Weighing in on Key Money Deals
More and more these days, I am being approached about the strengths and weaknesses of proceeding with “key money” deals. Key money deals are lease transactions in which an existing lease is assigned to a new principal and typically includes the present state of the restaurant, equipment and transferable liquor license for a sum of capital.
People often value them on different scales based on their initial construction and equipment costs, not to mention the state of the present market and the general amount of tender love and care put into the operation as a whole. Although many of these deals may seem appealing from a restaurant operator perspective, as a broker I am typically very weary of these transactions as it is important to perform a certain degree of due diligence.
The most important factors of a key money deal are weighing in the current rent, escalations and remaining lease term in comparison to typical market rates upon the time of evaluation, and the key fee. In order for a deal to be of true value, and justify the Key Money AKA Fixture Fee, the inherited rent must be considerably below market and below standard escalations (3 percent), and there must be enough time remaining in the lease to amortize your costs and become profitable.
If this formula doesn’t make sense on paper, it’s a long shot from the get-go. More often than not, the gross key money fee is very negotiable, and, of course, an attractive location, a fully constructed restaurant, equipment and a hassle-free liquor license are certainly worth something. However, the greater value is in a strong lease.
Keep in mind that when you inherit someone’s lease, you are also on board for their tax responsibility, which will have an older tax base year (from when the initial lease was executed) and could be a significant annual number going forward. I find this is often a reason people try to sell their leases in the first place. If the formula makes sense, and the numbers are comfortable, also make sure to perform the proper due diligence on the premises itself. I always advise the help of specialists for HVAC and venting and even a general contractor to go through the site and confirm everything is kosher. The last thing you want—next to a poor lease, of course—is a space in which you are inheriting headaches or installations that will later have to be brought up to current code. That can end up being very costly and time-consuming. I often find first-time operators are more inclined to proceed with key money, because they are not very familiar with the market, construction procedures and initial approval processes to move forward on the landlord’s end.
At the end of the day, key money deals are something certain restaurant operators might want to consider, but these deals need to be met with caution and require a sincere amount of thought. Neighborhoods like the Lower East Side and East Village have a greater number of these transactions based on the difficulty to obtain liquor license approval in that vicinity. Otherwise, as a broker, I try to steer clear of key money transactions and focus on new direct leases.
In my opinion, it’s worth going through the motions of construction and liquor to negotiate one’s own lease on one’s own terms and at a fresh tax-base year. Key money deals can be tricky but can prove to have some value, as long as you make sure you have the right personnel behind you to make the proper evaluation.