Why rent above 15% of revenue kills most cafés

Every café listing shows you rent. Very few sellers show you rent as a share of revenue, and that is the number that tells you how much room the business has to be wrong.

My rule of thumb, and the one the scorecard uses: under 10% of revenue is comfortable, 10 to 15% is workable, and over 15% you are mostly working for the landlord.

The arithmetic

Take a café turning over $800,000 a year. These figures are illustrative, not from a specific listing, but they are typical of how the lines stack up.

• Food and drink at 30%: $240,000
• Wages at 35%, including a manager: $280,000
• Everything else (utilities, insurance, card fees, repairs, marketing, accounting) at 10%: $80,000

That is $600,000 before rent, leaving $200,000 for rent and profit.

At 10% rent ($80,000), the owner is left with $120,000, a 15% margin.

At 18% rent ($144,000), the same café, with the same coffee and the same staff, leaves $56,000, a 7% margin.

Same business. The only difference is the lease, and it has cut profit by more than half.

Why it's the cost you can't move

Food cost moves with sales: sell fewer coffees and you buy less milk. Wages flex too, though only partly, because you still need a minimum crew to open the doors and run a shift.

Rent doesn't flex at all. It is due on the same day whether the month was good or terrible.

Run a slow quarter through the same two cafés. Revenue falls 10% to $720,000. Food cost falls with it to $216,000. Wages only fall 5% to $266,000, because rosters can't shrink in proportion. Other costs stay at $80,000.

• At 10% rent: $720,000 − $216,000 − $266,000 − $80,000 − $80,000 = $78,000 left
• At 18% rent: $720,000 − $216,000 − $266,000 − $80,000 − $144,000 = $14,000 left

The low-rent café took a 10% sales drop and kept most of its profit. The high-rent café is within one bad month of working for nothing, and that is before it pays the owner anything for the hours they put in.

Outgoings and reviews

The headline rent in a listing is rarely the real number. Before you calculate the percentage, find out:

• Outgoings. Many leases charge the tenant a share of council rates, water, building insurance, and sometimes land tax or building management costs on top of base rent. Some listings quote base rent only.
• How the rent reviews. A fixed annual increase, a CPI increase and a market review are very different things. A market review can move rent sharply, and you often won't know the number until the review date.
• What happens at renewal. If the lease has an option, check whether the rent for the option term is set, capped or reset to market. A café that works at today's rent may not work at the renewed one.
• Turnover rent. Some centre and tourist-site leases add a percentage of sales on top of base rent. If so, add it to the calculation.

Use rent including outgoings, projected at the next review, as a percentage of verified revenue. That is the number to hold against 15%.

What to ask

Put these to the broker and, where you can, the landlord or their agent:

• What is the total annual rent including outgoings, and how much of that is outgoings?
• When is the next review, and is it fixed, CPI or market?
• What is the rent during the option period, and who has the right to exercise it?
• Is there turnover rent or any other charge on top?
• Will the landlord confirm all of this in writing before I sign?

Lease terms differ by state, so have a lawyer who does commercial leases read the lease before you commit. If the numbers only work at last year's rent, they don't work.