The glut of underused strip malls in the U.S. may be a cash drain for commercial real estate developers, but it has become a gold mine of sorts for thriving restaurant operators.
Some of the industry's top names are aggressively eyeing strip malls for new locations, lured by the ready availability of empty spaces and ability to negotiate good deals.
These "brownfield" developments, so called because the ground has already been cleared and developed, offer a number of advantages to restaurant operators, experts say.
First, restaurant companies don't have to invest in building new locations from the ground up. Second, as the spaces are empty, cash-strapped developers give restaurants leeway to customize them to fit their needs — at favorable rates.
Finally, many brownfield developments are located in high-traffic suburban areas — attractive spots for leading fast casual restaurant operators such as Chipotle Mexican Grill (NYSE:CMG - News), Panera Bread (NASDAQ:PNRA - News) and Buffalo Wild Wings (NASDAQ:BWLD - News).
"The fast casual sector has done really well in suburban locations, and it's a little easier to find locations in the suburbs right now," said Bart Glenn, a restaurant analyst at D.A. Davidson & Co. "Many of these fast casual restaurants end up in strip centers that either went out of business or are being repurposed.
Mini-Malls Go Small In many cases, repurposing goes against the traditional template of finding a big anchor tenant to serve as centerpiece, analysts say.
"You're seeing them do a redevelopment with a smaller retail operation like Barnes & Noble (NYSE:BKS - News) and a couple of restaurants," said Stephen Anderson, senior restaurant analyst at Miller Tabak & Co.
Developers will take what they can get in a rough property market. In the last five years, with a commercial real estate credit crisis and recession, vacancy at U.S. neighborhood and community retail centers has zoomed from 7% to 11%, according to real estate data tracker Reis.
Buffalo Wild Wings has been particularly effective at finding good locations in underutilized strip malls, Anderson says.
"They've done a good job taking advantage of these kinds of real estate opportunities," Anderson said. "If a retail chain goes belly up and leaves a big empty space, the developer is happy to build a restaurant to Buffalo Wild Wings' specifications, and at a good price.
Buffalo Wild Wings recently announced the opening of its 800th restaurant. Watchers figure that number can go much higher.
"I think they could double that by the time they finish expanding in the U.S. and Canada," said Mark Smith, analyst at Feltl & Co. "They have a really strong growth story.
Chipotle has been even more aggressive. Its tally of new restaurants opened this year could top 145, and it expects 155 to 165 in 2012. The company currently has more than 1,100 restaurants. Analysts expect it could accommodate 2,000 to 3,000 in the U.S. alone.
Panera also has been busy opening new locations. In a third-quarter conference call, CEO William Moreton said Panera is raising its 2011 new-unit target to between 110 and 115, which is 10 to 15 units more than its original range.
"We're also raising our 2012 new unit expectation to the same 110-to-115 units,"Moreton said.
It's not surprising that Buffalo Wild Wings, Chipotle and Panera are expanding, considering they rank among the restaurant industry's best financial performers.
But even companies performing less robustly have begun to add new units after a years-long decline. The list includes casual dining chains like Cheesecake Factory (NASDAQ:CAKE - News), Olive Garden (owned by Darden Restaurants (NYSE:DRI - News), Chili's (owned by Brinker International (NYSE:EAT - News) and P.F. Chang's China Bistro (NASDAQ:PFCB - News).
The number of new units in the casual dining sector grew an estimated 2% during the third quarter, according to a report from JPMorgan analyst John Ivankoe. That might not sound like much, but it marked the first time since 2009's first quarter that new unit growth reached that high.
Ivankoe expects new unit growth of 2.1% this quarter, 2.6% next quarter and 2.8% the quarter after that.
Those gains are well up from a six-quarter stretch in 2009 and 2010 when growth never rose above 1.7%. But they are still well down from 7%-plus growth numbers reported in 2006 and early 2007.
"Though unit growth appears to have bottomed, it is unlikely to reach pre-recession levels again as domestic opportunities are more limited," Ivankoe noted.
Restaurants are expanding for a couple of reasons, analysts say. The slowly improving economy has led to an increase in customer traffic. And in many cases, companies that delayed expansion plans during the downturn are simply picking up where they left off before the downturn hit.
For real estate brokers and developers, the restaurant industry's appetite for suburban strip mall locations is a mixed blessing.
On the plus side, they are landing well-capitalized clients to fill empty spaces. On the minus side, they don't have much bargaining power.
"It's still very much a buyer's market for most of these locations," Glenn said.
Deluxe Is Different For brokers, the supply-demand equation is more favorable in the market for upscale, urban restaurant locations.
"For the higher-end properties it's still a very tight market," Anderson said. "Higher end restaurant chains like Bravo Brio (NASDAQ:BBRG - News) and (Darden's) Capital Grille are probably finding it a little tougher to find good locations in urban center-city areas.
No matter the market, he expects brownfield developments to continue dominating the restaurant real estate landscape over the near term.
"The big opportunity will come from brownfield development rather than new mall development," Anderson said. "It will be a couple more years before you see new development on any significant scale."