Tim Reamer – Cottonwood | Commercial – Harrisonburg Va Commercial Real Estate

July 5, 2016  |   No Comments Yet

Protesters across the United States have been organizing in an effort to raise awareness of income inequality. Operating under the banner “Fight for 15,” organizers are demanding an increase of the minimum wage to $15 per hour—an increase double that of the current rate of $7.25 per hour.

Political candidates have supplemented the voice of these activists and the large unions that back them. Most recently, Washington D.C. pledged to join cities like New York, Seattle, and San Francisco to increase the minimum wage to $15 for at least some sectors. California Governor Jerry Brown signed a bill recently to phase in a statewide $15 minimum wage by 2022 and New York is expected to do the same in the near future. They’re not alone–many cities and states have embraced the conversation around an increased minimum wage.

Virginia is not one of them, but should there be an increase in the federal minimum wage, Virginia would likely match it. In the Commonwealth, 50,000 employees earned exactly the prevailing federal minimum wage of $7.25 per hour in 2015 according to the Bureau of Labor Statistic and a large percentage of these workers are employed within the restaurant industry and this creates a math problem for all involved.

Mary Kay Henry, international president of the Service Employees International Union (SEIU), recently stated in a Guardian article: “There is not a price tag you can put on how this movement has changed the conversation in this country. It is raising wages at the bargaining table…I believe we are forcing a real conversation about how to solve the grossest inequality in our generation.”

Without question, the SEIU and Fight for 15 have changed the conversation–if in no other way than there is actually a conversation. Moreover, it can’t be disputed that these efforts have resulted in increased wages for some across the nation. That said, putting a price tag on these results turns out to be quite easy–at least as far as restaurants are concerned.

A typical restaurant realizes gross revenues of $450,000-$550,000 annually. Some earn more, some less, but on average an independent restaurant in the market will sell close to half a million dollars in food, drinks, and other merchandise. National chains often earn double to quadruple or more as their top line number, but unfortunately, the math doesn’t change all that much—the numbers are just bigger.

Large figures on the top line of financial statements are often the cause of misrepresentation. And while it makes for great protest signs and memes that can outrage the Twitterverse, there is often a problem with the assumption that an independent restaurant “made” $500,000 last year or $12 million a day in the case of McDonald’s. Simply, the problem is—it isn’t true.

Restaurants, like any other business, have expenses, and gross revenues aren’t profits. Within the restaurant industry the cost of food, alcohol, and labor divided by gross revenue is known as the Prime Cost and it is an unbelievably important metric. Most operators aim to keep this percentage of sales at or below 60%, but more often than not this combination of expenses slide closer to 65%. A prime cost that exceeds 65% is generally the sign of a failing restaurant, and if the percentage stays that high for a sustained period of time—it’s the kiss of death because the restaurant still has to pay for operational expenses and occupancy costs.

In total these two categories account for 30% of a restaurant’s budget. Operational expenses, comprised of items like supplies, maintenance, repairs, fees, debt repayment, and marketing, take 20% of total revenue and occupancy costs (those associated with the real estate) require another 10%.

If you’re doing the math—you know total expense is already at 95% of the total gross revenues earned, leaving, on average, somewhere between 5%-10% for the item that allows a business to remain viable–profit. For a business earning a very typical $500,000 per year, this means they will likely be rewarded with $25,000-$50,000 for their investment, knowledge, and labor.

So, assuming a $15 minimum wage–imagine the typical restaurant described above has ten part-time employees each working an average of twenty hours per week and earning minimum wage. Under the current structure, annual labor costs for this restaurant would be $75,400. A $15 minimum wage, however, pushes labor costs for the same employees to $156,000 annually–a difference of $80,600 and substantially more than the remaining revenue previously allocated to profit. In other words, under this scenario–a restaurateur, theoretically, would have to be willing to pay $30,000-$60,000 per year out of pocket to operate their business. This is without considering the fact that other hourly employees earning greater than minimum wage and even salaried employees associated with the business will likely expect a commensurate increase in pay. If everyone else were receiving a raise—wouldn’t you want one too?

Of course, there are other options–the owner could choose to increase prices and seek out opportunities for purchasing efficiencies in an effort to increase margins, but let’s be honest, you’re not willing to pay substantially more for your pizza and most businesses operating in a competitive landscape aren’t so bloated that they can choose to stop wasting money that would have otherwise been profit. No, historically, when the cost of anything increases we tend to purchase less of it and when the value of something falls below that of a comparable priced alternative, we tend to choose the alternative. This is fairly universal; it doesn’t matter whether it’s cheesesteaks or employees.

Look, this isn’t an attempt at fear mongering, the data is pretty clear. Meta-analysis of 105 different economic studies of labor demand suggests that an increase of only 10% in the wage rate for low-skill workers is likely to cause 6.35% of such jobs to be lost. Some of these job losses would be classified as technological unemployment. We see examples everyday from self-checkout and ATMs replacing clerks to automation replacing large portions of the industrial sector with a thousand more historic examples. So it shouldn’t come as a surprise that Wendy’s and others are considering self-checkout kiosks in addition to mobile and payment apps as a means to reduce expenses.

At the corporate level, some of the bigger chains are likely to have the capital reserves to implement this strategy, but what about the franchisees (who have all of the same expenses described above in addition to marketing fees and royalties that require another 6% of gross revenues) and independent restaurants? Do they have the capital reserves to implement this type of strategy? Likely not—it’s pretty clear they typically don’t have the margins. Not all job losses attributed to labor costs are a result of innovation as would be in the case with Wendy’s. Some are a result of failure of the business to control expenses and controlling expenses becomes exponentially more difficult when they are legislated.

These types of debates can become emotional and emotions tend to push people to the extremes that result in oversimplifying the debate to lazy people versus greedy rich guys. In this case and in reality, the problem is less about greed versus entitlement or worth versus value—it’s about math and therein lies the problem.

Tim Reamer provides commercial real estate brokerage and consulting services with Cottonwood Commercial and specializes in retail representation, investment property (multifamily | commercial | NNN), and development projects. Learn more at www.timreamer.com.

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