SAN DIEGO—There are a number of compounding reasons why the restaurant business as we know it is under attack, so restaurant owners will need to look ahead and make changes to their business models, Location Matters' president and principal Mike Spilky tells GlobeSt.com. In a recent company newsletter, Spilky said to expect “more closing restaurants to come, more inventory of commercial properties for sale” in the San Diego market.

Spilky added that the restaurant market peaked in San Diego six months ago and that the average consumer would be surprised to know that most of his favorite dining spots are likely breaking even, losing money or turning very small profits, with the exception of some very high-volume operations, the next “it” place or tenants holding down grandfathered leases with exorbitantly low occupancy costs. Others that are successful understand the value of entering undeserved trade areas and the power of limited competition. Restaurants are now more than ever increasingly forced to modify their overall business model to stay alive.

We spoke with Spilky about these concerns and what retail landlords and restaurateurs should know about this market.

GlobeSt.com: Why is there concern in the retail real estate market with regard to restaurants in San Diego?

Spilky: There are a number of compounding reasons why the restaurant business as we know it is under attack. First and foremost, there are simply too many restaurants, and the market is hitting a saturation point. Not only that, but consumers are not eating out as much and resorting to the growing glut of delivery options available such as Door Dash, UberEATS and others for convenience and cost savings. The restaurants that participate in these services typically don't see a profit on these sales due to the percentage that is paid to the delivery-service provider. Further competition is coming from grocery stores' prepared foods, home-chef meal delivery services and more. In San Diego, our some 150 breweries now compete with restaurants by serving lots of beer and food in some form, occupying inexpensive, large industrial spaces.

Aside from oversaturation and a competitive set, costs for restaurants across the board have increased tremendously, specifically food costs and labor. With the recent minimum wage hike, we are seeing the fight $15 starting to backfire on business. Rents have increased to a frothy sum in some trade areas; only further exacerbating a restaurant's already-suffering gross margins.

GlobeSt.com: What do restaurant owners and retail owners who lease to restaurants need to know and do in order to survive the next wave of changes in this sector?

Spilky: Restaurant owners will need to look ahead and make changes to their business models. These will need to be big, sweeping changes that can have large-scale effects on customer experience. All of this stems from the growing necessity to cut back on costs—namely, labor and the cost of goods. Some examples could be going from full service to a fast-casual service model or some hybrid of the two. Also, adding more technology, more customer point of sale and mobile ordering are things to consider as well.  We are even seeing restaurants look at robotics to replace kitchen staff. Restaurants will need to re-engineer their menus to cut back on portion sizes, remove items that don't sell as much, etc. The initial investment restaurants make in a new location will need to decrease as to help mitigate the increased risk and hedge against lower ROI projections.

In addition to changes in their business models, growing restaurants need to focus on seeking sites that are in trade areas that are underserved and overpopulated. I call this the “Disneyland Model,” and ideally it occurs where there is no potential for further retail development to compete in the future.

The effects on the restaurant space will undeniably trickle down to retail property owners, and we are already seeing plenty of evidence of this. Property owners will have to lessen the occupancy-cost burden on certain tenants. Casual-dining restaurants are the most susceptible to a loss of profitability. Full-service or even buffet-style restaurants are both at risk because they occupy very large spaces and employ lots of staff. Owners of these sorts of property must have contingency plans in place to potentially demise these buildings into smaller fast-casual tenants or change the use entirely. The restaurants that seem to fare best are those with a low-cost-of-food model. Some examples include breakfast-heavy restaurants, many Asian concepts and restaurants that have more than 50% of sales coming from the bar.

Developers of new centers will need to build projects in underserved markets; otherwise, they will just be contributing to the problem of oversupply. Tenants will need to be chosen carefully—I always see hands-on owner/operators able to weather a storm much better than their chain counterparts. I would recommend that a landlord dig deep into a restaurant's business model, including all costs and other nuances usually kept private. They may even want to hire a consultant who understands the business from the inside out to help with this sort of vetting.

GlobeSt.com: If fewer restaurants will be leasing this space, what do you see happening to it?

Spilky: Great real estate will always be great, and these spaces will remain full. The only turnover we may see will be a result of mismanaged operations or concept burnout. Poor locations and locations with heavy nearby competition will see turnover and vacancy. In some instances, these spaces will likely be better suited for conversion to a different use entirely.

GlobeSt.com: What else should our readers know about upcoming restaurant and retail real estate changes?

Spilky: We have been seeing declining traffic and sales for many of our restaurant colleagues and clients here in San Diego, but all is not lost—those who follow a strong investment discipline will be able to navigate the headwinds. My concern stands with the unknown; if food prices continue to climb or we see a small recessionary pull back in consumer spending or tourism in our city, this will be cause for additional worry.

SAN DIEGO—There are a number of compounding reasons why the restaurant business as we know it is under attack, so restaurant owners will need to look ahead and make changes to their business models, Location Matters' president and principal Mike Spilky tells GlobeSt.com. In a recent company newsletter, Spilky said to expect “more closing restaurants to come, more inventory of commercial properties for sale” in the San Diego market.

Spilky added that the restaurant market peaked in San Diego six months ago and that the average consumer would be surprised to know that most of his favorite dining spots are likely breaking even, losing money or turning very small profits, with the exception of some very high-volume operations, the next “it” place or tenants holding down grandfathered leases with exorbitantly low occupancy costs. Others that are successful understand the value of entering undeserved trade areas and the power of limited competition. Restaurants are now more than ever increasingly forced to modify their overall business model to stay alive.

We spoke with Spilky about these concerns and what retail landlords and restaurateurs should know about this market.

GlobeSt.com: Why is there concern in the retail real estate market with regard to restaurants in San Diego?

Spilky: There are a number of compounding reasons why the restaurant business as we know it is under attack. First and foremost, there are simply too many restaurants, and the market is hitting a saturation point. Not only that, but consumers are not eating out as much and resorting to the growing glut of delivery options available such as Door Dash, UberEATS and others for convenience and cost savings. The restaurants that participate in these services typically don't see a profit on these sales due to the percentage that is paid to the delivery-service provider. Further competition is coming from grocery stores' prepared foods, home-chef meal delivery services and more. In San Diego, our some 150 breweries now compete with restaurants by serving lots of beer and food in some form, occupying inexpensive, large industrial spaces.

Aside from oversaturation and a competitive set, costs for restaurants across the board have increased tremendously, specifically food costs and labor. With the recent minimum wage hike, we are seeing the fight $15 starting to backfire on business. Rents have increased to a frothy sum in some trade areas; only further exacerbating a restaurant's already-suffering gross margins.

GlobeSt.com: What do restaurant owners and retail owners who lease to restaurants need to know and do in order to survive the next wave of changes in this sector?

Spilky: Restaurant owners will need to look ahead and make changes to their business models. These will need to be big, sweeping changes that can have large-scale effects on customer experience. All of this stems from the growing necessity to cut back on costs—namely, labor and the cost of goods. Some examples could be going from full service to a fast-casual service model or some hybrid of the two. Also, adding more technology, more customer point of sale and mobile ordering are things to consider as well.  We are even seeing restaurants look at robotics to replace kitchen staff. Restaurants will need to re-engineer their menus to cut back on portion sizes, remove items that don't sell as much, etc. The initial investment restaurants make in a new location will need to decrease as to help mitigate the increased risk and hedge against lower ROI projections.

In addition to changes in their business models, growing restaurants need to focus on seeking sites that are in trade areas that are underserved and overpopulated. I call this the “Disneyland Model,” and ideally it occurs where there is no potential for further retail development to compete in the future.

The effects on the restaurant space will undeniably trickle down to retail property owners, and we are already seeing plenty of evidence of this. Property owners will have to lessen the occupancy-cost burden on certain tenants. Casual-dining restaurants are the most susceptible to a loss of profitability. Full-service or even buffet-style restaurants are both at risk because they occupy very large spaces and employ lots of staff. Owners of these sorts of property must have contingency plans in place to potentially demise these buildings into smaller fast-casual tenants or change the use entirely. The restaurants that seem to fare best are those with a low-cost-of-food model. Some examples include breakfast-heavy restaurants, many Asian concepts and restaurants that have more than 50% of sales coming from the bar.

Developers of new centers will need to build projects in underserved markets; otherwise, they will just be contributing to the problem of oversupply. Tenants will need to be chosen carefully—I always see hands-on owner/operators able to weather a storm much better than their chain counterparts. I would recommend that a landlord dig deep into a restaurant's business model, including all costs and other nuances usually kept private. They may even want to hire a consultant who understands the business from the inside out to help with this sort of vetting.

GlobeSt.com: If fewer restaurants will be leasing this space, what do you see happening to it?

Spilky: Great real estate will always be great, and these spaces will remain full. The only turnover we may see will be a result of mismanaged operations or concept burnout. Poor locations and locations with heavy nearby competition will see turnover and vacancy. In some instances, these spaces will likely be better suited for conversion to a different use entirely.

GlobeSt.com: What else should our readers know about upcoming restaurant and retail real estate changes?

Spilky: We have been seeing declining traffic and sales for many of our restaurant colleagues and clients here in San Diego, but all is not lost—those who follow a strong investment discipline will be able to navigate the headwinds. My concern stands with the unknown; if food prices continue to climb or we see a small recessionary pull back in consumer spending or tourism in our city, this will be cause for additional worry.