Why Invest in Restaurant Net-Leased Assets

There are plenty of investment options to choose from in the single-tenant net-leased sector and they all come with their own pros and cons. Drug Stores tend to be on high traffic hard corners backed by solid credit, but house a large box with a cash flow stream to match that may be difficult to replace if it ever became vacant. Dollar Stores come with great credit, but often times in tertiary markets. The auto sector can provide higher returns and high rents for specialty buildings, but can also be on odd shaped parcels with their own potential environmental concerns, while banks can provide the same high rents for a specialty building backed by excellent credit, but tout the same replace-ability issue if they ever became vacant.

So Why Invest in Restaurant Net-Leased Assets?

The variety of price points paired with long-term leases, rental increases, and well-known popular brand name concepts make the restaurant sector especially attractive to investors. Many 1031 exchange buyers look to the sector for a passive place to park their money because many of the factors just named provide a certain sense of security and perceived safety in an investment world riddled with risk. A few years ago the market was labeled one of the biggest peak markets we have seen in the past 10 years, which rang true. Since 2015, cap rates for restaurant net-leased properties have continued to compress, further than most other net-leased sectors, stabilizing on average somewhere between 50-65 basis points lower than other similar net-leased assets. Because of the high demand and increased equity in these types of investments, corporations and franchisees operating business on these parcels of real estate have been actively taking advantage of the market by accessing the built up equity under their operations through sale-leasebacks and using the proceeds to grow into more units, remodel existing units, and pay down debt among other things. In an environment where investment supply is limited, the additional deal inventory is driving transactional velocity even further for the many selling investors who then become 1031 exchange buyers.

Investors also choose to place their money in the restaurant sector because it has been perceived to be somewhat recession proof. “Recession-proof” is stated with a grain of salt as the more high-end casual dining segment may take a hit when the economy is down and consumers have less money in discretionary spending, but ultimately people need to eat. While some casual dining concepts are recently struggling, due to changing consumer preferences, they are working to increase their sales by changing up business models, implementing new technologies, and utilizing delivery and online ordering services. The overall sentiment in the marketplace is that “most of them will figure it out”. The casual dining segment provides some benefits over the QSR segment in that the price points tend to be higher since the footprints are larger and rent per square foot remains fairly the same. However, the segment provides risk in that lower discretionary spending could hurt a higher end casual concept during a downturn. That is why many investors look to the quick service restaurant segment as a hedge against the inherent risk of recession. Many QSR concepts have a focus on a cheap and fast food offering that can feed an entire family for a very reasonable price. Even concepts with middle of the road average ticket prices ebb and flow through the ups and downs of the market. In addition, the industry as a whole provides jobs at fairly cheap labor, which remain a necessity in a downed economy.

Then there are the core aspects of real estate to consider. Most restaurant sites provide the benefit of adhering to many of the core retail necessities when it comes to desirable core real estate. Restaurants tend to be located on hard corners with frontage on high traffic corridors. They tend to have strong parking ratios in high density metro markets on parcels with great ingress/egress. Restaurants simply tend to be on good core real estate sites. If the restaurant were ever to leave, these aspects of the remaining real estate could provide you with more options to redevelop the property than a small specialty building such as a quick lube oil change facility might provide.

There is also the tenant base and the market for restaurants in general. Although investment supply in general is lacking compared to the large pool of buyers out there, compared to other sectors, restaurant inventory is in plenty supply and has transactional velocity over most other triple net property segments. Restaurants tend to be a high demand asset sector, which bodes well for owners when it comes time to exit or exchange their investment. Why is the restaurant sector in such high demand? Well when it comes to restaurants, you have a plethora of well established strong credit tenants. You also have two sub-segments of QSR and Casual Dining, which together provide a very wide range of price points, business models, and rent structures. An investor choosing an investment in the restaurant segment is like throwing a kid into a candy store full of different gum ball machines and saying,

“Which type of gum ball would you like to receive every month?”

You can also find a wide range of risk and return. You have corporate credit grade investments that could trade for as low as 3% or 4% cap rates, while also having the upside of taking on smaller operators or franchisees with similar lease terms but at double the returns or higher. With these smaller operators and franchisees comes the opportunity for even an unsophisticated landlord to structure a blend and extend for added value. Smaller operators have the flexibility to get creative in their holdings, operations, and business growth opposed to some of the larger corporate structures that stick by strict policies and standards. There are numerous reasons to invest in the restaurant sector and any investor building a diversified portfolio of net-leased investments would be wise to include a healthy number of restaurant assets into their mix.

The downsides? The downsides include all the many risks associated with any real estate investment. Each tenant, lease, property, and market has its own inherent risks, challenges, and pressure points to watch out for. I would encourage you to use the information you gather here to your advantage, but also seek advice from your trusted real estate advisor to ensure you understand the intricacies of each deal, how they might affect your investment decisions, and to gain a comprehensive understanding of all your options when it comes to your long-term investment strategy.

If you have any specific questions regarding an asset, a concept, or your current investment situation, feel free to reach out to me directly at 813-387-4796 as I welcome the opportunity to help you in any way that makes sense for you.

 

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