By Merrie S. Frankel

Food has become increasingly important in retail malls and community centers. For many years, food courts or similar offerings were the order of the day, with fast food restaurants (like McDonald’s or Burger King) being the leading format. Food service was viewed as a necessary (albeit revenue-generating) retail property amenity, like telephones and restrooms, rather than as a key component in driving traffic to the site and helping to optimally merchandise it.

Today there’s a different recipe. Restaurants are a seriously regarded component of malls and community centers, as are the mix of restaurant formats, their placement on the property and their number. In their competitive value efforts against warehouse clubs and supercenters, restaurants, if well chosen, can help create the fun, “go to” positioning landlords seek and impact the returns shareholders receive.

Quick Casual Catches On

A relatively recent restaurant concept called “quick or fast casual” has become the new food court staple in many malls and shopping centers. Quick-casual or quick service restaurants (QSRs) are a hybrid concept, combining the quick service of traditional fast-food outlets, with the perceived higher-quality food of casual, sit-down restaurants. QSRs produce custom meals quickly (though not as fast as “fast food”), rarely have table service, and are more upscale in look and feel.

The common denominator for these QSRs is a variety of food concepts. There are a plethora of concepts within the quick-casual dining category such as Cosi, Panera Bread Co. (and St. Louis Bread Co.), Corner Bakery, Wolfgang Puck Express, Baja Fresh, Panda Express, Pei Wei Asian Grill (owned by P.F. Chang), Café Express, Moe’s Southwest Grill, Fazoli’s, Quiznos and Subway. Even the cafeteria is making a comeback as the automat Horn & Hardart, a form of QSR, undergoes a rebirth in strip centers.

The more people dine out, the more flavor and variety they require. Doron Valero, president and chief operating officer of Equity One, Inc. (NYSE: EQY), adds that the food options are becoming more ethnic with Thai, Japanese, Mandarin, and Chinese buffets in abundance as people desire something they cannot make at home. Another common factor for these quick-casual restaurants is fresher, faster, healthier food, with greater variety and lower price points.

And the numbers show the money is where the mouths are, as a secular change is underway in the retail food sector. According to industry estimates, the quick-casual market is a $5 billion to $6 billion industry that is growing 15 percent to 20 percent annually, expected to double in five years, and account for half of all food service growth by 2010, according to The McKinsey Quarterly.

This growth is aided by a greater number of people eating away from home and looking for alternatives from the standard fare. Whereas a 3.5 percent increase is forecasted from 2002 to 2007 in consumer spending at home, a 4.9 percent increase is projected for food spending on food away from home, according to Retail Forward’s Economic Forecast–U.S. Retail Outlook to 2007.

Need for Speed

Naturally, as the types of restaurants that are tenanting retail centers evolve, so will the locations, concepts and credit aspects change. Even supermarkets are competing with the burgeoning supercenters, says Len Brumberg, executive vice president of New Plan Excel Realty Trust (NYSE: NXL). Supermarkets like Whole Foods, Fairway and Wegmans are adding quick-casual food courts and restaurants.

RETAIL
# of REITs	35
Market Cap.*	$44,891,633
Industry Market Cap.*	$177,849,396
% of Industry	25.2%
Yield	6.1%
YTD Total Return	16.5%
One Year Return	22.8%
Three Year Return	17.1%
Five Year Return	12.3%
Average Daily Trading Volume (shares)	195,562
Weighted FFO Growth (2001–2002)	4.9%
*These figures represented in thousands. Data as of May 30, 2003.
Source: NAREIT.

Location is always an important issue in retail real estate. QSRs have substantial flexibility in location, are more easily placed in “line” positions in centers, and, unlike fast food concepts, do not need drive-throughs.

Jonathan Kayne, COO for the Mid-Atlantic region of Federal Realty Investment Trust (NYSE: FRT), says these restaurants are considered to be traffic generators for the centers in two ways. First, he says they thrive on dense neighborhoods containing office tenants during the day and local inhabitants during the night, thus generating alternative traffic at lunch and dinner for both the restaurant and the retail center tenants. Furthermore, fast-casual restaurants (similar to many other retailers) like to cluster with similar concepts to generate momentum, to share customers, and to offer choices to consumers, who may be coming in groups, yet want to have different style meals.

Lease negotiations adopt a special complexion with food concepts. The new concepts require more renovations, greater seating and heightened décor than fast food. These concepts also usually require special HVAC systems and upgraded electricity, as well as amenities, such as woodburning ovens and special doors. Consequently, it takes longer to lease to these concepts due to the greater buildout and approvals needed from local governments—adding approximately 180 days to the time before which the restaurant will open its doors. Although the general lease will contain percentage rent with fixed steps, newer centers are selling or leasing pads to the QSRs. More recently, landlords such as Weingarten Realty Investors (NYSE: WRI) are building a “floater” building for the concepts, which consists of a free-standing multi-tenant building that is leased to a variety of tenants. The tenants like this locale as it provides good visibility.

Lease terms are usually five to seven years (plus options), but may be as long as 10 years in order to amortize the tenant improvements over a longer term. It has become standard for landlords to pass up to one-half of the improvement costs to incoming restaurant tenants; landlords tend to require around a 12 percent return on that investment in addition to the base and/or percentage rent. With such an investment, including custom tenant improvements, the landlord wants to ensure the concept and the company will endure, says Michael Glimcher, president of Glimcher Realty Trust (NYSE: GRT).

Credit issues, therefore, are important. New concepts may not be the strongest credits, but drive tough deals nonetheless. Several points should be reviewed when negotiating with such tenants:

• Credit: Determine the creditworthiness of the tenant, and decide if you are comfortable. If the tenant is a subsidiary of a larger, perhaps high quality parent, then parent support becomes an issue—especially the explicitness and enforceability of such support. Due to the growing popularity of QSRs, almost every major restaurant company is staking out a brand in the quick-casual arena in order to diversity their sales. For example, McDonald’s owns Chipotle Mexican Grill, Jack in the Box purchased Qdoba Mexican Grill, PF Chang owns Pei Wai, and Wendy’s International owns Baja Fresh and controls 45 percent of Café Express. Third-party supports, such as bank line of credits, are also a consideration.
• Destination Tenants: Is the restaurant a traffic generator for the property? How does that factor in to the thinking on the value it brings to the center, given its credit status? Restaurants that are strong traffic generators often have longer lifespans and contribute to the center’s profitability.
• Franchises: Be cognizant of the relationship between the franchisor and franchisee, cautions Mary Lou Fiala, president and COO of Regency Centers Corporation (NYSE: REG). Since the character and level of support can vary widely, this affects the tenant’s credit position; thus, one needs to underwrite the franchisor, too.