Food & Beverage Tomorrow: How restaurants are navigating challenging times

The restaurant industry is contending with a slowing economy, a marked increase in food costs, labor shortages, higher rents and a dearth of suitable sites for expansion, making day-to-day operations and future planning more challenging.

These headwinds are impacting all restaurant types—from quick-service drive-thrus to fine-dining establishments—prompting industry decision-makers and investors in retail real estate to rethink their approaches to 2023 and beyond.

Slowing economy, inflation impacting demand

When the economy slows, restaurants are typically among the first to see declines in traffic and check sizes. As of February 2023, however, sales at food and drinking places remain strong, up 15.3% year-over-year, though part of the increase is fueled by price increases to offset higher costs.

People still want to eat out, but how they do so is changing. CBRE’s Global Live-Work-Shop report, which surveyed 20,000 consumers worldwide, found that 37% of U.S. diners are eating out more, while 48% are ordering more takeout.

This means many restaurants will likely be able to withstand a slowdown, so long as they can keep their inflated costs in check.

Inflation weighing heavily on food costs

Core inflation remains elevated at 6.0% as of February 2023 and food inflation remains high. The cost of food prepared at home rose 10.2% year-over-year and the cost of food away from home increased 8.4% year-over-year.

With food costs higher, restaurants have increased prices, up 8.0% and 7.2% year-over-year, respectively, at full-service and limited-service restuarants. A key consideration for restaurants: keeping prices in check to maintain their customer base. Many are absorbing the brunt of inflation-related cost increases to keep customers in the fold despite slimmer profits.

Higher labor costs and more regulations

Virtually every restaurant is grappling with labor shortages, a years-long issue exacerbated by the pandemic, which prompted people to leave the workforce in droves—many never to return–and the gig economy, which offers Gen Z and Millennial workers flexible alternatives to restaurant jobs.

To attract workers, restaurants have raised wages and offered incentives such as signing and retention bonuses and lifestyle concessions like four-day work weeks or flexible scheduling. These tactics are bearing fruit, but at a significant cost. Hourly wages for fast-food workers hit $15.17 in October, up 26% from before the pandemic, while sit-down hourly wages rose 21% to $18.70, according to The Wall Street Journal’s analysis of U.S. Labor Department data.

Restaurants in some parts of the U.S. are also contending with new labor laws targeting the food service sector. In California, for example, a new law could set the minimum wage for food service workers as high as $22 per hour. In Washington, D.C., voters passed a law gradually replacing the tipped minimum wage with the full minimum wage by 2027. Proponents of these measures argue that they repair a broken system that allows restaurants to profit at the expense of their employees. Those against argue that these measures will force operators to adopt more automation and other measures to decrease staff. These changes could lead to higher costs for consumers, potentially driving down traffic and sales.

Challenging real estate market conditions

2022 was one of the strongest years on record for the U.S. retail real estate market. Steady demand amid little new construction dropped the nationwide retail availability rate down to 4.9%, while the national average asking rent rose 2.5% year-over-year to an all-time high of $22.78 per sq. ft., according to CBRE Research.

This is creating a challenge for food chains seeking to expand. Among the limited spaces available, many are either in less-than-desirable locations, require significant capital outlay or can’t be leased at rental rates where restaurants can operate profitably. Rents will likely stay high as the retail development pipeline remains low.

Higher construction costs and interest rates are compounding the problem. CBRE forecasts construction costs to increase 5.4% overall in 2023 following two consecutive years of double-digit increases. With costs to build and finance new retail centers and restaurant spaces higher, fewer projects will get underway despite strong demand. Increased construction costs are also affecting deal-making, as pro formas are tight for both landlords and tenants.

As a result, the competition for suitable sites—especially those in strong or fast-growing markets—is intense. In some cases, owners are receiving upward of a dozen offers on a listing, leaving many would-be restaurateurs unable to enter desired markets and putting significant pressure on the brokerage community to deliver results in hyper-competitive landscapes.

How restaurants can move forward

Restaurants will adjust their strategies in 2023 to minimize costs and focus on achievable opportunities in the marketplace. With food, labor and rent costs still increasing, restaurant executives will carefully watch each of these areas.

To retain customers amid a slowing economy, restaurants will provide options at multiple price points. Full-service restaurants, for example, will diversify their menus—ranging from drinks plus a small plate up to a full meal—to keep foot traffic up. Consumers will likely take out more to avoid delivery fees and tips. Restaurants will adjust accordingly, devoting more labor, resources and space to fulfill to-go orders. This includes more investment in drive-thrus or less costly pick-up windows, which are becoming more prevalent as people cook less at home, especially as grocery prices rise faster than restaurant prices.

To address labor challenges, restaurants will invest more in technology like kiosks and QR codes to take orders, as well as robots and other automated tools to help fulfill and deliver them.

As for expansion, restaurants will target markets with growing populations and lighter regulations. They may also scale back expansion plans due to higher construction and financing costs.

For retail real estate investors, this means that they’ll likely see less demand than in 2022. Many restaurant companies have secured their real estate pipelines for 2023 and 2024 already, with a view toward 2025 and even 2026. Given the sparse development pipeline, investors will remain in a strong position, but may see some turnover as higher rents price out restaurants contending with slim profit margins. Restaurants may also push back on percentage rent clauses in leases that are based on revenue, as the recent increase in sales is largely driven by inflation rather than profits.