RESTAURANT LEASES AND OPTIONS TO RENEW: DO THEY TRANSFER TO BUYERS?
The last couple of episodes, I have been talking about restaurant leases. Today I’m going talk about restaurant leases and the options to renew term.
We will discuss the following:
- Assignment of the Lease
- Original Lease
- Exercise the Option
Assignment of the Lease
When someone buys a restaurant, the contract has a contingency that is agreeable lease term to both buyer and seller. How the lease is negotiated is going to having bearing to not only the buyer, but also the seller. Once the buyer and seller are under contract, the landlord will be presented with the buyer’s financials and other pertinent information. The landlord will almost always assign the existing lease to the buyer. The seller may still have time left on an existing term on the lease.
Here is an example of a scenario:
The seller has two years left on a lease with an option to renew. The initial lease was first written as a five year base term with two five-year options. If the seller sells to the buyer, the buyer then goes to the landlord and the buyer is approved. Said buyer will be assigned to the current existing term, in this case the two years. Almost all leases have the verbiage that the option is personal to the original lessee. If I’m the seller, those options are mine The Landlord is obligated to exercise those options given the conditions, but the landlord is not obligated to assign the option to renew over to the buyer. Most of the time when a lease is being negotiated, they are unaware of this if they are not working with either a qualified restaurant broker or a commercial real estate agent.
Oftentimes if I’m working on an assignment, I’ll read what the terms of the options are and I’ll ask in the assignment that there’s a clause that says that those options transfer over to the buyer. Now, the seller has only two years left no options, or the seller is on a month-to month and is no longer in a lease. That’s not a problem in selling a restaurant, because we’re always going to be doing something with the buyer and the landlord, so we could easily create a new lease. Although it’s not a barrier, it does put the seller in a vulnerable position because at any minute the landlord could issue a 30-day notice, or whatever the terms of the lease are, to vacate the premises for the seller.
Let’s say there are no options and they are in the base term, the landlord may want to assign that to the buyer. Most buyers will not want to spend top dollar on a successful restaurant with no lease term. If you do not have a lease term, you literally don’t have your business. You are incredibly vulnerable for that landlord to issue the notice to vacate.
Sometimes the landlord may want to terminate the seller’s current lease and write a new lease with the buyer. Landlords do not often do that because with an assignment, the landlord doesn’t have to negotiate all of the terms. They do not have to pay an attorney to write a new and does not have to go back and forth to the seller to negotiate those terms because all of the terms are already there. However, if the landlord does terminate the current lease with the seller, the seller gets to sell the restaurant leave free and clear. The landlord will then issue a new lease with the buyer.
When a landlord assigns a lease from a seller to a buyer, most often due to the language in the lease, the landlord cannot unreasonable withhold the assignment to the buyer. The landlord can keep the original holder of the lease, the seller, even as it transfers to the buyer. What that means is that the seller can sit as a guarantor on that lease for the remainder of the term, through all the options.
A great example of this is when I sold my restaurant. I was responsible for the lease for 15 years if any operator after me were to default. I had it for five years prior to selling it to a new operator. That operated was under the same lease with the same concept for five additional years. When that operator sold it to the final owner of the restaurant, they unfortunately did not exercise the option so they were on month-to-month. When they were in contract to sell to another buyer the landlord sold the real property and the buyer of the real property wanted to own and occupy. This is a rare scenario. Most of the time landlords at this level of retail are in the business of collecting rent. They don’t typically buy the commercial real property and then also run the business out of that real property. But in this case, they did. Unfortunately, the final owner of my restaurant was unable to sell the restaurant because they did not have lease term. Which means they did not have the assignment of the lease originally.
Exercising the Option
Inside the lease, there will be the clause about how the current owner of the lease is to exercise that option. The verbiage is very specific about how you can communicate with the landlord with a very strict time boundary to exercise the option. Let’s say that the term is the operator has to contact the landlord no sooner than nine months and no later six months before the expiration giving the operator a three month window for contacting the landlord to exercise that option. Most of the time, they are not tying that date to the dates that are bound in the lease, the lease commencement. Time and again the timeframe to exercise the lease will fall off of an operator’s radar.
If you are a restaurant operator, go to your lease and look to see if there is an option and the parameters within that option. Set a reminder now. The minute that you are outside of those parameters to exercise the option, you go to a month-to-month. So what does that mean? It makes you vulnerable. The landlord might keep you on but the landlord can now negotiate lease terms to whatever the lease terms the landlord wants. When you negotiate those options inside of the lease, the terms of those options are already determined inside the lease.
Base rent changes when you exercise the option. The rent will increase in the options differently. Most of the time, the first option might have one protocol and the second option will have another protocol. The same thing holds to both options. They have to be exercised and they have to be exercised in a very legal way, in a time-bound fashion.
So, whether you are a buyer or a current operator, make sure you put it on your calendar to contact the landlord to exercise that option.
Ryn Longmaid is a restaurant broker and consultant at Santa Rosa Business & Commercial in the San Francisco NorthBay and the host and founder of the Facebook Live Series, Deep Dish: discussions on the business of restaurants for restaurateurs, restaurant buyers and sellers and the restaurant curious.
As well as being a licensed real estate broker, Ryn is a CBB with the California Association of Business Brokers (CABB), a CBI with the IBBA and she holds an MBA in Sustainable Business Management. In addition to being a proficient business broker, Ryn has over 20 years’ experience in the restaurant, hospitality, and food industries. She has served as the executive chef for Amy’s Kitchen, personal chef to actor Don Johnson, she founded and operated a successful and longstanding restaurant. She has also held teaching posts in restaurant management at the Art Institute-San Francisco and The Culinary Institute of America-Greystone.