. Landlords are looking for a balanced, holistic mix within their own developments — which means you might end up with your dream restaurant or a Rite Aid in your building. But Hartley adds that there are some cases in which landlords would be wise to keep a neighborhood's personality in mind: It might be a bit jarring, for example, to come across a Chipotle location on Portland's trendy SE Division Street.

And while most community groups might advocate for an independent full-service restaurant or a locally owned fast-casual spot — or a balance among the two — landlords aren't so much concerned about saturating a neighborhood with fast-casual concepts. In fact, Papadopoulos says that competition is a good thing for DC landlords. An existing fast-casual has theoretically already built up a core of diners that a new fast-casual could tap into. So where the community really has a say, Hitchcock says, is in voting out a concept rather than choosing one to begin with. If residents don't go, the restaurant will close.

Which brings up an interesting side point about the preference for local versus national concepts. While local full-service and fast-casual restaurants are certainly great for building a development's buzz and are what community groups tend to think they want, for some landlords, that's really no match for a well-funded national restaurant. "People care less about local concepts than you would believe," says the Chicago-based Tristano. Chicago's Wicker Park residents may want an independent full-service restaurant, but chances are if a Shake Shack arrived, it would be met with the same glee as seen in Austin, Hollywood, and elsewhere.

That said, money is always the top answer. Developing a restaurant space is considerably more expensive than a regular retail or office space. At the very beginning of construction, developers must take local regulations and basic kitchen requirements into consideration by providing adequate ventilation and other features. Kia Hartley, also vice president of Urban Works, explains that developers will then want a higher return on their investment. And that's most likely going to come from a tenant with good credit and strong financial backing.

But though it may seem like the best chance at competing in such a tough real estate market is to be a national chain — either small like Shake Shack or big like Chipotle — there's plenty of hope for the independents. For one, restaurateurs can follow their colleagues into the fast-casual game and expand out strategically. Hitchcock points to David Chang's fried chicken sandwich shop Fuku, which tested out its concept in the East Village before opening a second location in the pricier (and much denser and lunch-friendlier) Midtown.

Meanwhile, Isabella has pushed forward on concessions deals at Nationals Park, Ronald Reagan Washington National Airport, and Los Angeles International Airport, and a 10-concept food hall inside a ritzy Virginia mall. For him, the appeal of airport and stadium deals was the foot traffic and quick turnovers, while his upcoming foray into food halls is more about the experience.

Restaurateurs can also take their own risks. Greeley points out that Portland wouldn't have beloved concepts like Salt & Straw if they hadn't started out on smaller blocks. Isabella acknowledges there were some doubts when he opened his Greek restaurant Kapnos three years ago on a less-traveled intersection of DC's 14th Street. But he got lucky in the years that followed, as the neighborhood became one of the most popular in the city. Now the rising rents in DC have pushed him to find new and less developed markets in the surrounding areas of Virginia and Maryland.

But even if one has never opened a restaurant before, Hartley believes it's worth trying. She acknowledges it's an uphill battle right now, but there are so many upcoming Portland developments, as well as one-off spots in less hyped neighborhoods with more approachable rents.

A first-time restaurateur just needs to get his or her financials in order and craft a sales pitch to sell a landlord on the investment. (Even empire-builders have to do this; Isabella says that he's partnered with well-reputed chefs like Jennifer Carroll and Jonah Kim on newer projects in part to deflect landlord concerns that the quantity of his restaurants would diminish their quality.) Some landlords really are gamblers. If you have a great concept, they win big.

And that's one of the great ironies of the restaurant real estate game. It's the big landlords — the corporations, the ones you might expect to care more about money given how much they've made — who are most likely to take a chance on the independent restaurant. After all, if they can handle the risk, landlords might just be able to claim credit (both in their checkbooks and their brand names) for bringing a Restaurant of the Year into a neighborhood.

By's Amy McKeever. Read the original article here.