Starbucks, New Leases, & Termination Options

Starbucks, New Leases, & Termination Options

Starbucks as a tenant is notorious for their hardball negotiation tactics.

Who can blame them? Starbucks, founded in 1971 out of Seattle, is one of the strongest quick service restaurant (QSR) tenants you could wish to have occupy your property. With over $20 Billion in revenue, over 26,000 locations nationwide, and a credit rating of A2, it is no wonder Starbucks is one of the highest paying restaurant tenants in rent averaging over $60 per square foot.

They negotiate hard simply because they have the leverage to do so.

If you would like a lesson on how to negotiate, I will reserve that for a separate article or you can contact me directly to discuss in more detail, but for now I want to address how these negotiations can impact the value of your property. These hardball negotiations on Starbucks end will certainly put them in a further position of power in regard to controlling their own destiny with their real estate and location growth, but it should be understood that it does not mean Starbucks is an investment to now shy away from. If anything, it should show that they are a stronger investment than ever. Not only are they one of the strongest guarantees you can secure, but they are looking out for their own long-term interests and success.

In recent years, Starbucks has been approaching landlords about signing new 10-year leases. Typically, when a store reaches the 10-year old mark, it is time to upgrade the store. For Starbucks, this could mean significant capital expenditures to bring the store up to new standards. They see these expenditures as a necessary evil and tend to ask the landlord in return for a new longer lease in order to secure their capital investment long-term. Sometimes they ask for a rent reduction or some other concessions, while other times they may just be looking to secure a new 10-year lease in lieu of exercising their next 5-year option. If you have been approached with this offer, I am sure you felt butterflies in your stomach as your eyeballs turned to dollar signs and you felt like your investment just became 10-years stronger. There is no doubt that Starbucks showing interest in signing a new 10-year lease is a solid opportunity to explore, but reel your excitement in a bit and prepare to read the fine print.

Many of these new 10-year leases include a termination option at year 5, which is not the end of the world. After all, if they are willing to put real dollars into renovations and sign a new 10-year lease, it would appear their intent is to stay for the entire 10 years; that 5-year termination clause is simply a hedge against an unforeseeable future. It is important, however, to understand how this will affect the equity of your entire investment. The value of your property is directly correlated to how much lease term you have remaining and the strength of your guarantee.

In this scenario, guarantee is not the issue, however, remaining lease term is. On paper, it appears you have a new 10-year lease. From the graph below, you can see that the average cap rate for a 10-14 year corporate lease over the past 12 months has been 5.88%. Talk about equity; if Starbucks is $60 per square foot on a 2,000 SF building ($120,000 NOI), then a 5.88% cap rate puts your value just over $2MM.

cap rate versus guarantee vs lease term graph

Here is the problem:

Investors and buyers will not see a new 10-year lease. Investors will see a termination option in year five and in order to hedge their own risk, they will assume the tenant will leave after 5 years. Effectively, that simple little 5-year termination clause crushes your current value as an opportunity cost versus a true 10-year lease. You will see from the graph above that the average cap rate for a 5-9 year corporate lease is at 6.27%. You just lost about 40 basis points worth of value and that is being generous because these figures include a range of lease terms lumped together. More realistically, you are looking at a 50-75 basis point hit in value by keeping that 5-year termination clause in a new 10-year lease. See more detailed recent cap rates for Starbucks specifically at my last cap rate market update.

When it comes down to it, however, fighting over striking the 5-year termination option from your new lease is not worth losing Starbucks as a tenant. There are few tenants willing to pay $60 per square foot and so the likelihood of replacing that rent and cash flow stream is slim if you do not come to an agreement with Starbucks. Hence, why they hold all the leverage.

Here is the silver lining: Do not beat yourself up if you have signed a new 10-year lease with Starbucks and it includes one of those 5-year termination options. The values are still strong for Starbucks net-leased properties and investor perception is still very strong for these assets as they are still great long-term investments with solid financial backing and stability.

DSC_0266

I listed this Starbucks location in New Port Richey, Florida (pictured above) recently and if you are looking to enter the net-leased investment realm, consider this deal. Just as mentioned above, this client had Starbucks approach him about signing a new 10-year lease. They were asking to include a termination option at year 5. Through working with me, the client was able to secure a very marketable deal. Starbucks signed a new 10-year lease, keeping their option to terminate in year 5, however they are required to give 6 months notice to the landlord and pay a penalty of about $50,000. Worst case scenario, that equates to almost an entire year of cash flow for the landlord if they do plan to exercise their option to terminate in year 5. In these situations, though, all signs point to an intent to stay long-term. Starbucks is investing dollars to renovate the location and if you ever visit, the drive thru stack consistently wraps around the entire building. As an investor, how can you go wrong with a new 10-year Starbucks deal on a hard corner with frontage on a thoroughfare that boasts 59,000 cars per day?

That’s Net-Lease Investor Gold.

You can find more details on this specific Starbucks Offering Here

Ultimately, it comes down to what your long-term strategy is for the property. It is often times easy with these “coupon clipper” properties to set them and forget them. Rent is deposited every month, year after year, and the landlord gets to sit back and sip the pina coladas, but I urge all my clients to stay fresh on their feet. Before you know it, you could be down to just 12 months remaining on your lease, which does not put you in much of a position of power when it comes to tenant renewal, property values, and retaining your existing cash flow. I work with clients on a regular basis to keep a pulse on the market and ensure they are maximizing their equity, exchanging in and out of the market, and over time increasing the overall portfolio value of their investments. Some of the strategies I help clients execute on include sale-leasebacks and blend-and-extends among other strategies to help them mitigate risk and maximize value in situations such as these.

More specifically, I have helped many Starbucks landlords find a Win-Win common ground with Starbucks during negotiations as referenced above in order to maintain their cash flow stream, maximize the value of their investment, and ultimately establish a successful future for Starbucks to stay at their property long-term. If you would like more detailed information around how to maximize the value of your property through new lease negotiations or if you have interest in purchasing a Starbucks net-leased property, please contact me directly at 813-387-4796 and I would be happy to help wherever it makes sense.

The Tenant & Landlord Relationship

The Tenant & Landlord Relationship

Tenants and Landlords both have the same end goal:

Maximize the Value of Their Investment.

Sometimes it can be tempting for either side to try to improve their own situation at the expense of the other; it can be tempting to trust one another to have a genuine interest in your own investment’s success. The important point to consider here, however, is that the tenant’s investment and the landlord’s investment are one and the same. The tenant and landlord, whether they like it or not, became business partners when they both entered into a lease agreement. With that in mind, you cannot build a sustainable business and maximize business profits without trusting the partner you are in business with. In order for a landlord to maximize the value and sustainability of their property, and for a tenant to do the same for their business, there must be a constant Win-Win mindset on both sides. When both sides give, the entire investment thrives. This article serves to highlight some of the most common tenant/landlord relationship hurdles, how to maintain a Win-Win mindset for each, and then current applications of this Win-Win mindset in today’s evolving Food & Beverage industry.

Lease Guarantees and Credit

To start, let us highlight a few of the most common tenant/landlord relationship hurdles

A tenant would not sign their name in ink if they thought their business was going to fail. Lease agreements are signed by tenants eager to be successful, but whether you are a tenant operating the business or a landlord investing in their business as a tenant, there is risk involved with entering any agreement. It is the landlord/investor’s job to weigh that risk against the return of their investment dollars, while it is the tenant’s job to mitigate that risk for the landlord and prove that they will back up all their talk with a profitable walk through the next real estate cycle. More important than proof of concept doing business under a lease is the credit and guaranty backing that lease. Having a Nationally recognized concept holds little weight when the guaranty on the lease is a 1-unit operator without money to pay for a new AC unit, let alone money for rent this month. Similarly, you may have a tenant that no one has ever heard of, but a personal guarantee on the lease worth hundreds of millions of dollars. The lease risk is in the guaranty and while a tenant may be reluctant to give an ideal scenario of a corporate guaranty in an attempt to protect their business, there should be a happy medium for both parties that coincides with the long-term value of the expected cash flow stream. When it comes to what credit is backing the lease, the bottom line is that if a tenant wants out, they will find a way out. A tenant with money that wants out will fight you hard to get out. A tenant without money will disappear in the dark of the night and take all the lightbulbs with them. As an investor, you may be buying the guarantee, but you are also investing in the success of their business. If you are not willing to grow together, you are both bound to fail.

Information Sharing

Which Came First: Unit-Level Sales? Or a Sustainable Rent-to-Sales Ratio?

As a tenant, your gut reaction may be to hoard your financial data in an attempt to secure a well below-market rent and add that money to your bottom line. What happens when the market shifts, your sales dip below sustainable levels and you need a rent reduction, but your landlord does not believe you because they have no access to hard facts around the financial health of your business?

Unit-Level Sales and Tenant Financials are imperative to both parties getting on the same page and coming to a mutually beneficial agreement for long-term success. Without this transparency, tenants cannot trust their landlords and landlords cannot trust their tenants. When there is no trust, every engagement is a head-to-head battle to keep hold of their chips. Tenants become over-leveraged on rent putting their business at risk, while landlords cannot effectively maximize the value of their asset and cash flow stream for sustainable long-term growth.

For a Win-Win to occur, there needs to be transparency on both sides. Landlords should be requesting and requiring financial data before even signing a lease, while tenants should be concerned if their landlords are not doing so. It is simply bad business on both sides. As a landlord, how can you maximize cash flow while maintaining sustainability and mitigating risk without an indication of how well their business is operating? As a tenant, how can you get your landlord’s buy-in to manage your occupancy costs or even get a lease agreement signed without some kind of proof of concept? The paradox is that once both sides let go of that information control, both sides acquire an even more solid control of their business and investment.

Competitive Landscape

Tenant’s should not be the only ones concerned with encroaching competitive concepts. A landlord remain aware of what other restaurants are entering the surrounding market. This awareness includes staying conscious to who they actively recruit to be neighboring tenants within their shopping centers or adjacent single-tenant properties. While some restaurant concepts can complement each other, others can cannibalize each other. A competitor moving in could mean a 20%-40% loss in sales. Alternatively, it could mean monster sales growth in the same respect if a competitor down the street shuts its doors. Landlords and tenants should work together to share intel on the surrounding landscape so that both sides can stay ahead of any market shifts and craft their long-term investment strategy accordingly.

Landlord/Tenant Concessions

Landlords used to buying into established cash flow streams and then watching them get chiseled down by struggling tenants asking for rent reductions can become desensitized to the core of what a sustainable tenant/landlord relationship should look like. For an investor or landlord trying to protect their investment and their cash flow stream, the instinctual reaction is to be adversarial towards the tenant. In a situation where the tenant does not share their financials or sales data, the landlord can feel like the tenant may be crafting a sob story and taking advantage of their relationship to pocket additional profit in a rent reduction, which is all the more reason that tenants should be more than willing to share their financial situation with their landlord. As an investor, this instinctual reaction is simply a function of trying not to feel like you’ve taken one step forward, but two steps backwards; backed into a corner, a landlord will scratch and claw their way back to where they started even if it means giving no concessions and keeping rents as high as possible. This mindset, however, will run a restaurant out of business and eliminate the entire cash flow stream for the investment; neither of which is forward progress for the landlord or the tenant.

Landlords should keep in mind that when working with tenants, the best chance for big success is a great build out. Sometimes additional T.I. for a tenant works wonders for their balance sheet as it sets them up for the most success, but allows them to maintain cash on hand. That extra T.I. will often create better visibility, better landscaping, and the ambiance necessary to capture higher guest volume and solidify a location for long-term success. The tenant on the other side also needs to understand that many times, for an existing landlord, T.I. is an unexpected capital expenditure in the midst of a diminishing or completely depleted cash flow stream. In the end, like everything else, both parties benefit most from a Win-Win.

Food & Beverage Trends

From speaking with landlords, tenants, developers, and investors in the restaurant sector, there are a few common threads we are seeing begin to trend in newly successful restaurant concepts. Below is a summary of what we have heard lately:

  • Chicken and Asian-Inspired Cuisine is Trending in the Southeastern United States
  • Flavor Profiles are Becoming Less Important
    • The Focus is on Volume and Quick Service
  • Footprints are Shrinking
    • 7,000 SF Concepts Finding Ways to Shrink to 3,000 SF Prototypes
  • Health Conscious Food Transparency Becoming a Necessity
  • Customization/Individualization is Driving Traffic
  • Localized Design and Community Integration a Consumer Focus
  • The Dine-In Experience is Evolving to Compete with Delivery Alternatives

New concepts having success with these business model shifts are a sign of changing consumer preferences and the major players are not naïve to these changes. Everyone we talk to is proactively striving to evolve to meet the desires of consumers and maintain relevant in this ever-changing industry.

Overall though, Restaurants are moving up in the retail world. It used to be that Food & Beverage accounted for close to 10% of shopping center occupancy, but that has been moving closer to 30% today. Some fear that the market is becoming too saturated with restaurants and that the general population will not support sustainable sales for the density of restaurants entering the market. Keeping this in mind, tenants should think critically about their plans for expansion and the numbers they are crunching to get there, while landlords should remain focused on the key elements of a good investment:

  • Core Real Estate Characteristics
  • Tenant Overall Credit/Track Record
  • Tenant’s Commitment to Site
    • Recent Capital Expenditures
    • Extended Lease Term
  • Tenant Financials/Sustainable Unit-Level Rent-to-Sales

Ultimately, retail and restaurants will ebb and flow. In any given year, whether concepts are expanding or contracting, the general population will still need to eat. The tenants that will be left standing will be those that have secured A+ real estate, have enough equity to slip through the slumps, optimize their infrastructure to maximize profitability, and most importantly those that keep a close eye on their occupancy/food costs; raising labor/food costs can put unanticipated pressure on occupancy costs/rent. The good news is that all of those tenant characteristics scream slam dunk investment for investors and property owners.

Sustainability of business and of cash flow is based on that kind of Win-Win.

We are actively working to help our clients bridge the gap between tenants and opportunities. Whether you are a tenant actively seeking growth opportunities or a landlord working to maximize the health and value of your property, give us a call to see how best we can serve you.

Restaurant Sector More Bullish Than Others

Restaurant Sector More Bullish Than Others

A brand-new Taco Bell just sold for a 5.5% cap rate in Fleming Island, Florida! If you know where cap rates have been trading across product types in the net-leased sector, this may not appear to be too surprising. Cap rates have compressed in the net-leased sector as far as 120 basis points from where they were at the last market peak, but this go around, the restaurant sector has compressed even further than other net-leased product types. That means that values today are some of the highest we have ever seen, especially in the restaurant sector.

As a frame of reference, 2007 saw one of the hottest historical markets ever; values peaked and buyers were bullish. In that market, brand new 15-year to 20-year Taco Bell leases were trading at 7% cap rates. These long-term Taco Bell deals were typically backed by 50+ unit operators. The Taco Bell in Fleming Island that just sold was a new 20-year lease backed by a 19-unit guarantee and traded for at a 5.5% cap rate. That is a 150-basis point spread from the last market cycle and it’s not an exception.

dunkin representative photo

Just last month, we sold a brand-new Dunkin Donuts with a shorter-term lease and a smaller guarantee at a 5% cap rate. The deal was a brand-new 10-year Dunkin Donuts lease backed by a 13-unit guarantee in St. Petersburg, Florida. Within only a few weeks of bringing it to market at a 5% cap rate, we had sourced multiple offers. The competition created ultimately resulted in a 36-day closing at full list price. Only 12 months ago, 10-year Dunkin Donuts deals were trading at an average cap rate of 6%. For further perspective, in 2006, the average cap rate for a comparable Dunkin Donuts was 7%.

We are seeing restaurant properties trade 25-50 basis points lower on a cap rate basis than most other net-leased sectors right now.

Restaurants are hot!

Even when faced with the potential risk of shifting consumer trends and the sales slumps of the casual dining sector, buyers understand that restaurants serving the general population are not going anywhere. Similar to how multi-tenant shopping centers are attracting more service based tenants to compete with online sales competition, restaurant brands are evolving to cater to these changing consumer trends and when the dust settles, people will still need to eat.

Because of the aggressive restaurant cap rates versus other sectors, owners in the restaurant sector have been weighing their options and crafting a strategy for how to take advantage of these recent trends. For our clients, the biggest concern is where to put the money and ensure a successful exchange. The initial thought is that you are trading into the same market and so the opportunity is perceived to be a wash, however, we have had success in moving our clients from the restaurant sector to other net-leased sectors where cap rates, although compressed, are not as bullish.

Often times, there are opportunities across other sectors such as drug stores and auto-related investments that can not only replace or improve our client’s current cash flow position, but also improve their real estate investment in general; better guarantee, longer lease term, or upgrading their core real estate to larger parcels or hard corners.

Values remain the highest they have ever been, while cap rates remain more compressed than in the last market peak. Both buyers and sellers should remain bullish in the current market as prices in this market are still extremely aggressive compared to the historical 10-year average and the net-leased opportunities on the market offer a long-term passive cash flow stream often with a hedge against inflation via regular rental increases, especially across other sectors.

Whether or not you plan on transacting in 2017, I am always available as a specialized restaurant net-leased expert and resource for market information. It is my mission to ensure you have the tools necessary to proactively plan your long-term investment strategy. For more detailed research specific to your property or market, give me a call directly to discuss how I can help.

National Net-Leased Report | 2017 Outlook

National Net-Leased Report | 2017 Outlook

The outlook for 2017 remains strong. Restaurants are still hanging on to some of the lowest cap rates across the net-leased sector, which bodes well for existing investors’ values. One would think that these low returns would deter buyers, but with all of the exchange capital floating around and the stability of restaurant net-leased investments, buyers still view these long-term investments as a hedge against inflation.

Check out the cap rate comparison graph below showing the most recent cap rate ranges by both sector and major brand:

Cap Rate Comparison Across Sectors

Overall, positive economic momentum has carried into 2017 and it is being driven by confident consumers. Although rising interest rates have sparked a slight investor re-calibration, there still seems to be some runway left in this market. The spread between cap rates and the 10-year treasury is maintaining a steady gap and although we would anticipate interest rates to go up at some point, they appear somewhat stable for now.

Net-leased properties recorded a 23.9 percent advance in the average asking rent last year, which has more than doubled the pace of multi-tenant shopping centers over the same period. A lot of this is due to strong corporate backed tenants or franchisees getting aggressive to secure additional sites and locations. The good news is that asking rents in net-leased properties are still below the pre-crisis peak with an average tenant paying $19.62 per square foot nationwide.

For 2017, store openings will be led by the dollar-store segment, however consistent expansion in the fast-food sector will continue over the comping year. From all angles, I see this year shaping up to be a busy one across the entire net-leased sector!

Access the Full Report Here

If you would like more specialized insight or research in regard to your current investment portfolio or more information around what restaurant net-leased investments are currently available on the market, feel free to contact me directly at 813-387-4796.

Restaurant Market Update | Cap Rate Trends

Restaurant Market Update | Cap Rate Trends

Net leased restaurants had a home-run year in 2016!

2016 historical cap rate graph

Although net-leased inventory increased over the past twelve months, more buyers entered the market and the inventory could not keep pace with the demand, which had a positive impact on both cap rates and values. The fact is that property values are higher today than they were at the last market peak and it is not entirely due to higher rents. The average cap rate in 2016 is over 130 bps lower than the historical 10-year average. As interest rates begin to creep upwards moving into 2017, it is expected that cap rates will rise as a result. However, although cap rates across the board are expected to rise between 25 bps and 50 bps over the next 12 months, demand for net-leased restaurants is expected to remain, which should yield another busy year in 2017.

Check out the trailing 12 stats below for some of the strongest QSR brands in the marketplace today.

2016 QSR data

McDonald’s and Chick-Fil-A maintained the lowest cap rates in the marketplace, while Starbucks held the highest price per foot on a sale, which is closely tied to the high rents they are willing to pay for their locations. Quick Service Restaurants as a net-leased investment continue to be in high demand for investors primarily due to their passive nature and small price point. High performing QSR brands like McDonald’s and Chick-Fil-A are aggressively traded because in addition to the strength of their guarantees, they maintain a business model that affords a fairly low rent per square foot. This allows an investor to replace the cash flow stream if the property were ever to become vacant.

Although full service restaurants operate under a variety of business models with various preferred demographics, the average cap rate for some of the biggest and best performing brands landed around the same range (See graph below for details). Carrabba’s (Bloomin’ Brands) and Red Lobster (Darden) held the highest price points in 2016 sales, while IHOP maintained some of the highest paid rents across the sector. The larger footprint of these buildings yields a higher rent, which is why the price point on full service restaurant net-leased deals is typically double the price point on QSR properties. Over the past year, most of these transactions were all cash deals because despite the low interest rate market, financing often times created negative leverage.

2016 sit down data

Demand remains strong in the restaurant net-leased sector and although the average rent per square foot has crept upward over the past 12 months, new long-term leases being signed are being closely critiqued by tenants to ensure they do not spread themselves too thin in the event of another downturn. Values remain the highest they have ever been, while cap rates remain more compressed than in the last market peak. Both buyers and sellers should remain bullish in the current market as prices in this market are still extremely aggressive compared to the historical 10-year average and the net-leased opportunities on the market offer a long-term passive cash flow stream often with a hedge against inflation via regular rental increases.

Whether or not you plan on transacting in 2017, I am always available a specialized restaurant net-leased expert and resource for market information. It is my mission to ensure you have the tools necessary to proactively plan your long-term investment strategy. For more detailed research specific to your property or market, give me a call directly to discuss how I can help.

The Market is Warming | 2014

We’re already moving through 2014!

Not only did it fly by, but activity in Commercial Retail space around the Tampa MSA has caught fire. When we sold a CVS in November for a 5% cap rate, which was a National record low cap rate for drug stores, we thought things were pretty hot. In January, however, our deal inventory for both shopping centers and net-leased assets started ramping up. It sounds like we are not the only ones seeing the market pick up either.

NREI released an article about sales data in January of 2014, which shows that sales volumes are up and cap rates are reaching new lows in the Retail sector. The article shows year-over-year sales volume for the retail sector to be up 27 percent!

Bill Rose, Vice President and National Director for our National Retail Group with Marcus & Millichap, explains in the article that as a firm, our inventory is up over last year and we are projected to have an improved 2014. Locally in our Tampa office, that is certainly true. In 2013, we doubled the transactions we closed in 2012. Entering 2014, I alone activated 5 new listings in January, which is clearly a strong indication of a good start to the year for both multi-tenant retail and net-leased investments.

Not only are the real estate markets picking up in the Retail sector, but it appears businesses are starting to bounce back as well. Hessam Nadji’s investment sales blog reported in March of 2014 that retail sales have lifted for the first time in three months, which is likely due to consumer spending starting to pick up. He anticipates that as the job market continues to grow, retail sales should gain even more traction. That’s great news for our local Tampa market and surrounding sub-markets as the Tampa-St. Petersburg-Clearwater metropolitan area has the third highest number of jobs in February 2014 among all the Florida Metros. That’s not even mentioning the projected jobs that will be created in the near future from the many developments looking to enter the Tampa MSA.

Hessam continues to point out that there are many economic indicators that support retail sales to continue growing forward. Although the mandatory health insurance and rising interest rates are looming concerns in the near future, these are small speed bumps compared to what the retail sector has endured in the past few years.

The fact is, things are looking up from all angles at this point. Businesses are doing better, consumers are spending more, investors are buying up deals aggressively with the cheap financing that is available and owners are finding it possible to sell their properties for more aggressive cap rates than we have seen since the last boom. We expect the second quarter to fly by even faster than the first. We have just as many buyers to accommodate, except now we have a little more deal flow to accommodate them with, so we don’t have time to slow down.

If you’re looking for a deal, you’re not alone. The shortage in deal inventory combined with the cheap money recently made available by lenders is causing a unique environment where large pools of investors are competing for a small pool of deals. Investors have been willing to take down deals at compressed cap rates because they are still able to make their desired return from the spread on financing.

The good news for investors is that more deal inventory is trickling in.

More and more owners are realizing that it’s not just a great environment to buy in, but also a great time to sell. Many of our clients and owners are moving off the fence and bringing their properties to market with confidence.

Let’s be honest, these record low interest rates will not be around forever. At some point within the next few years those rates will go up, investor returns will squeeze from the spread, and that will cause cap rates to go up and property values to go down respectively. Unfortunately, until our economy bounces back strong enough to support raises in the rental markets, values are very much reliant on available financing. If you’ve been on the fence about buying or selling, now is the time to seriously consider your options.

I welcome the opportunity to provide more detailed and localized information relevant to you and your retail investment goals.

If you have any questions, or if I can provide you with additional information locally or in other markets across the country, please feel free to contact me at (813) 387-4796.