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Pacific Coast Business Times: Flat population, more competition spells trouble for restaurants

February 03, 2017
Santa Barbara, California – Published 2/3/2017
Alex Kacik

The South Coast is in the midst of a restaurant bubble, Santa Barbara restaurateur John Bennett said.

While the Santa Barbara area benefits from a healthy tourism industry, population growth has remained relatively flat, meaning that restaurants are competing for the same dollar. A net of around 70 new restaurants have opened from Carpinteria through Goleta over the past 10 years, said Bennett, who hasn’t seen this much movement in his 30 years in business.

More competition, minimum wage hikes, California lacking a tip credit, rising property values and a dearth of housing and high regulatory costs all slim already razor-thin margins in the restaurant industry. If there isn’t some contraction in the industry, the bubble will likely burst, Bennett said.

“I think Santa Barbara is in a restaurant bubble,” Bennett told the Business Times during a conversation at his restaurant Benchmark Eatery. “I am not trying to complain or be pessimistic, I am just looking at the numbers. We have more restaurants and the same number of people to fill the seats. It’s not sustainable.”

The Bennett family’s restaurant group owns Brophy Brothers, On the Alley, Benchmark, the Cliff Room and Farmer Boy. John Bennett also handles the back house management for the Montesano Group, which owns Lucky’s Steakhouse, Joe’s Café and others.

Aldo’s, Café Primo, Julienne, Sojourner, Gandolfo’s and Hungry Cat all recently closed in Santa Barbara, while a handful of new restaurants have opened in and around the Funk Zone. The Californian Hotel project on lower State will add several more. Goleta also has a number of new restaurants that will serve the residents of a variety of new developments.

But Bennett expects more restaurants to close than open over the next few years as the market corrects itself, he said.

“I call it the revolving door of restaurants,” Jim Turner of the Radius Group said.

One of Bennett’s fellow restaurateurs told him that the property valuation of the building he occupied more than tripled, raising his expenses by more than $55,000 a year and causing him to close. Property values are artificially high given the slow-growth politics of the region and lack of development, sources said.

“The inflated cost of real estate in Santa Barbara is an interesting problem,” said Brendan Searls, who recently transformed the former El Cielito restaurant in La Arcada into Viva Modern Mexican. “Most of the leases are triple-net, which means you have to absorb the cost of property taxes. Santa Barbara is oversaturated with restaurants, the population density isn’t there and the cost of real estate is unusually high. But you know this coming into the market. It is a matter of perspective.”

Searls co-founded the old Bogart’s Café at La Arcada more than 20 years ago, now Petit Valentien, and Dargan’s Irish Pub & Restaurant in downtown Santa Barbara. Searls also co-founded Pizza Mizza, opened a second Dargan’s in Ventura and helped grow Brendan’s Irish Pub & Restaurant to three Ventura County locations.

While Ventura County doesn’t have the same year-round tourism industry, it has a denser population and less competition, he said.

As for the city of San Luis Obispo, it has seen the number of restaurants increase but the overall square footage has remained relatively consistent, SLO Economic Development Manager Lee Johnson said. Yet a significant number of additional housing units and new hotels are poised to bring increased foot traffic, which should sustain the city’s restaurant industry, he said.

Many Santa Barbara restaurateurs spend more than 25 percent of their gross revenue on rent, well above the recommended 10 percent threshold, said Robert Rauchhaus of the Radius Group.

“I think it will have to go really poorly for the restaurant industry before the old way of doing business makes way for new models,” he said.

One of the major issues is that California is one of a handful of states that doesn’t have a tip credit, said Trevor Large, a founding partner of Buynak, Fauver, Archbald & Spray. A tip credit allows a restaurant owner to factor in tips to its minimum wage obligation.

The lower-end restaurants with smaller profit margins will be the first to feel the impact when they have to raise prices to offset the cost of the minimum wage as it incrementally increases to $15 an hour by 2021, he said. Eventually, the competition and increased cost will put them out of business, Large said.

“There is a confluence of a lot of bad factors that make it tough for the average restaurant to prosper, let alone survive,” he said. Bennett described it as a “perfect storm.”

The leisure and hospitality industry, which is one of the biggest contributors to the local government’s bottom line, will be the hardest hit by the increasing minimum wage, Large said.

“People don’t understand how it adds to our quality of life,” he said. “In 10 years we may be saying, ‘What happened to all these restaurants and hotels?’”

Corporate chains like Blaze Pizza and Pieology Pizzeria that have the ability to absorb losses are growing their market share while independent restaurant owners are taking a hit, Bennett said.

The Downtown Organization of Santa Barbara is leading a reshaping of the downtown corridor. It has tapped retail consultants Downtown Works to study the mix of retailers, who shops downtown and what they are buying with the hope that the data will attract tenants into an increasing number of vacant storefronts.

“It would be nice to get the city, all the brokers, tenants and landlords on board to come up with a game plan for State Street,” Turner said. “It’s time to reinvent State Street.”

Some landlords offer fluctuating lease rates to accommodate the slower months of the year, Bennett said. Landlords could also chip in on some building improvements to help attract tenants, he said.

While many investors and small business owners are attracted to the allure of owning a restaurant on the South Coast, now is not the time to open, Bennett said.

“I don’t think it’s time for people to come into the industry and open in this area,” he said.

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