Starbucks will open 300 net new stores in fiscal year 2020 despite the pandemic.
Source: Starbucks

The spate of restaurant closures brought on by the pandemic is creating opportunities for big chain eateries to expand their real estate footprints, even as many restaurants refocus operations on delivery and takeout services that require fewer square feet.

Nearly 100,000 U.S. restaurants indefinitely suspended operations or closed permanently during the first six months of the pandemic, according to the National Restaurant Association. Restaurant closings are expected to continue during the fall and winter months, compounding challenges for landlords tasked with filling space vacated by bankrupt retailers.

Independent, mom-and-pop restaurant operators will continue to suffer disproportionately in the mandatory reduced occupancy environment, and larger, well capitalized chains may seize opportunities to expand while lease terms are favorable to tenants, according to Peter Saleh, a managing director and restaurants analyst at BTIG.

Some restaurant chains, such as Chipotle Mexican Grill Inc., are already in expansion mode, adding dozens of new locations. Brokers are coming forward continually with new lease opportunities, Tabassum Zalotrawala, Chipotle's chief development officer, said in an email.

A Papa John's International Inc. franchisee in the Philadelphia area, meanwhile, announced plans to open 49 new locations beginning in 2021 — the pizza chain's largest brick-and-mortar store development agreement in North America in more than 20 years.

"There is going to be a short term opportunity for the chains to take more share from some of the independents," Saleh said in an interview.

A new, new normal

The pandemic accelerated secular shifts in consumer behavior that were already upending the restaurant industry. Takeout and delivery services that had become increasingly popular via the proliferation of mobile applications like Postmates and Uber Eats, for example, have become standard operating procedure in the social distancing age, forcing even in-restaurant dining purists to expand operations in that arena, or shut down, according to Alex Susskind, a professor of food and beverage management at Cornell University.

"There were some segments of the restaurant business that really frowned upon delivery and takeout. They didn't do a lot of catering, and the heart and soul of their business was in the four walls of their restaurant. And if you didn't like that, and you didn't want to wait two hours — 'Too bad. Move on.' Well now that's not how we're doing business."

The new way of doing business has prompted a full-blown real estate reckoning for restaurants, which have been contending with rising commercial rents for years, raising the hurdle of profitability in a notoriously low-margin business.

For many, optimizing real estate has meant allocating more space to kitchen operations, and carving out dedicated takeout and delivery stations. Some restaurants, like Burger King and Del Taco Restaurants Inc., have explored ditching in-store dining altogether at certain locations — and the added labor, design and maintenance costs that come with it — and multiplying the number of takeout lanes.

"The pandemic has given everyone an opportunity to really think about what the space means and how you can maximize, or optimize, the things that you pull out of that space," Susskind said.

Shrinking to grow

For some chains, real estate optimization has meant a general downsizing. McDonald's Corp. said in July that it will close 200 of its 14,000 U.S. locations, more than half of them low-volume stores in Walmart Inc. locations. And Starbucks Corp. said in June that it plans to close up to 400 U.S. locations over the next 18 months, before eventually opening more stores. A Starbucks spokesperson said the company expects to add 300 net new stores in fiscal year 2020, down from an original expectation of 600 stores.

"Not only are they [restaurants] taking advantage of better real estate opportunities, they're also using this as an avenue for closing underperforming locations," Anne Haerle of Southern California-based Synergy Restaurant Consultants, said in an interview.

Euromonitor International expects the number of limited-service chain restaurants to decline by 5% in 2020, to 189,708 from 198,937 in 2019, and for the number of independent limited-service restaurants to drop 7% to 103,899 in 2020, from 111,156 in 2019.

Prospective new restaurant operators — there are many who see Covid as a window of opportunity — are exploring much smaller footprints. Alex Diaz, a restaurant consultant with TRG Restaurant Consulting, said many players are floating ghost kitchen concepts, or standalone kitchens for fulfilling delivery orders. And developers are looking at breaking up larger restaurant spaces and even industrial warehouses into tiny 500-square-foot parcels where the sole focus will be food preparation for delivery.

While the dining room experience will remain paramount at the upper end of the restaurant quality spectrum, takeout and delivery services are likely to continue at elevated levels even among that group in the post-Covid environment, Haerle and Diaz said. Some restaurants will move to separate the two spheres of business: smaller dining locations in one part of town, and a commissary kitchen in another.

"If you want to stay in business, you have to be creative about how you get food into people's hands," Haerle said.

New partnerships

Landlords have had to be creative, too. Faced with the prospect of a glut of empty restaurant space, many real estate owners are collaborating with restaurant tenants to craft individualized work-arounds involving rent abatement and deferrals. Some are rethinking the restaurant lease structure altogether, offering rents based on a percentage of sales, Keith Durst, a principal and founder of FOC, a company that advises developers and restaurants, said in an interview.

Among the real estate investment trusts, Four Corners Property Trust has the highest exposure to restaurants, counting 24 as top tenants, according to S&P Global Market Intelligence data.

The company, which declined to comment for this article, has offered rent deferrals and abatements only where tenants exchanged "favorable concessions and lease modifications," Four Corners President and CEO William Lenehan said on a recent earnings call. The concessions include term extensions, increased financial reporting and annual rent bumps, among other items.

"Despite the ongoing difficulties in coping with the pandemic, through these difficult negotiations we have longer contractual lease duration and higher rent growth than we had going into this," Lenehan said. "I believe we have strengthened our working relationships with many of our tenants."

For well-capitalized players, current market conditions have created a window to make the leap and become real estate owners themselves, Cornell's Susskind said. He expects the pandemic to yield new business partnerships between real estate and restaurant owners in the coming years, as players learn to better manage risk.

"I think savvy restaurants will see plenty of opportunities to partner with the real estate side of the business," Susskind said. "This is a market that's ripe for entrepreneurial spirit."