New research predicts a significant rebalance of the relationship between rent and turnover in the UK casual dining sector

12 August 2020

Latest research on the casual dining sector, undertaken by Colliers International, reveals a need to rebalance the relationship between rent and turnover when landlords and tenants negotiate new leases.

The report, ‘Can the UK find a new appetite for eating out?’ looks at the sector’s trajectory prior to lockdown and how it can begin to ‘right-size’ itself in the face of the new customer attitudes and economic realities brought by the pandemic. Colliers believes that the key to this is constructive collaboration between casual dining operators and the landlords who provide the space from which they trade.

Around 30 per cent of 217 restaurants that were handed back to landlords following the Casual Dining Crunch in 2017/2018 remain vacant. Of those restaurants that have been re-let, around 80 per cent have seen a reduction in rents, with the average discount being 20 per cent.

The biggest deductions were in the South West (-37 per cent) and North East (-27 per cent), although some restaurants, many of which are located in London, witnessed increased rents.

Vacancy rates are particularly high for restaurants located in leisure schemes (44 per cent), while the landlords of a large number of eateries on high streets and in retail parks have secured new tenants, with respective vacancy rates at 23 per cent and 13 per cent.

There are also regional discrepancies in rent reductions and with incentives, typically in the form of rent-free periods, twice as high in the North West and South West, as those offered in the East Midlands.

The research explains that with economic activity and consumer spending significantly declining due to COVID-19, the restaurant sector is forecast to face a shortfall of up to £23 billion this year . This is triggering a fundamental restructuring of the sector and the property market which it serves.

Vacancy rates and reductions in rents payable are expected to exceed those seen following the 2017/2018 crunch. Colliers anticipates that there will need to be a significant rebalance of the relationship between rent and turnover in order to kick start the casual dining sector post COVID.

Nigel Ball, Director, Licensed & Leisure at Colliers International commented: “The rapid growth of the casual dining sector is well documented and created competition for sites from established and emerging occupiers, which fuelled rental growth.

“Operators have since found themselves with overheads that are too high, margins which are too low and a target market which is nervous about a return to eating out on the scale which prevailed prior to the pandemic.

“It is not possible to precisely predict how the UK casual dining sector will emerge from the impact of COVID-19 as the pandemic is yet to fully play out. Our analysis shows a strong regional correlation between rents payable and household disposable income. The recessionary impact of the pandemic will inevitably result in lower rental values when vacant properties are relet.

“Independents and – eventually – new startups may flourish in a re-based sector of substantially lower rents but this will not totally fill the voids created. Operators’ revenues, profits and their ability to pay rent will remain under pressure, and to get through this period there will have to be an unprecedented level of collaboration between landlords and operators. Landlords will need to have – or be able to access - a forensic understanding of the sector, operator profitability and what their locations can support. Risk will need to be shared and perhaps a greater use of turnover to determine rents can offer both operators and landlords the hope that better days lie ahead.”

The research explains that although the Coronavirus Act has temporarily banned landlords from evicting their tenants if they fail to pay their rent and the government’s furloughing scheme helps in the short-term, restaurants will have to adapt their business models.

“Landlords and occupiers will have to work together to create a survival strategy for the sector. From a property perspective, this is likely to feature increased incentives, flexible leases with a higher turnover element, and rent reductions. Given the severity of the COVID-19 impact on the hospitality sector, we expect further significant reductions in rental values, and increases in vacancy rates,” added Ball.

He continues: “At the heart of the landlord/operator collaboration challenge is the property lease which both parties sign up to. In the face of an extremely uncertain current market – and to future-proof themselves against the possibility of new pandemics – operators will want to pay rents that are based increasingly on turnover rather than what the property business believes is the objective rental value of an outlet.

“The turnover element of the rent stipulated by leases will become much higher and base rents will need to reduce if landlords and operators can find a viable way of working together. The turnover element of casual dining rents used to usually be a ‘cherry on the cake’ for landlords – a means of them enjoying part of the upside of an operator trading well. Going forward, the philosophy behind the use of turnover clauses will be entirely different. It will predominantly be a risk mitigator for operators that allows them to maintain a viable margin for their business – and stay in occupation of the property.”

The report shows that in contrast, the base rents which were applied to old-style turnover leases and often represented 80-90% of an outlet’s estimated rental value – will be reduced to a much lower proportion. As a result, landlords will need to have a deeper understanding of the sector in order to set rents which are sustainable and identify the casual dining offers with longevity, with which they will want to work.

Oliver Kolodseike, Associate Director, Research & Forecasting at Colliers International said: “The reopening of pubs and bars on 4th July 2020 was welcomed by the hospitality sector and the Government's 'Eat to Help Out' scheme and VAT reductions, which started last week (Monday 3rd August), are timely measured but to restore trading viability, support existing operators and woo new offers into vacant space, rents must inevitably fall and the sector has to target new and sustainable profit margins.

“As a consequence, we expect there to be a further significant reduction in rental values, and an increase in vacancy rates, together with a structural change in the way that casual dining property leases are structured.”