Navigating the complex world of commercial real estate leases can be daunting for restaurant owners. Whether you’re opening your first eatery or expanding an established brand, understanding the different types of commercial leases is crucial for your business’s financial health and operational success. The right lease agreement can significantly impact your profitability, while the wrong one could lead to unexpected costs and headaches down the road.
Understanding the Basics of Commercial Leases for Restaurants
Commercial leases for restaurants differ significantly from residential leases. They typically involve longer terms, more complex negotiations, and various financial structures that can dramatically affect your bottom line. Unlike residential leases, commercial leases offer less legal protection for tenants, making it essential to understand what you’re signing before you commit.
Restaurant spaces come with unique requirements—proper ventilation, grease traps, specific plumbing needs, and health department regulations—all of which can influence the type of lease that works best for your situation. Let’s explore the most common types of commercial leases you’ll encounter in the restaurant industry.
Gross Leases: Simplicity with a Price Tag
Gross leases are among the most straightforward lease structures in the commercial real estate world. With a gross lease, you pay a fixed monthly rent that covers almost everything related to occupying the space.
How Gross Leases Work
In a gross lease arrangement, your monthly payment typically includes:
- Base rent for the space
- Property taxes (T)
- Common area maintenance (M)
- Building insurance (I)
- Utilities (in some cases)
For restaurant owners, especially first-time operators, gross leases offer predictability. You’ll know exactly what you’re paying each month, making budgeting simpler and more reliable. This can be particularly valuable when you’re trying to establish a new restaurant and need to keep expenses predictable.
Pros and Cons of Gross Leases
The main advantage of a gross lease is simplicity. You pay one amount, and the landlord handles the rest. This arrangement can save you time and administrative headaches since you won’t need to manage multiple property-related expenses.
However, this convenience comes at a cost. Gross lease rates are typically higher than other lease types because the landlord builds in cushions to protect against rising costs. You might end up paying for increases in property taxes or insurance premiums that wouldn’t affect you under other lease structures.
Additionally, in a gross lease, you have less control over building maintenance and services. If your restaurant requires specific maintenance schedules or upgrades, you’ll need to negotiate these points carefully in your lease agreement.
Net Leases: The Industry Standard
Net leases are perhaps the most common type of commercial lease in the restaurant industry. They offer landlords protection against rising costs while potentially providing tenants with lower base rents compared to gross leases.
Types of Net Leases
Most leases are Triple Net Lease (NNN)
Triple Net Lease (NNN)
The triple net lease is the most common in restaurant real estate. Under this structure, you pay the base rent plus all three major expenses: property taxes, insurance, and maintenance. Effectively, you’re responsible for almost all costs associated with occupying the property.
Triple net leases typically offer lower base rents since you’re taking on more of the property expenses. This can be advantageous if you want more control over your space and are comfortable managing these additional responsibilities.
For established restaurant operators with multiple locations, triple net leases can provide consistency across properties and more control over maintenance standards that directly impact your customers’ experience.
Learn more about restaurant space leasing
Modified Gross Leases: Finding Middle Ground
Modified gross leases represent a compromise between gross and net leases. They offer flexibility in how expenses are divided between the landlord and tenant.
How Modified Gross Leases Work
In a modified gross lease, you typically pay base rent plus some, but not all, of the additional expenses. The specific division of costs is negotiated between you and the landlord. For example, you might pay for utilities and cleaning services, while the landlord covers property taxes, insurance, and structural maintenance.
This lease type is common in multi-tenant buildings where certain expenses (like common area maintenance) are shared among tenants proportional to the amount of space each occupies.
Advantages for Restaurant Owners
Modified gross leases can offer the best of both worlds: some of the predictability of a gross lease with some of the cost advantages of a net lease. This structure allows for customization based on your restaurant’s specific needs and the landlord’s preferences.
For example, if your restaurant concept requires specialized equipment maintenance that you prefer to handle yourself, you can negotiate a lease where you take responsibility for those elements while the landlord handles other building aspects.
Percentage Leases: Aligning Landlord Success with Yours
Percentage leases are uniquely structured agreements that tie your rent directly to your restaurant’s performance. These leases are common in shopping centers, malls, and high-traffic retail areas where landlords want to benefit from successful tenants.
Structure of Percentage Leases
A percentage lease typically consists of two components:
- Base rent: A minimum monthly amount you pay regardless of sales
- Percentage rent: An additional amount calculated as a percentage of your gross sales above a certain threshold
For example, your lease might specify a base rent of $5,000 per month plus 6% of gross sales over $100,000 per month. This means if your restaurant generates $120,000 in a month, you’d pay the $5,000 base rent plus 6% of the $20,000 above the threshold, for a total of $6,200.
Benefits and Risks
Percentage leases offer several advantages for restaurant operators. The base rent is often lower than in other lease types, reducing your fixed costs. During slower months, you pay less rent, providing some financial relief when you need it most. This structure also aligns the landlord’s interests with yours—they have an incentive to help your business succeed, potentially through marketing support, property improvements, or other assistance.
However, percentage leases also come with risks. During highly successful periods, you’ll pay more in rent, which could affect your profit margins. These leases also typically require you to provide detailed sales reports to your landlord, which means sharing sensitive business information. Additionally, the definition of “gross sales” must be carefully negotiated—does it include delivery sales, catering, merchandise, or alcohol?
Understanding percentage rent versus revenue for restaurants
Variable Leases: Adapting to Changing Conditions
Variable leases include mechanisms for adjusting rent over time based on external factors. These leases help landlords maintain the property’s value while potentially offering tenants protection against dramatic rent increases.
Index Leases
Index leases tie rent increases to a specific economic indicator, most commonly the Consumer Price Index (CPI). For example, your lease might specify that rent increases annually by the percentage change in the CPI, allowing it to keep pace with inflation.
This lease type provides predictability in how increases will be calculated, though not necessarily in the amount of the increases themselves. For restaurant owners, index leases can be beneficial in stable economic times but potentially challenging during periods of high inflation.
Step-Up or Graduated Leases
Step-up leases include predetermined rent increases at specific times throughout the lease term. For instance, your lease might start at $6,000 monthly and increase by $500 every two years. This structure gives you complete clarity on future rent obligations, allowing for better long-term financial planning.
Graduated leases are particularly common in longer-term restaurant leases, where both parties want certainty about future costs without renegotiating the entire agreement.
Special Considerations for Restaurant Leases
Beyond the basic lease structures, restaurant operators must pay attention to several industry-specific lease terms that can significantly impact their business.
Use Clauses and Exclusivity
Use clauses define what activities are permitted in your leased space. For restaurants, these clauses should be carefully negotiated to ensure you can operate your concept as intended, including considerations for alcohol service, outdoor seating, delivery services, and operating hours.
Exclusivity clauses prevent the landlord from leasing space to competing restaurants within the same property or shopping center. These provisions can be valuable protective measures, especially for specialized concepts. For example, if you’re opening a pizzeria, you might negotiate an exclusivity clause preventing the landlord from leasing to other pizza restaurants.
Buildout Allowances and Improvements
Restaurant spaces often require significant customization, from kitchen installations to dining room design. Commercial leases typically address who pays for these improvements and what happens to them when the lease ends.
A tenant improvement allowance (TIA) is an amount the landlord contributes toward your buildout costs. This allowance can significantly reduce your initial capital requirements and should be carefully negotiated based on the condition of the space and the improvements needed.
Additionally, the lease should clarify which improvements become permanent fixtures of the property and which remain your property to remove when the lease ends.
Assignment and Subletting Rights
Restaurant businesses sometimes need flexibility to assign their lease to a new owner or sublet part of their space. Your lease should include clear provisions for these scenarios, including what consent the landlord must provide and under what conditions.
These rights become particularly important if you plan to sell your restaurant business in the future or if you need to downsize your operation temporarily.
Negotiating Your Restaurant Lease
Understanding the different lease types is just the beginning. Effective negotiation can save your restaurant thousands of dollars over the lease term and provide operational flexibility when you need it most.
Key Points to Negotiate
When negotiating a restaurant lease, pay particular attention to these areas:
- Rent amount and structure (including any percentage calculations)
- Lease term and renewal options
- Responsibility for repairs and maintenance
- Buildout allowances and improvement rights
- Assignment and subletting provisions
- Personal guarantees and security deposits
- Exclusivity and use rights
- Signage and exterior appearance regulations
Remember that most aspects of a commercial lease are negotiable, especially in markets with higher vacancy rates. Don’t hesitate to ask for terms that better suit your restaurant’s needs.
Guide to leasing a restaurant in Toronto
The Importance of Professional Representation
Given the complexity and long-term financial impact of restaurant leases, working with experienced professionals is essential. A real estate broker specializing in restaurant properties can help you find appropriate spaces, understand market rates, and negotiate favorable terms.
A real estate attorney with experience in restaurant leases should review your agreement before signing. They can identify potential pitfalls, suggest additional protections, and ensure the lease accurately reflects what was negotiated.
The benefits of using a realtor to decipher your restaurant lease
Common Pitfalls to Avoid in Restaurant Leases
Even experienced restaurant operators can encounter lease-related challenges. Here are some common pitfalls to watch out for:
Overlooking Operating Costs
In triple net leases especially, operating costs can significantly increase your total occupancy expense. Request historical data on property taxes, insurance, and maintenance costs before signing, and negotiate caps on annual increases if possible.
Insufficient Tenant Improvement Allowances
Restaurant buildouts are expensive. If your tenant improvement allowance doesn’t cover the necessary work, you could face substantial out-of-pocket costs before even opening your doors. Get professional estimates for your buildout and negotiate an allowance that reflects these costs.
Restrictive Use Clauses
Overly restrictive use clauses can limit your ability to adapt your concept or add revenue streams like catering, delivery, or retail sales. Ensure your lease provides the flexibility you need to evolve your business over time.
Inadequate Assignment Rights
If you plan to sell your restaurant business eventually, restrictive assignment provisions can complicate the process or reduce your pool of potential buyers. Negotiate reasonable conditions for lease assignment that protect both your interests and the landlord’s.
Beware the pitfalls of commercial leases
Emerging Trends in Restaurant Leasing
The restaurant industry and commercial real estate markets continue to evolve, creating new lease trends and opportunities.
Shorter Lease Terms
While traditional restaurant leases often ran 10-15 years, many operators now seek shorter terms with renewal options. These arrangements provide flexibility in uncertain markets while still offering stability for successful locations.
Pandemic-Related Provisions
Since the COVID-19 pandemic, many restaurant leases now include force majeure clauses that specifically address government-mandated closures or restrictions. Some also include rent abatement provisions tied to occupancy restrictions.
Technology Integration
Modern restaurant leases increasingly address technology needs, including provisions for high-speed internet access, digital signage rights, and accommodations for delivery service integration.
Sustainability Considerations
As restaurants focus more on sustainability, leases may include provisions for waste management, energy-efficient equipment, and shared costs for environmentally friendly building upgrades.
Making the Right Choice for Your Restaurant
Selecting the best lease type for your restaurant depends on various factors specific to your business:
Business Stage
New restaurants might benefit from the predictability of gross leases or the aligned incentives of percentage leases. Established concepts with proven track records might prefer the control and potentially lower base rent of triple net leases.
Location Type
Different locations typically come with different lease expectations. Mall locations often use percentage leases, while standalone buildings frequently employ triple net structures. Understanding the norms for your desired location type can help set realistic expectations.
Financial Strategy
Your restaurant’s financial strategy also influences the optimal lease structure. If you prefer fixed, predictable costs, a gross lease might be best. If you’re confident in your sales projections and want to minimize fixed costs, a percentage lease could be advantageous.
Growth Plans
Consider your long-term plans when negotiating lease terms. If you might expand or contract your space needs, ensure your lease includes options for additional space or subletting rights.
Restaurant property negotiation strategies
Conclusion
Understanding the various types of commercial leases available for restaurants is essential for making informed decisions that support your business’s success. Each lease type offers different advantages and considerations, from the simplicity of gross leases to the performance-based nature of percentage leases.
The right lease structure depends on your specific restaurant concept, financial situation, and long-term goals. By working with experienced professionals and carefully negotiating terms that address your unique needs, you can secure a lease arrangement that contributes to your restaurant’s profitability and operational success.
Remember that a commercial lease is more than just an agreement about space—it’s a long-term business relationship that can significantly impact your restaurant’s financial health and operational flexibility. Taking the time to understand your options and negotiate favourable terms will pay dividends throughout your lease term.
