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Law360 (March 9, 2021, 6:17 PM EST) --
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| Andrea Gendel |
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| John Rothman |
By ditching the in-house kitchen, seating and dining experience, the so-called ghost kitchen model — also known as a cloud, virtual or dark kitchen — has found room to grow amid an otherwise chaotic real estate market and increasing consumer demand for restaurant meals without the dine-in experience.
A ghost kitchen is a professional food preparation and cooking facility set up for the preparation of take-out, delivery and catering-only meals. It may produce multiple brands for the same tenant or serve as a commissary kitchen used by multiple third-party operators simultaneously in a shared facility.
The space contains all of the kitchen equipment and facilities required for the preparation of restaurant and catered meals, without a dining or client-facing pickup area, although in some cases, a ghost kitchen may have a very limited area for walk-in customers.
Without diners, a ghost kitchen is heavily reliant on its own or third-party delivery apps like DoorDash and UberEats for customers and orders. Still, it also means that the restaurateur can avoid paying rent on the square footage that would otherwise be devoted to dining space.
Ghost kitchen leases can offer lower risk than leases for a traditional dine-in restaurant model by reducing initial startup costs and ongoing operating expenses.
The elimination of waitstaff, reduction of buildout costs such as dine-in fixtures and furniture, shared use of kitchen and other cooking equipment, thereby reducing the share of the rent, and, potentially, without seating, fewer New York City Department of Buildings and state Department of Health requirements, have given new and existing restaurants newfound possibilities.
With the reduced risk and costs, and today's pandemic-related reduced rents, new restaurateurs, or those looking to move from an online-only presence to brick and mortar, are looking to take advantage of this lower barrier of entry into the competitive and costly foodservice field, while exiting restaurants are able to move to less expensive space, cut operating costs and thereby, remain viable.
At the same time, property owners with vacant premises in this market can benefit from leasing space to ghost kitchens and collecting rent, rather than seeking new traditional restaurant or retail tenants who, these days, are few and far between.
Not only are ghost kitchen tenants taking over and converting defunct restaurant premises, but they are also leasing storage and warehouse space, portions of parking garages and even dine-in food hall space that has been rendered unprofitable due to the pandemic.
While there is tremendous benefit in ghost kitchen models for landlords, tenants and the licensees that operate in such kitchens, such parties must consider certain legal issues pertinent to this type of use.
Tenant Considerations in Ghost Kitchen Lease Negotiations
Term
If the tenant is considering using the space for its own operation, it is advisable to have a shorter lease term for kitchen space, with fixed renewal options. Statistically, many startup food and restaurant operations do not make it past the first year of operations. If the tenant intends to lease space with the intention of licensing to third-party users in a commissary-style space, a longer term may be advisable.
Third-Party Licensing
An important revenue generator for some ghost kitchen tenants comes from the ability to license kitchen space to multiple operators in a commissary-style kitchen.
Several independent companies may use different areas of a shared kitchen facility simultaneously, or a single tenant may develop multiple different in-house brands under one management company.
Even tenants whose business models do not currently include hosting multiple operators should preserve this option in the future. Tenants should focus on ensuring that they have the free right to license all or a significant portion of the leased premises to third-party operators without the need to obtain a landlord's approval or consent.
Furthermore, tenants should ensure that they not be required to pay their landlords any so-called profit in connection with any licenses of the premises (i.e., the excess, if any, between the rent per square foot paid to the landlord under the lease and the license fee paid under the license).
Ability to Freely Change Cuisine Concepts
Given the flexibility of the ghost kitchen model regarding concepts, a tenant should ensure that it is not restricted to a particular cuisine style or menu. Tenants should include broad permitted use provisions that allow general cooking operations in the ghost kitchen space without cuisine restrictions or limitations.
Tenants might also consider future options to add dine-in space, which may be desirable as we emerge in a post-pandemic world. Without being bogged down by use restrictions, a tenant can ensure that they stay competitive and adaptable for the next big food trend and attract a wide variety of licensee operators.
No Continuous Operations or Limit on Hours
A ghost kitchen tenant should ensure that its landlord has as little operational oversight as possible, particularly in the area of required hours of operation or micromanaged oversight of kitchen maintenance and repair.
In order to maximize tenant sales to ensure a consistent rental stream, landlords in traditional brick-and-mortar restaurants typically insist that tenants abide by a continuous operations provision or minimum hours of operation requirement, whereby tenants are limited in their ability to go dark.
However a ghost kitchen may have legitimate reasons for not operating during standard dining hours, depending on the brands and cuisines operating on-site, or the kitchen may be open 24 hours per day, 7 days a week.
For example, a waffle licensee and an artisanal pizza maker may have completely different target hours of operation. Flexible operating hours that make sense for individual concepts and brands reduce costs and ensure efficiency during targeted operational windows.
Due Diligence
Tenants should understand the condition in which the premises will be delivered, the adequacy of utilities, and whether the space will meet the intended ghost kitchen model's requirements.
Is the space a legally permissible working kitchen with sufficient utilities, or are other permits/signoffs required? If the latter, the lease should specify which party will perform the work and obtain any required change of use. Additionally, tenants should ensure adequate loading and delivery areas in the building for supplies and outgoing packaged food.
High Kitchen Usage and Overruns
With the high usage associated with a ghost kitchen, tenants should ensure that their landlords agree that their spaces may be used for longer hours than a traditional restaurant, as such costs may increase a landlord's operating costs, depending on the type of property.
With licensees typically charged a flat fee, as discussed below, it is also important for tenants to understand their responsibility for any utility overages above the license fee, as landlords won't typically be willing to undertake such obligations.
Landlord Considerations in Ghost Kitchen Negotiations
Indemnification of Landlord
Multiple users operating simultaneously in a shared kitchen space, exacerbated by a constant stream of third-party delivery services coming in and out of the premises, can create a liability nightmare for landlords.
A landlord with a potential ghost kitchen tenant should consider requiring approval over any third-party user license agreements to ensure it has the same protections as the landlord requires under the lease.
Additionally, landlords should negotiate an indemnification provision in their leases that includes a tenant indemnity for breach of the lease and broadly covers all operations in the tenant's premises, any licensees, and their respective agents, employees and contractors.
This indemnity should also cover all third-party claims. It should be required to be included in any license agreement so that the licensees are equally responsible for landlord indemnification.
Clear Allocation of Obligations
The lease should also clearly allocate the tenant's relevant repair, maintenance and regulatory obligations under the lease, including, without limitation, compliance with state Department of Health regulations and obtaining permits and final closeouts of applications from relevant governmental authorities in connection with the tenant's buildout and use of the space.
Disclosure of Occupants and Insurance
Landlords should consider how much oversight they desire over third-party licensees operating in a ghost kitchen. In addition to requiring a tenant to provide the landlord with the name and sufficient details about occupants using the space, the lease should require tenants to provide certificates of insurance.
This would provide evidence that each licensee of the premises carries the requisite insurance. It is advisable to speak to a risk manager to determine the types of insurance and limits that licensees will be required to carry, in addition to the insurance carried by the tenant.
Signage
Consider the level of signage that the ghost kitchen tenant will need. It may not be necessary to give a ghost kitchen tenant the same level of exterior signage or visibility as a traditional retail tenant since there lacks a client-facing operation.
If signage is permitted, consider whether any licensees using the space in common should have the right to install their own exterior or even interior signage or whether the landlord prefers no delineation of the individual operators within the space.
Licensee/Operator Considerations in Ghost Kitchen Negotiations
Flat Fee for all Costs and Rent Abatements
Streamlining all ghost kitchen operating costs into a simplified, all-inclusive monthly fee allows a restaurant operator to focus on what chefs do best — cooking and food creation — without having to worry about variable additional costs like utilities, cleaning services and insurance.
Removing the complexity of monitoring back-of-house and utility costs unrelated to cooking lets licensees pay greater attention to content creation and business development. Licensees should consider requesting an abatement of a license fee if they are unable to use the premises for any reason, particularly if there is no early termination right, as discussed below.
Short Terms or Early Termination Rights Without Penalty
The ghost kitchen should be where restaurateurs can create and test out new concepts and food fares and develop their brands. Unfortunately, not all ideas pan out, and savvy restaurant operators should look to avoid long-term deals altogether or to build in an escape clause into their license agreements allowing the licensee to terminate on 30 days' written notice without penalty.
Repair/Maintenance Obligations
Wherever possible, a restaurant licensee should shift the burden of repair/maintenance of the premises and all kitchen equipment to its licensor (i.e., the tenant under the lease with the landlord) and/or the landlord.
As there may be shared equipment not exclusive to a single licensee, the licensor and/or landlord are better situated to handle repair and upkeep obligations, with the cost of the same shared proportionally with all licensees.
Due Diligence
As with any tenant in connection with a lease, a licensee in a ghost kitchen should perform its diligence as to the permitted uses and request that the tenant represents that space may be used as a kitchen or commissary. If the licensee requires specialized equipment that is not included in the space, this may require landlord consent or require permits, all of which should be vetted before signing any license agreement.
Prudent parties willing to adapt to consumer demand changes and new markets will find the ghost kitchen model beneficial — from lowering operational expenses to exploring previously untenantable leasable space. However, understanding the landscape is critical.
Andrea Gendel is a partner and co-chair of the leasing practice at Pryor Cashman LLP.
John Rothman is an associate at the firm.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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