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SR-308-002 (7) Council Meeting: July 22, 2003 Santa Monica, California TO: Mayor and City Council FROM: City Staff SUBJECT: Proposed Minimum Rental Structure and Lease Term for Beach Concession Stands and Cafe for State Legislative Approval Introduction This report recommends that the City Council approve a proposed minimum rental structure and lease term for beach concession stands and café for State Legislative approval. Background Under an Operating Agreement with the State of California, the City has a concession agreement with Chaos Enterprises, Inc. dba Perry’s Beach Cafe and Rentals to operate four (4) concession stands on the State Beach. This concession agreement expires in June 2005. The Operating Agreement with the State requires the City to submit a proposed rental structure and lease term for beach concessions as a Budget Package Request to the State Legislature in July 2003 for approval in July 2004. Once approved by the State Legislature, staff will issue a Request for Proposals (RFP) in the fall of 2004 for the operation of four (4) beach concession stands and one café location at the beach. The café location, 1100 PCH, was originally a concession stand but has not been operational as such since 1993 due to its close proximity to the stand located at 1200 PCH. The RFP will include the minimum rent structure and lease term for both the 1 four stands and the café. Proposers may bid on both the concession stands and café or on either one. The RFP will encourage proposers to bid in excess of the minimum rent. The State Legislature will consider the rental structure and lease term as part of the 2004-2005 budget package. In 2004, staff will issue a Request for Proposals for the concession stands and café. Staff will return to Council in early 2005 with a recommended operator and request to negotiate an agreement. Discussion The last time the City submitted proposed rental terms for beach concessions to the State was in 1996. At that time, the State concession guidelines required minimum annual base rent versus a percentage of gross sales. The State Legislature set the percentage at 20%. Since 1996, there have been changes in the State concession guidelines which provide greater flexibility in establishing term and rental structure for beach concessions. In 1996, the City received only one proposal, from Chaos Enterprises, Inc. dba Perry’s Beach Café and Rentals, in response to the RFP. Subsequently, staff learned from prospective proposers that the 20% rent requirement was prohibitive because businesses generally need a period of time paying lower rental amounts to establish their operations. While 20% was at the high end of the rent scale, Perry’s had been paying this amount since 1990. However, downturns in the economy coupled with the 2 lingering effects of 9/11 have made it increasingly difficult for the current concessionaire to meet the required payment schedule. Minimum Rent - Concession Stands Staff collected data from a number of other State, city and county beach concessions in an effort to determine a rental structure for the beach stands that will generate acceptable minimum revenue to the City as well as encourage prospective proposers to elevate the quality and selection of food and services to beach visitors. Most beach stand concession agreements on State beaches require percentage rent on gross sales in the seven percent (7%) to fourteen percent (14%) range (Attachment “A”). Tiered percentage rent is typically used with concession stands so that the lessor participates in the concessionaire’s increased sales. It is important in the RFP process to set the minimum rental structure low enough to attract an array of prospective operators while making it clear that higher minimum base rent and percentage rent will result in a more competitive proposal. Staff recommends minimum base rent of $100,000 annually, or 14% of annual gross sales, whichever is greater, for the four concession stands. This percentage rent is within the range used by comparable beach concessions. The RFP will require that proposers include tiered percentage rent based on gross sales thresholds. Proposals that include higher tiered percentage rent on gross sales will be more competitive. The competitive process is structured to yield an operator that will provide improved food 3 quality, breadth of choices, upgraded facilities and enhanced marketing of the concessions. The goal of setting the proposed minimum rent at a lower rate is to encourage proposals from high quality operators. Although the proposed minimum rental structure may be lower than the current agreement, it is anticipated that the improved quality of the product and services will result in higher sales volumes and thus higher revenue to the City through its percentage participation. Minimum Rent - Cafe Staff collected data from a number of other State, city and county beach restaurants in an effort to determine a rental structure for the cafe that will generate acceptable minimum revenue to the City as well as encourage prospective proposers to provide a high quality operation to beach visitors. Most restaurant or cafe agreements on State beaches require percentage rent on gross sales in the six percent (6%) to twelve percent (12%) range (Attachment “B”). Tiered percentage rent is used with restaurants so that tenants that are required to make a substantial capital investment in the facility bear less of an immediate burden from rental payments. As sales volumes increase, the lessor shares in the benefit. The 1,500 square foot café location has not been operational since 1993 and will require a significant capital investment in its facilities to make it functional. Staff recommends minimum base rent of $60,000 annually, or 8% of annual gross sales, whichever is greater, for the café. The percentage rent is within the range used 4 by comparable beach cafes. The RFP will require that proposers include tiered percentage rent based on gross sales thresholds. Proposals that include higher tiered percentage rent on gross sales will be more competitive. Length of Term - Concession Stands Lease terms for concession stands are generally three to five years. Some State beach stand concession agreements include an option to extend for a second three to five year period. The proposed term for the concession stand agreement is five (5) years with one five (5) year extension option. This proposal is based on lease terms for comparable beach concession agreements and standards for State Park and Beach concession operations. A five year term gives a tenant sufficient time to amortize the initial investment and to establish an effective marketing plan to promote the concessions. If the operation is successful, both parties can agree to exercise a second five year option. Length of Term – Café Lease terms for restaurants generally reflect the amount of capital investment required. A longer lease term may be offered to facilitate securing financing and to allow sufficient time for amortization of new capital investment in the premises. Café or restaurant lease terms normally run for five years with one or two five-year extension options. The proposed term for the café agreement is five (5) years with two (2) five year extension options. This proposal is based on lease terms for comparable beach restaurant agreements and standards for State Park and Beach restaurant operations. 5 Budget/Financial Impact Over the last three years, gross sales at the four beach concession stands have ranged from a high of $1,009,904 in FY 99-00 to a low of $832,511 in FY 01-02 with a three- year average of $893,558. Gross sales were influenced by several factors over the last three years - weather, restricted access due to the reconstruction of the sewer line along Pacific Coast Highway, the economic downturn and the effects of 9/11 on tourism. Weather obviously has the most significant impact on sales and while the beach experienced relatively good weather over the past three years, the other abovementioned factors negatively impacted beach visitation and concession sales. Based on the percentage rent provisions of the existing lease with the City, the four beach concession stands generated $200,000 or approximately 4% of Beach Fund revenues in FY 2003-03, compared to $4,518,621 or about 80% of annual Beach Fund revenues generated by beach parking. Given the relatively small percentage of revenue associated with the concessions, the emphasis for the beach concessions should be to provide high quality food, service and facilities to beach goers. The proposed rental structure being submitted to the State Legislature for approval is the minimum amount acceptable to the City. As mentioned earlier, prospective operators will be encouraged to propose base and percentage rent that exceed the minimum rent. If the selected operator were only able to pay the minimum base rent for the beach concession stands, it would result in $100,000 to the Beach Fund. In order to generate the same revenue the City now receives, the stands would have to generate 6 $1,211,884, the equivalent of 20% more than Perry’s highest gross sales, and include a tiered rent structure so that the annual rental payment would equal $200,000. As an example, if the minimum annual base rent is $100,000 and the tiered rent structure is 14% of the first $500,000 in sales, 18% of the next $500,00 in sales, 20% of the next $250,000 and up, the revenue to the City would be as follows: $500,000 x 14% = $ 70,000 $500,000 at 18% = $ 90,000 $211,884 at 20% = $ 42,377 Total rent = $202,377 An experienced and quality operator should be able to generate higher sales volumes. The higher sales volumes will result in the City realizing greater rental payments. Since there is no café in operation, the minimum base rent from the café of $60,000 would be new revenue to the Beach Fund. The minimum rent is set low to attract a greater response to the RFP. It is anticipated that proposals will include a minimum annual base rent exceeding $60,000. The new agreement will not go into effect until FY 2005-06. Therefore any impact will be included in future years’ budgets. Recommendation Staff recommends that the City Council approve the following basic lease terms for submittal to the State Legislature: 1) concession stands: a minimum base rent of 7 $100,000 annually, or 14% of annual gross sales, whichever is greater; a tiered percentage rent based on gross sales thresholds; and a proposed term of five (5) years with one five (5) year option; and 2) café: a minimum base rent of $60,000 annually, or 8% of annual gross sales, whichever is greater; a tiered percentage rent based on gross sales thresholds; and a proposed term of five (5) years with two (2) five year options. Prepared by: Barbara Stinchfield, Director, Community and Cultural Services Elaine Polachek, Open Space Manager Attachment A Attachment B 8 Attachment “A” Lease Rates at Selected Beach Stands Name Percentage Rent Imperial Beach 8% Oceanside 10% San Clemente 13% Manhattan Beach 7% Huntington Beach 10.5 – 14.5% * * Huntington Beach percentage rent based on tiered sales volumes Attachment “B” 9 Lease Rates at Selected Beach Restaurants/Cafes Name Annual Base Rent Percentage Rent Ruby’s- Oceanside Pier $65,000 6% of first $1.5 million 7% of next $250,000 8% of next $250,000 9% and up Fisherman’s – San Clemente Pier none 6% Ruby’s – Huntington Beach Pier $100,000 7% of first $800,000 8% of next $500,000 10% of next $700,000 12% and up Duke’s – Huntington Beach Pier ground lease 4% of first $1 million 5% of next $3 million 6% and up Ruby’s – Seal Beach Pier $38,000 6% Surf View Café – S.M Pier $15,457 10% Mariasol – S.M Pier $50,400 5.25% Pier Seafood – S.M. Pier $19,782 8% 10