Distressed Property Trends: Restaurants

From Mom-and-Pop’s to Mega Chains – The Economic Strain on California’s Dining Industry

This article was written before the Los Angeles wildfires devastated the region.

George Marshall, owner of Vivian’s Millennium Café in Studio City, California, never imagined that running a mom-and-pop café would become this difficult. Situated in the heart of the entertainment industry, his café, a staple of the community since 1964, is now fighting an uphill battle to stay afloat.

The café, an old, converted house with a charming patio and an avocado tree, once thrived on a steady stream of business professionals, tourists, and regulars, but rising costs, supply chain issues, and increased competition from mega-chains have taken a toll. At the same time, labor costs have surged with California’s $20 minimum wage law, forcing George to reduce staff hours and adjust scheduling to accommodate these new financial pressures. And George’s café has been hit hard by inflation. Food prices have skyrocketed, particularly for essential ingredients like meat, dairy, and produce, squeezing already tight profit margins.

“We’ve had to raise menu prices, but we’ve been very careful to keep them minimal. Even a small price increase can deter customers,” says George.

George is doing everything he can to adapt to the changing landscape. He’s reduced waste, negotiated better deals with suppliers, and made other difficult business decisions. However, the restaurant’s old-school charm and focus on quality service – something chains simply can’t replicate – remain its biggest differentiator.

“Rent hikes, insurance costs, and the cost of doing business in California are making it harder to stay in business,” says George.

George knows that, like many other small business owners in California, his success doesn’t just depend on his own adaptability.

He believes that policymakers need to play a role in helping small businesses survive this economic squeeze. “We need better access to small business financing, tax incentives for small businesses, and policies that reduce the burden of rising costs,” he says.

For now, Vivian’s Millennium Café continues to serve up its signature breakfast and brunch dishes, standing as a small oasis in the midst of a challenging landscape. But as George knows all too well, the restaurant business in California – especially for small, independent operations – is becoming increasingly difficult to navigate.

The Restaurant Industry’s Importance in California

California’s restaurant industry is responsible for one in 10 jobs in what would be the fifth largest economy in the world, if the state were a country. By this measure, the restaurant industry is the largest private employer in the state. Some 85,700 restaurants in the state are responsible for pumping $151 billion into California’s economy, according to statistics from the National Restaurant Association.

The size of the industry is reflected in its footprint within the commercial real estate marketplace. According to data from CoStar Group, leases for food service businesses represented 19 percent of all retail leases nationally in 2023.

California’s restaurant industry also represents an important pathway to prosperity for California’s diverse communities, as more than 70 percent of its workforce and 58 percent of its owners are minorities, according to the Association. While more work must be done to align ownership demographics
with the demographic level of people of color in the state, restaurant ownership is a significant opportunity for building wealth in communities of color. Fast food industry jobs are often the first rung on the career ladder, providing an important entry into the workforce for many young Californians and  recently arrived immigrants in California.

However, while people always need to eat, the restaurant industry is anything but a sure bet. Research suggests that between 17 percent and 30 percent of new restaurants fail within the first year, and the industry is prone to being impacted by changes in consumer behavior or regulations. In recent years, the state’s restaurant industry has faced many different headwinds, including the COVID-19 pandemic, inflation, and the state government’s decision to significantly raise the minimum wage for more than 750,000 fast food workers. Another persistent and long-term threat has been continuing high interest rates, which affect the revolving credit line that so many businesses depend on for day-to-day expenses.

We will discuss each of these threats to the restaurant industry’s bottom line, starting with the threat of the high cost of credit. We will also discuss what this uncertainty means for the commercial real estate industry on the whole.

Pricey Credit Lifelines

There are roughly 20,000 full-service single-location restaurants in the state. Few new restaurateurs open their doors with deep pockets and a team of patient investors. Most have enough money to begin operations, and then rely on a “build-it-and-they-will-come” business model to keep paying the bills.

Even those who have enough runway to gain customers and keep their doors open usually will dip into personal savings or use personal credit cards to meet day-to-day financial obligations. A 2023 survey of fullservice restaurants found that 68 percent of owners carry some debt, and the average amount of debt stands at $51,863.

Revolving credit is good for business, but standing debt can be costly. It is the rare startup restaurant that has a zero balance each month on their credit card bills, and this can be a drag on the business model. Many restaurants make their money during periods of high traffic and then operate at a loss during other parts of the year. Each time interest rates spiked during and after the pandemic, the cost of doing business this way became more expensive for these small restaurant operators.

Not every restaurant owner is in the same boat, of course. Those with bigger pockets (think Burger King or McDonald’s) have access to a larger amount of cash and better rates for loans. However, a study by the California Restaurant Association found a 12% increase in closures of independent restaurants between 2022 and 2024.

While the Fed has begun to lower interest rates, and signaled it will make further cuts, it appears that the recent era of cheap credit is not coming back anytime soon, and that could spell trouble for smaller restaurant operators. Even if restaurants can navigate this debt, it may curtail future expansion plans. If restaurants can’t expand, this could cascade into downward pressure on the commercial real estate market.

Changing Consumer Behavior

Another thing that may not be coming back anytime soon is pre-COVID consumer behavior when it comes to the dining experience. The restaurant industry and the commercial real estate market will have to adapt.

This is, in part, because of the same inflationary pressures that have driven up interest rates. Since the end of the pandemic, consumers have come to terms with persistent sticker shock, be it at the grocery store or the restaurant. This has changed consumer behavior, with many rediscovering how to use their  kitchen once again. When eating out, consumers favored more low-cost options. A recent Civic Science survey found that 55 percent of respondents said they were cutting back on dining out, and 27 percent said they would eat at less expensive restaurants.

The conventional wisdom was that when the pandemic lifted, Americans would flock back to the traditional dining experience. This has only partly proven true. While dining out has reached pre-pandemic levels, Americans may be spending less than before. For one thing, costs are increasing due to inflation quicker for food at restaurants than at home. The USDA reported that the cost of meals at restaurants rose 2.9 percent quicker than for food consumed at home in 2024.

In addition, young Americans are shifting their dining behaviors to a more “introverted” model. This means that they are more likely to want to eat at less crowded restaurants at earlier times and are more comfortable than others ordering from so-called “ghost kitchens”, or eateries that lack any restaurant apparatus.

If young consumers continue to favor cheaper dining options or ghost kitchens, then the consumer real estate market must adapt. The pricey restaurant space may no longer garner premium lease rates, while kitchen space may become the new gold standard of the dining real estate marketplace.

California’s Wage Hike Experiment

While rising interest rates and changing behavior are variables to the business model of restaurants nationwide, the California restaurant industry is facing unique economic headwinds. The cost of living in California is more than 40 percent higher than the national average. The cost of living is even higher in California’s major cities. Meanwhile, wage growth has not kept up with the rising costs. The MIT living wage calculator suggests workers would need to earn just over $21 an hour to make a living wage in California.

This is why the governor, and the state legislature have enacted a series of measures to increase the minimum wage. Starting in the beginning of 2025, the minimum wage in the state has increased to $16.50 per hour. For fast food workers, the minimum wage is now $20 per hour. There have been many predictions about what this wage increase would mean for the state’s restaurant industry, with many industry insiders warning it would lead to job loss.

Early results, however, show that the fast-food industry actually has gained 11,000 jobs since the rate hike was initiated, but that may not tell the whole picture. Again, large-scale fast-food chains have deep pockets, and may be able to absorb such a labor cost increase. And even with this gain, there have been some notable fast-food closures. These include a landmark Arby’s on Sunset Boulevard in Los Angeles and a notable McDonald’s at Stonestown Galleria in San Francisco. Both franchise owners cited the new minimum wage law as a factor in shutting down.

And California’s overall economic picture is not rosy. Its unemployment rate remained highest in the country (5.3%), and the state’s private sector lost 154,000 jobs in the first half of 2024. After several years of losing population, the state’s population grew in 2024, fueled by immigrants settling in the state.

There has been anecdotal evidence that several large restaurant chains see significant headwinds to doing business within the state in the post-pandemic business climate.

Blaze Pizza has relocated its corporate headquarters in what it says is an effort to pursue growth opportunities in the Southeast. Rubio’s, a fast-casual Mexican restaurant chain, recently announced it had closed 48 underperforming locations because of California’s business climate. In addition, The LA Times estimated that over 100 notable restaurants closed in Los Angeles in 2024, up from 65 such closures tallied in 2023. Restaurateurs who shuttered operations listed the wage increase as a key obstacle to staying in business. Among the wave of LA restaurant closures is Hart House, comedian Kevin Hart’s vegan fast food chain of restaurants.

Opportunities in a shifting landscape

Change creates opportunity for commercial real estate investors if they have the flexibility to adapt. For instance, if consumers are eating at home more, then commercial real estate plaza developments anchored by grocery stores may be a good place to invest in the short term. For example, grocery-anchored shopping centers in California saw a 6.8% increase in foot traffic in 2023. Likewise, fast food locations may be more insulated from rapid change than other restaurant sectors.

What Mortgage Professionals and Investors Need to Know

As California’s restaurant industry grapples with shifting economic dynamics, mortgage professionals and real estate investors need to recalibrate their strategies to navigate this turbulent landscape. The state’s unique combination of high living costs, wage hikes, inflation, and changing consumer habits has reshaped the dining sector, and this transformation extends into the commercial real estate market.

For investors, the key to success may lie in identifying viable restaurant spaces that can withstand economic pressures. Traditional, high-traffic restaurant locations may not be as lucrative as they once were, as many operators shift towards smaller, more cost-effective spaces or opt for new dining models like ghost kitchens and delivery-only concepts. The demand for larger dining spaces is declining, but there is an emerging market for smaller, streamlined kitchen spaces, especially those suitable for takeout and delivery operations.

Investors should also closely monitor evolving market conditions and be prepared to pivot quickly. By staying agile and adapting to changing trends, mortgage professionals and investors can not only mitigate risks but also capitalize on the opportunities that arise in a shifting marketplace.

For mortgage professionals, understanding the local economic conditions and tenant profiles is essential. Assess the financial health of potential restaurant tenants, including their ability to withstand fluctuating costs and economic downturns. By doing so, lenders can reduce the risk of defaults and ensure that commercial mortgage portfolios remain robust. Additionally, mortgage professionals must anticipate the need for rent renegotiations. With rising costs and shifting demand for restaurant space, many tenants are likely to seek more favorable lease terms to stay afloat, which could impact long-term cash flow  rojections for investors.

The commercial real estate landscape in California is rapidly evolving, and those in the mortgage and investment sectors must stay informed and adaptable. By conducting thorough due diligence, monitoring market conditions closely, and being prepared for rent renegotiations, professionals can ensure their portfolios remain profitable even as the restaurant industry faces unprecedented challenges.