How much rent should you pay in a hospitality business? This question has come up a number of times in conversations and consulting jobs in the recent past. The simple answer is ‘as little as possible’, of course — but are there any rules or guidelines?
Before I give you my thoughts on this subject it is useful if I remind you that every dollar you pay your landlord is a dollar out of your pocket. If you stitch yourself up for an ill-considered lease you can easily find that all your profits go to your landlord and you have bought yourself a job with long hours for modest return. I see this situation quite often.
Rent and marketing should be considered together
I never consider rent on its own when I’m looking at a business. Perhaps surprisingly, I always consider that the rent a business pays should be viewed in tandem with the cost of marketing the business. This is in recognition of the fact that with rents, like most things in life, you generally get what you pay for. A high rent site should bring many pedestrians past your door and may eliminate or greatly reduce the need for external marketing.
High rent can be a good deal under certain circumstancesI had a good example of this when I worked with a restaurant at Circular Quay in Sydney. The site was eye wateringly expensive at first glance, but when I did the feasibility study for the business, I discovered that three million pedestrians walk past the door each year, mainly tourists. This is what we call a ‘golden location’. To put it crudely you could put crap on a plate and still be wildly successful in a location like this and not have to spend a bean on marketing. This justifies an unusually high rent. In this
case it turned out to be 14% of turnover, which in most other cases would be totally unsustainable.
Cheap rent can be a bad deal
Let’s take the opposite situation; the seemingly cheap site that is off the beaten track. We see many of these; they could be up an alley, in a basement, on the 1st floor, in an isolated location by itself. What on the surface seems a good deal soon becomes less attractive when we consider the cost of marketing the business and educating the public that the business is there. It could easily cost you four or five percent of turnover for a few years to establish a viable customer base. This is why I have to link the costs of rent and marketing when I assess a business.
Another important consideration is parking. I see a disturbing number of restaurants and cafes with expensive fit-outs being located in places that are particularly difficult for customers to access. How far do you think people are prepared to walk to have a meal or a cup of coffee? Not far, I can assure you — especially when we look at fine dining, where a frocked-up goddess in elegant stilettos is not going to be comfortable walking more than a short distance from the Ferrari to the front door.
What do you get for your rent?
Moving on, what do you get for your rent? At the most basic, you get bare premises that you have to fit-out, perhaps even to the extent of having to install grease traps, exhaust systems, toilets etc. This is like standing in the wind tearing up thousand dollar bills. All of a sudden that cheap rent is not so cheap any more. At the other end of the scale some landlords will strike deals where they pay for the fit-out in return for a higher rent. In essence you are paying for you own fitout over time, instead of having to come up with all the money up-front. When you’re trying to establish a business on a strict budget, this could be very attractive.
The last thing you want to find is that over the course of your lease you are paying an ever escalating rent for rapidly deteriorating premises, because your landlord is a miser and doesn’t want to spend any money but wants the rent to keep pace with inflation. I’ve had clients with poor leases having to spend hundreds of thousands of dollars doing capital repairs and refurbishments, because the landlord won’t budge and it is too difficult and too expensive to shift the business to another location.
What is a fair percentage to pay?So, how much is fair? Well I believe that added together, rent plus marketing should not exceed 12% of conservative estimated turnover. Assuming 4% for marketing this would allow a maximum rent of 8%. If you can do better, good luck to you. If you assess that the site itself will guarantee customer numbers then I might pay up to the full 12% in rent, on the understanding that I would have to do little or no marketing.
Conversely, for an out-of-the-way site I might look for a low rent of around 4% of turnover, knowing that this would give me about 8% to spend on marketing. This would allow you to rapidly build a customer base and, depending on your operating standards, perhaps decrease your marketing costs as word of mouth kicked-in to the point where you are not spending anything on external marketing after a few years. You should be producing an above average profit at this point.
There is another way to go, however. Why not just negotiate a percentage of turnover rent in the first place, and then you’ll have a more predictable cost structure to your business?