THE

FOOD HALLIndependent F&B’s Pathway to Post-COVID-19 MODEL Profitability THE FOOD HALL MODEL Independent F&B’s Pathway to Post COVID-19 Profitability

Before the COVID-19 crisis, food halls were their low barriers to entry, the potential pool not only the fastest growing trend in food of entrepreneurial restaurant tenants and and beverage, but one of the hottest growth licensees for food halls was deep. The concepts in the greater retail world. These challenges facing food halls were not those socially-driven, experientially-focused of connecting with consumers. If anything, projects weren’t just a hit with consumers the very few food hall failures that had (overwhelmingly popular not just with occurred came from developers looking millennials and the emerging Gen-Z to replicate the success of best-in-class demographic, but foodies of all ages), but projects while ignoring fundamental they became a critical part of landlord and precepts of the model regarding developer strategies to backfill empty space operational, design, site selection, in ways the now challenged department economic, and tenanting considerations. store sector once did. Lastly, because of

1 CUSHMAN & WAKEFIELD At every level, we are witnessing how COVID-19 preys upon vulnerabilities. This is not just true epidemiologically, but also in terms of its impact on business. The "Independent Restaurant" has revealed Challenges with SBA Aid itself as one of the enterprises most All the funds in the first wave of the vulnerable to the challenges of this crisis; Small Business Administration’s (SBA) both because of the obvious impact of Payroll Protection Program were shutdowns and social distancing, but less obvious, because the traditional exhausted within a few days of Congress independent restaurant financial model was enacting the $342B plan. Of that flawed to begin with (more on this later). amount, 8.9% ($30.5B) went to the Accommodations and Food Services Against this backdrop, it would seem that industries (i.e., hotels and restaurants). socially driven food and beverage concepts would be the most vulnerable and that the Loan forgiveness was stipulated on era of the food hall may be ending abruptly. businesses retaining 80% of their staff Yet, as counterintuitive as this may sound, we see a strong case as to why the exact for at least two months with no more opposite is true—not just in terms of the than 25% of funds going towards ability to survive the immediate challenges business expenses. posed by the pandemic, but to emerge as one of the dominant forces to rebuild the Banks earned between 1% and 5% per independent restaurant industry in the transaction on processing these SBA- post-COVID world. guaranteed loans. But while smaller loans would have earned them higher No retail category post- commissions, the reality is that many COVID-19 had seen as much were understaffed and could serve their growth and relevance with larger clients first rather than manage consumers before the the more labor-intensive smaller lending pandemic as independent to independents. Anecdotally, few small food and beverage. operators report they received funding. We estimate that approximately 100,000 A second round of PPP funding added new restaurants opened in the U.S. since another $175B by the end of April, but 2010. By 2016, the USDA was reporting that this will still likely be nowhere near consumers were spending more money on food expenditures away from home levels of need in the marketplace. (restaurants) as they were at home (grocery). The multi-decade rise of foodie culture meant that American palates were becoming more experimental (spiking growth opportunities for cuisines once deemed outside of the mainstream), more refined (driving chef-driven concepts), and more organic (leading to an explosion of locally-sourced farm-to-fork players). The Food Hall Model: Independent F&B’s Pathway to Post-COVID-19 Profitability 2 The market was becoming oversaturated with dated restaurant concepts, so even prior to COVID-19, we entered 2020 anticipating a minor shakeout. This wasn’t because of waning consumer popularity, but because of changing preferences, a crowded marketplace with extreme competitive pressures and rising labor costs in what had been a sub-4.0% unemployment economy. That damage was likely to be minimal and focused on the weakest players. Only those struggling with less relevant outdated concepts, subpar food offerings, or the weakest balance sheets were at risk. Most of the sector was forecast to do well this year. The Delivery Conundrum Yet, in terms of individual business failures, While pizza chains have factored there may be no other portion of the U.S. delivery into their models for decades, economy that will be more challenged than most restaurant categories did not until restaurants in the months ahead. Why is delivery app services opened a powerful this so? Restaurants are not the only retail new channel for restaurants to market category where profitability is highly to consumers. However, they come with dependent on people entering the store. a hefty price tag. The answer is simple; the traditional operational model of the independent Fees to operators average between 15% restaurant is fundamentally challenged. and 30% per order. That’s rich for most First, profit margins were razor thin retailers operating under tight margins. entering the crisis. For almost all restaurant While many of these services have models, food and labor costs typically enacted programs to forgive or defer account for just over 60% of operating fees to independents, the reality is that expense ratios, but levels of service and the delivery model was only marginally quality of food offerings play heavily into vast differences between the Quick Service profitable (at best) to begin with. While (QSR)/Fast Food model vs. Casual or Fine this move will help many operators, and Dining. Outside of QSRs, independent delivery demand has surged, the reality restaurateurs achieving a 10% profit margin is that for most restaurant sectors were rare superstars. This is the case across relying on takeout, drive-thru, and the board, from mom-and-pop pizza places delivery alone will simply not offset to kitchens and dining rooms of the most losses from empty dining rooms. elite world-famous chefs. Further complicating this is the fact that roughly 90% of restaurants are small businesses1— even most of our seemingly monolithic

1 National Restaurant Association

3 CUSHMAN & WAKEFIELD corporate QSRs are, in fact, franchise- revenues. Safety and enhanced sanitation driven. This means that many operators measures will skyrocket at a time in which who were thriving just a couple of months businesses are already challenged. ago simply do not have the financial The way things are currently trending, even reserves necessary to survive two months those restaurant groups that entered the of lockdown. crisis with strong financials and deeper Unfortunately, the mere act of reopening pockets will face significant headwinds. So does not snap everything back to normalcy. far, we have seen amazing examples of Until the coronavirus situation resolves, ingenuity and, indeed, heroism from F&B most economists agree that consumer operators that have pivoted to creating behavior and spending habits will be alternative revenue streams. We have also fundamentally different, and more risk seen many landlords respond with both averse. Mass job losses totaled 20.5 million empathy and creativity in offering blend- in April, which has already driven consumer and-extends and rent abatement and retrenchment. In combination with forgiveness. But the reality is that many mandated occupancy limitations and the restaurant operators—most notably the need to redesign space to accommodate independents—have struggled to pivot social distancing required within their models and for those that have, restaurants to prevent additional outbreaks, alternate revenue streams are simply not this means that independent restaurateurs enough. Government aid to the sector, so are facing an extended timeline of higher far, has been difficult to secure and uneven operational costs and significantly reduced in its distribution. And though we have seen

The Food Hall Model: 4 Independent F&B’s Pathway to Post-COVID-19 Profitability THE FOOD HALL MODEL: F&B’S PATHWAY TO POST-COVID-19 PROFITABILITY Restaurants: The Lockdown Challenge CAN THEY SURVIVE ON DELIVERY AND TAKE-OUT ALONE?

SIX MONTHS

THREE MONTHS

ONE MONTH

0% 10% 20% 30% 40% 50% 60% 70% 80%

How long do restaurateurs believe they can survive a shutdown?

Source: Cushman & Wakefield Research; National Bureau of Economic Research

many landlords (and some of their lenders) If there were ever a time in trying to work with tenants, using creative which tenants, landlords, temporary occupancy structures, this certainly has not been universal. After the lenders, suppliers, and local challenges of the lockdowns, one must ask governments (tax revenues) the fundamental question, how many of are in the same boat, it is these property owners (and their lenders) now. By collectively working will be prepared to continue to make major together, the risk of a concessions (i.e. half rent to restaurants tenants facing 50% occupancy limits) for an widespread collapse could be extended period of time? mitigated. The potential burden to all, could be In April, the National Bureau of Economic Research (NBER) polled over 5,800 U.S. reduced by every level of the small business owners and found that 28% restaurant ecosystem of restaurateurs said they did not have the working together collectively. resources to survive a one-month But still, the question remains as to how long shutdown. 70% said they could not survive market players can and will remain a three-month shutdown. Only 15% believed committed to working together collectively. they could survive a six-month shutdown. This will be a major challenge if the pandemic The implications are dire for the industry, is prolonged. independents in particular.

5 CUSHMAN & WAKEFIELD So where does this leave independent F&B? The Quick-service restaurant (QSR)/

As landlords with restaurant tenants question Fast Food model is best positioned to get how to best support those businesses, many through this crisis. We estimate that are forced to envision upcoming or currently there are nearly 300,000 QSRs in the vacant space. The same is true for developers U.S. (including burger, sandwich, pizza, now reframing plans for future spaces. While chicken, Mexican, etc.). This model any statement made today on the future of already derived 70% of sales from drive- restaurants must be considered a tentative thru and takeout. But many of these one, it’s clear the mechanism for rebuilding food and beverage will require an updated businesses are franchise driven (from business model, one in which landlord/ mom-and-pops to corporate franchisers developer participation in the amenity is key. with generally deeper pockets). This model and its greater ability to adapt to economic and operation modification, is why Fast-Casual had been the hottest F&B we remain extremely positive on the future of sector. There are roughly 75,000 units, food halls. Food halls were already wildly but the movement is dominated by popular before the pandemic not just for the independents. It relies on delivery and quality of their food offerings, but for the takeout (few have drive-thrus) for about social experience they offered. Consumers 50% of revenues pre-COVID. felt as if they received a higher quality product at an approachable price point. The Casual Dining/MidScale category Following lockdowns, and what is likely to be includes both major chain operators and an extended period of social distancing, to mom-and-pops (from family owned say that there may be pent-up demand for experiential and social offerings will likely diners to full-service brewpubs). It is the prove to be a major understatement. And largest restaurant sector in terms of while the economic model attached to food sheer numbers, at roughly 392,000 units. halls proved to be a resounding success in Fast casual growth had largely come at the pre-COVID-19 marketplace, we do not the expense of weaker casual dining believe that this economic model needs to be chains, though most remained relevant limited to the food hall genre alone. to consumers. Pre-COVID-19, this sector The concept of the food hall as an generated about 20% of sales from important amenity for landlords and as a takeout (including curbside) or delivery. risk mitigator for F&B vendors is not a new one. Over the last five years, food halls have Fine Dining is the smallest sector; less grown at a rapid rate. Cushman & than 5% of its revenues came from Wakefield’s research, which has tracked alternate channels. It will be further food halls across the United States since challenged by consumer retrenchment, 2016, identifies 223 open and operating non-existent travel, and disappearing food hall projects, pre-COVID-19, with over expense account spending in the months ahead.

The Food Hall Model: Independent F&B’s Pathway to Post-COVID-19 Profitability 6 165 announced as in-development.2 The food hall movement was largely a response to demographically focused demand. Millennial and Gen-Z consumers who have led the "experience over goods" charge anointed quality F&B as their experience of choice.3 The economic impacts of this crisis are only likely to reinforce those views. With an experiential focus on authenticity, social interaction, and elevated concepts that still provided value, the food hall experience exploded upon the American consciousness. Its popularity with younger All well designed food halls are aligned consumers was only part of the attraction. The need for alternative space usage made with operational strategies that focus on “ the product increasingly attractive with economizing vendor sizes and shifting developers and landlords—the business more space to the customer experience model itself not only limited exposure to side of counters. Food halls that created weak tenants but kept the concept fresh spacious public areas are now poised to with the public. Most importantly, its creatively adapt multiple queuing lines, low-barrier-to-entry made it never want for wider aisles, programmable spaces, and potential new tenants and licensees. flexible seating strategies into a more When curated and operated with respect separated, comfortable - yet still very for the model (it is NOT an updated food social - customer experience. These court model), a food hall is a collection of types of adaptations are more difficult individual micro-economies presenting to execute in fast casual or quick service local, regional, non-chain, chef-driven fare that stands in stark contrast to traditional restaurants because they’re designed chain food and beverage. The experiential with longer, narrower queuing zones nature of this type of collaborative dining and more dense dining configurations.” and the engagement with innovative cuisine provided by independent vendors remains a highlight of the food hall. - Ed Eimer President, Before the pandemic, experiential concepts Eimer Design were among the strongest performers in both the retail and F&B world. The pandemic has put those concepts on hold, and many experiential players that were thriving will simply not make it through the crisis without help. But, we see the food hall model as the vehicle which can lead a resurgence of the experiential F&B economy.

2 Cushman & Wakefield Research 3 CNBC, https://www.cnbc.com/2016/05/05/millennials-are- prioritizing-experiences-over-stuff.html

7 CUSHMAN & WAKEFIELD It is also encouraging to see food halls exchanges, educational classes, "Flower adapt quickly to the crisis, perhaps more Pot Fridays", collaborations with than most retail categories. Our tracking of community groups, and private events. the industry indicates that 75% were able to Though food halls were a concept driven by stay open during the lockdowns by pivoting social interaction, they are actually in a to the ghost kitchen model. In Omaha, significantly more effective position than Nebraska at Inner Rail Food Hall, the venue most traditional restaurants to navigate the quickly got creative. Vendors teamed up challenges of social distancing policies. offering take-out packages billed as a “World Food Tour”, offering tastes of each The transformable space model designed concept. The creativity possible in a for food halls allows for easily collective is a potential boon, if tapped, for manipulatable seating at minimal expense operators struggling to get by primarily on to ownership. Space previously used for delivery and pickup models for now. entertainment programming can now be dining areas. We also believe there are Another inherent advantage for food halls lessons to be learned from the private upon their reopening is that their common booth seating found in finer restaurants; spaces have been designed to be flexible. while cloth privacy curtains for a table are The best examples of food hall designs likely non-starters in this new norm, leave room for programming, which operators can create safe, private pods with purposefully enjoys a broad definition. protective materials, disinfected after each Pre-COVID-19 food hall success was often use, to further enhance a sense of security closely linked to socially activated space, for guests. If designed thoughtfully, these live entertainment, podcasting, retail pods can create a sense of togetherness, pop-ups, art, farmers markets, craft while respecting distance.

The Food Hall Model: 8 Independent F&B’s Pathway to Post-COVID-19 Profitability THE FOODOpening HALL MODEL: Up F&B’S PATHWAY TO POST-COVID-19 PROFITABILITY AMID CORONAVIRUS, HERE'S HOW SOON GEN Z AND MILLENNIALS SAID THEY WOULD RETURN TO THESE ACTIVITIES:

As soon as isolation ends As soon as vaccine is out Activity Months after isolation ends Long after vaccine is out

RESTAURANTS 55% 16% 13% 16%

MOVIE THEATERS 39% 23% 14% 24%

DOMESTIC TRAVEL 38% 23% 14% 25%

GYM 35% 19% 12% 34%

CONCERTS 32% 23% 14% 31%

SPORTING EVENTS 29% 23% 17% 31%

INTERNATIONAL TRAVEL 27% 21% 15% 37%

LARGE EVENTS (e.g. COACHELLA) 24% 22% 14% 40%

Source: TruePublic, Margin of error: +/- 2.37%, April 10-16, 2020

Additionally, a significant number of food The Food Hall Model is the halls have outdoor patio or rooftop garden Independent F&B Model for space. While these spaces can certainly assist in offsetting the challenges of limited the Future The economic model of a food hall occupancy restrictions, they will also bring operates most efficiently on an all-inclusive an additional layer of security to patrons. percentage rent. Revenue generated by the Throughout the pandemic we anticipate food hall vendors is shared, then distributed that consumers will generally feel far more by the owner and venue operator of the secure in outdoor environments than in food hall to resolve operating expenses enclosed spaces. (including a rent component), with Ultimately, how much these measures heightened attention on revenue sharing of mitigate the ongoing challenges facing food beverage sales. halls, and the entire F&B sector, remain to be Food halls were seen as a “safe amenity” seen. But we do see the inherent design investment by developers prior to the flexibility of the food hall as giving them an shutdown. The recognition that a food hall advantage in the months to come. And the contained a number of independent pandemic will not last forever. businesses and was significantly less likely There are already major indicators of pent-up to "go dark" than a stand alone restaurant demand. Late April consumer polling of became an attractive attribute. Without a Gen-Z and Millennial consumers indicates long-term lease and large tenant-specific that 55% of this demographic (the primary build-out, a landlord felt secure about a driver of food hall popularity) say they would scenario in which a major vacancy will not return to visiting restaurants more quickly likely occur. In a food hall with multiple than any other activity (movie theaters, vendors, in the event of an unsuccessful travel, gyms, etc.) upon lifting of lockdowns. concept closing, the remaining ten vendors

9 CUSHMAN & WAKEFIELD continue operation while the vacated space alternative also has significantly higher quickly transforms to accommodate a fresh profit margins, typically between 15-20% idea. This model is a winning scenario for for the vendor compared to restaurants the owner and vendor. Owners expend which often struggle to reach 10% profit. capital, taking the burden off the vendor, Moving into the post-pandemic era, we will but enjoy the upside of their up-front likely see both significant belt tightening investment. Their space hosts and attracts from consumers and pent-up demand for readily available talent and reaps the socialization (both of which will favor the benefit for it. traditional fast casual tenant of food halls Under a short-term license agreement, and the venues themselves). We will also owing only a fair percentage of sales, the see more landlords and developers in need chef or restauranteur has very few fixed of backfilling retail space lost to the crisis costs. That percentage covers a laundry list and absolute need to reconfigure shopping of extra bills associated with food and centers towards those concepts that beverage establishments, including utilities, resonate with consumers. marketing, POS systems, CAM, and real Most importantly, large swaths of the estate taxes. In terms of a start-up cost, independent restaurant community are compared to a stand-alone restaurant going to need a rebuilding mechanism; one space, where initial investment typically with lower inherent risks for all, a better ranges between $250,000 to $2,000,000, operational model that allows for higher a single food hall stall investment ranges profit margins, and low barrier-to-entry. only between $25,000 to $75,000. The low cost to staff 350 SF of space and a Food halls will be where the industry condensed menu allows vendors to work rebuilds first. economies of scale. This low-cost

The Food Hall Model: 10 Independent F&B’s Pathway to Post-COVID-19 Profitability About Cushman & Wakefield

Cushman & Wakefield (NYSE: CWK) is a leading global real estate services firm that delivers exceptional value for real estate occupiers and owners. Cushman & Wakefield is among the largest real estate services firms with approximately 53,000 employees in 400 offices and 60 countries. In 2019, the firm had revenue of $8.8 billion across core services of property, facilities and project management, leasing, capital markets, valuation and other services. To learn more, visit www.cushmanwakefield.com or follow @CushWake on Twitter.

For more information

Garrick Brown Phil Colicchio Vice President and Head of Retail Executive Managing Director, Speciality Research, Americas Retail Services F&B, Entertainment and Hospitality [email protected] Consulting, Retail Services +1 916 508 3410 [email protected] +1 609 647 0142

Trip Schneck Jenna Postiglione Executive Managing Director, Speciality Analyst, Specialty F&B, Entertainment and F&B, Entertainment and Hospitality Hospitality Consulting, Retail Services Consulting, Retail Services [email protected] [email protected] +1 212 841 5936 +1 443 994 4365

Jacob Dinetz Analyst, Specialty F&B, Entertainment and Hospitality Consulting, Retail Services [email protected] +1 212 660 7730

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