How is Digital Tech Affecting Restaurants as an Investment

How is Digital Tech Affecting Restaurants as an Investment

Last month I talked about what we expect to see as the restaurant sector pushes forward this year. One of the anticipated shifts that we have already seen taking shape is the integration of digital tech into the consumer experience. Consumer preferences used to be convenience focused. As consumer preferences changed, business models shifted to offer guests a more custom and individualized experience, but the scale of offering such options cut into the convenience factor. Now concepts are learning new ways to offer consumers both convenience and individualization. How? Many of the solutions are being created through new technologies.

You used to have to browse direct mail magazines and call orders in to department stores if you wanted products shipped to you. Then, you could plan to receive them weeks later. Amazon has changed the game making orders a simple mobile click away with plans to standardize a 2-hour delivery window. As businesses started replicating the speed and efficiency of ordering through tech, you can now get groceries delivered through services like Shipt. Online ordering isn’t anything new to the restaurant sector, but concepts weren’t always been so eager to make those services available or to optimize their systems. Today, however, consumers want more, they want it faster, and they want it at a competitive price, so concepts big and small are brainstorming ways to deliver on those consumer demands.

Starbucks has done a great job making their mobile app an extension of their brand. Not only does it make it simple to pay (you just open up your app and allow the cashier to scan your barcode, which is tied to your Starbucks account and credit card), but it also offers new opportunities for guests to engage; partnering with music streaming services like Spotify to allow guests to customize their musical preferences; collecting stars for rewards programs that offer enticing discounts and promotions; a mobile store to purchase Starbucks merchandise directly from the app.

It is proving quite lucrative for Starbucks.

As a real estate investment, Starbucks is one of the highest paying QSR tenants on average paying over $60 per square foot, while the general average rent paid by QSRs floats around the $30 PSF mark. Part of what empowers Starbucks to be so aggressive on rent is their ability to turn a volume of transactions. This used to be a main function of their drive through stack; Starbucks locations with a drive through typically generate 20% more in sales revenue than a location without a drive through. Today, they are likely maintaining and increasing that guest volume through the technological efficiencies they are implementing. These technologies are not only making transactions easier for guests and catering to their changing preferences, but it is also making the entire transactional process faster allowing more foot traffic to get through the cash registers to check out. According to an article by Nation’s Restaurant News, 2017 saw 1.6 percent or 960 million restaurant visits being paid via mobile app. That was an increase of 50 percent over a year ago. Brands like Taco Bell have implemented similar apps, but aside from the convenience factor and efficiency factor, it is also allowing orders to be taken off site, which means less time guests have to stand around waiting for their food to be made, less congestion inside of restaurants themselves, and parking spaces being made available quicker allowing for additional guest volume to push through the stores. Guests can preorder their food and by the time they arrive, their food is ready. All guests have to do is sit down to eat or grab it and go.

In 2017, McDonald’s discussed their new “Experience of the Future” (EOTF) business model shift, which may take several years, but plans to utilize self-serve kiosks and more outdoor eating spaces aimed at cutting labor costs, increasing efficiencies, and improving the overall guest experience. McDonald’s is a master at guest volume. They are one of the lowest paying quick service restaurant concepts in terms of per square foot rent and in addition they have one of the lowest average ticket prices for guests across the board. The amazing thing about the concept, however, is that even with those items considered, they tout some of the highest average sales per unit across most quick service restaurant concepts and demand some really high investment sale prices when selling your real estate with them as a tenant. Why is that? Their strong credit guarantee and generally core real estate sites certainly help, but it is also because they churn such a volume of guests that their low average ticket price still yields them very aggressive unit sales figures, which translates to a low rent to sales ratio and a less risky investment for investors that will pay a premium for all of the above. Contact us about our restaurant report for more detailed information regarding average cap rates, unit sales, and year over year growth per specific concept.

These technologies are changing the game, but with these added benefits for these concepts comes added costs. Also according to the above referenced Nation’s Restaurant News article, 16 percent of cash paying non-tech users were concerned about identify theft or credit card fraud. Although it may be rare to find a completely cashless restaurant as it sits today, anyone implementing these technologies is going to have to bulk up their IT costs to ensure the apps run smoothly, safely, and prevent any sort of outside hacking.

The good news is that it is not only the smaller footprint Quick Service Restaurant concepts jumping on board. The casual dining sector has been shocked into some big changes as many larger footprint concepts have seen consistently declining sales as these consumer preferences continue to shift. These shifts have especially hurt the casual dining concepts offering cheaper meals as their average tickets do not generally have the profit margin fat to spare, which some of the more fine dining concepts can absorb due to higher tickets and heavy alcohol sales. It will be important to a casual dining concept’s success to get more people through their doors and turn over tables faster. Concepts like Chili’s have begun using tablets at tables, which allow guests to place their orders, order refills, and make their payments when they see fit in addition to adding other experiences such as games, news, and promotional upsells. Many think that the human connection a physical server brings is an experience people dine out for and cannot be replaced by technology, which may very well be true, but it seems the path to success is not a black and white, this or that philosophy. Instead, restaurants can leverage these technologies and use them in conjunction with physical servers to improve efficiencies, reduce human error, and give the guests totally new and unique dining experiences, while simultaneously allowing for more guest traffic by reducing the time it takes to turnover tables.

On the real estate investment side, many of the struggling casual dining concepts have seen cap rates go up due to some of the risk perception of their concepts increasing in the marketplace. There are many casual dining concepts still aggressively expanding, maintaining strong sales, and doing a great job of capitalizing on these technologies to cater to changing consumer preferences, but many are wondering how long it will take struggling concepts to figure things out and re-stabilize. The overall buyer pool for casual dining concepts has shrunk a bit as investors have begun moving more towards quick service restaurant investments. Because QSR concepts have smaller footprints, location centric sites with dense high traffic corridors, less of a need for an “experience” since guests are looking for speed and convenience, and the generally low ticket price that can remain in demand during a down market, these investments are perceived as a less risky alternative. With that said, some investors are viewing this as an opportunity to capitalize on how low their current QSR investment cap rates are and move into emerging or strong operating casual dining concepts where there may currently be more risk, but also more upside in the future. Some are simply following the old adage of selling what everyone is buying and buying what everyone is selling; the idea that you could sell your Starbucks for a 4.5% cap rate, but exchange into a well-located Applebee’s at a 7% cap rate with a strategy to hold on for the ride until the casual dining sector settles in, evolves, and starts demanding lower cap rates again. With core real estate principles at top of mind, those investors are weighing worst case scenario situations of re-tenanting the space, signing a new long-term lease with a new tenant down the road, and then looking to exit at that point once value has been created again.

There are a million ways to slice the salami and an investors appetite for risk can vary dramatically. A good deal to one investor can be a nightmare for another. One thing we can be sure of is that there is no lack of opportunity out there. We are helping clients strategize and exchange in and out of these types of opportunities on a daily basis. We welcome the opportunity to learn more about your situation and what we can do to compliment your existing investment efforts. We promise that if you work with us on a long-term basis, you will not only keep a pulse on ever changing market trends to avoid potential risks in the marketplace, but you will also undoubtedly find new opportunities to increase your cash flow, grow your portfolio, and maximize your equity along the way.

Planning Your Exit Strategy

Planning Your Exit Strategy

 

Most times, when we determine the best property for our clients to purchase, we emphasize the importance of not only the entry strategy, but also, just as important, is the exit strategy. Normally, when an investor purchases a NNN restaurant property, the most important focus is how to get in the deal and how much will it cost. We ask you to take a half step back, just momentarily, to look at how we position our clients for long term success.

We believe that the Exit Strategy is just as important as the entry strategy and here’s why:

At Marcus & Millichap, we do two things and we do them more effectively than any CRE firm in the nation. We build and preserve our client’s wealth. While it is imperative to thoroughly examine each property’s worth for our investors based on their acquisition criteria and coupled this with the dozen or so variables that are factors in the overall value equation, it is also crucial to be able to measure what the property will be worth in the future.

Because of our extensive restaurant brand and tenant knowledge, we are privy to certain information that most brokers don’t have access to. If we know that a certain restaurant franchisee has a pattern of dividing their portfolio into subsidiaries and smaller lease guarantees and the language in the lease is ambiguous and provides them this option, we will factor this into the future value of the property’s worth. Simply put, when a lease guarantee is reduced from a massive franchisee guarantee to a smaller regional subsidiary guarantee, the restaurant’s lease and real estate value is negatively altered. We often advise our clients away from this type of scenario. Conversely, we have also experienced the opposite trend. Our experience has shown us that certain restaurant corporations are reducing the amount of total franchisees they communicate and do business with. As a result, they offer financial incentive for the smaller Mom & Pop franchisee to sell their business operation to a larger regional franchisee. They also offer financial incentives for the larger company to purchase those businesses such as extensions of the franchisee agreements for a reduced cost. This play increases the value of a Restaurant Property as the larger restaurant guarantee increases stability and worth due to the size and history of the larger company.  These are just two examples of what we commonly experience and are able to steer and advise our clients accordingly.

As restaurant specialists, we know this category more precisely than “Catch All” brokers that not only handle other retail categories, but also other completely different product types.

Let’s talk about lease length:

There is definitely a “Best” time to purchase a restaurant asset. We know that there are lease trigger value reduction times. These are defined as increments of time in which the lease reduces from a “5” number to below. Please allow me to explain. When a lease term reduces from 20 to 19 years, 15 to 14 years, 10 to 9 years and 5 to 4 years, the value perception dramatically alters the worth. We have seen properties lose over 50 basis points literally overnight and 35 to 45 basis points is typical. This is why we target properties that have just come out of one of those value reductions for client acquisitions. If we can pursue and secure a property with 18 or 19 years remaining on an original 20 year lease, that is the best scenario. It is exactly like driving a brand new car off of the lot. You know the saying, “That car just lost 10% of its value without traveling one block.” Why do many savvy investors buy cars with one or two years on them with ultra-low mileage? It’s because they allowed the original owner to take that loss and they purchase the car, virtually new, but at a discounted price.

SMART!!!

The same theory applies with NNN Restaurant Properties.

Now that we covered entry strategy, let’s talk about exit strategy:

The same property that you purchased with 19 years on the lease, we will recommend that you hold and cash flow for 8 ½ years, until the lease term has 10 ½ years remaining. Then, as your broker, we can list and transact this property at the absolute highest price by promoting the fact that there is an impending rent increase (which is most often the case every five years), and the perception will be a secure lengthy 10+ year term. With this strategy, you are on the positive side of the “5” number and transact the property before it loses significant value.

When we secure your property acquisition, we always provide the best-case scenario as to when to sell and exit that same property you are buying to maximize its value and your equity. Most brokers do not employ a long-term approach with their clients and are simply focused on the single transaction. Many of our most successful NNN restaurant property clients execute this strategy over and over. It truly assists them in “Climbing the Ladder” one rung at a time and has proven to be extremely effective. In fact, many have shared with us that this one strategy is responsible for much of their wealth.

Because we have the largest inventory of properties and buyers in the nation, our ability to access and secure a property for you with the right “formula” is compounded and multiplied. This fact coupled with our specialization of restaurant properties allow us to guide our clients like no other broker can. We always joke that we are the brain surgeons of restaurant and it really is true!

We build long term relationships with our clients. We are not simply seeking to secure one transaction, but instead take the time to learn about our clients and their goals and long-term objectives. We enjoy investing our time in our clients to learn as much as possible, so we can most effectively guide them to successfully reach their destination.

Above outlines just a few strategies and perspectives that we wanted to share with you. It’s no mystery that the majority of our 30 almost thirty property closings last year were multiple transactions for the same client. We either executed dispositions or acquisitions for our client for multiple properties. Or, we handled the disposition of their property (known as down-leg) and also represented them in their acquisition of their next property (called up-leg) in a 1031 Exchange.

There is a definitive reason for this. Our clients know that they are in the best hands possible. We leave no stone unturned on our mission to provide the absolute best brokerage services for our clients. Our resources coupled with our unwavering commitment we make to our clients is truly second to none and we demonstrate this each and every week. We have the bundle of letters of recommendation to prove it! Ask to see them or a phone number for one of our many satisfied long-term clients who would be happy to share their experience.

 

Why Invest in Restaurant Net-Leased Assets

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.

 

Burger King: Corporate Owned to Franchise Run Investments

Burger King: Corporate Owned to Franchise Run Investments

Burger King has been part of quite the wild ride. As an income producing property investment, it can be considered one of the most popular options because of the attractive lease structures, experienced franchisees and powerhouse institutional parent backing. When looking to identify solid net-leased investments that also have upside, Burger King may be worth a strong look, but first let us start with a quick history lesson on how the concept has grown to what it is today.

It was 1953 when Keith Kramer and Matthew Burns built a stove called the “Insta-Broiler”. Living in Jacksonville, they were searching for a restaurant concept and settled on a burger joint called “Insta-Burger King”. After James McLamore, a student at Cornell, visited the hamburger stand operated by the McDonald’s brothers, he and his fellow classmate David Edgerton bought an Insta-Burger King franchise in Miami. By 1961, Burger King had begun expansion across the United States becoming famous for their signature burger, The Whopper. Just six years later in 1967, Pillsbury purchased the concept for a whopping $18 million and with Pillsbury’s support had the means to scale their operation becoming the second largest burger chain in existence, only behind McDonald’s.

Because of the intense competition between the two burger concepts, Burger King franchise agreements were restructured to restrict franchisees from operating franchises in other chains, in addition to regulating how far away your stores were from your home in order to cut down on absentee ownership. With the continued growth of the Burger King brand, TPG Capital paired up with Goldman Sachs and Bain Capital to purchase the concept for $1.5 billion before its IPO in 2006, which generated $425 million in revenue. Then, in 2010, 3G Capital purchased the concept for $3.2 billion.

That is about when Burger King began shifting its business model to focus heavy on franchising. Burger King makes its money from primarily three revenue streams: Sales from corporate operated locations, Income from leasing owned property, and Revenue from Franchise fees. In 2011, Burger King had 1,395 company owned and operated locations, but in 2012 Burger King began selling off stores. In 2012, about 59 percent of Burger King’s revenue came from store sales and operations. One year later, only 8 percent of the company’s revenue was from operating stores. Burger King had sold 96 percent of all their stores to franchisees in order to focus more on branding, product development, and other support resources that would help franchisees find further success.

Quarterly-Revenues-2014-09-01-BK

Their philosophy became:

Let the franchisees do what they do best so we free up time to find new ways to make the concept better.

That is why today, an investment in a Burger King net-leased asset, even operated by a small franchisee, can be an extremely safe, stable, and attractive option. That is also why many of these Burger King assets demand aggressive cap rates compared to other concepts on the market. In 2016, the average cap rate across all Burger King investment sales was 6.04%, while the historical all-time average cap rate across the restaurant sector lands at about 7.12%. This data includes both long term leases and short term leases; both corporate backed leases and franchisee backed leases. The graph below shows the average cap rate across a number of quick service restaurant concepts. You will notice that Burger King offers investors a very competitive return compared to other concepts, but while also offering a very well established brand and operation.

avg cap rate qsr 2017 trailing 12 months

For a long-term lease (10-20 years remaining), that cap rate can compress 50-100 basis points. In 2017, there have been a number of fee-simple properties backed by small franchisees (5-unit to 20-unit guarantees) selling at cap rates from 5.08% to 5.59%. Although corporate backed leases will demand a more aggressive cap rate in most instances, the franchise and support structure employed by the Burger King concept has proven a successful business model for smaller franchisees and those investments continue to demand a very competitive cap rate because of it.

So where is the upside?

Burger King is moving towards and would prefer to have fewer, but larger franchisees. Fewer franchisees operating more stores means less micromanaging, fewer contacts to keep in front of, and economies of scale. Fewer operators obviously means fewer moving parts. That is why purchasing a store operated by a small franchisee could provide very attractive upside in the future. Because a small franchisee backed lease still offers stability of concept and a hedge against risk, it will still demand an aggressive cap rate; however, an investor would still be able to capture a higher return than purchasing a corporate backed lease, which exposes the investor to even smaller risk. Why wouldn’t you capture that higher return on a solid long-term net-leased asset, while also keeping in mind the potential upside in the future. If you purchase a property operated by a 5-unit franchisee and plan to hold for 10 years, the chances of that operator being acquired by a larger more regional franchisee are fairly strong. That means that by the time you are ready to revisit an exchange, you will likely have built up equity in rental increases, real estate appreciation, but most importantly an increased financial guarantee or at the very least a stronger operator behind your original guarantee. Now, when you decide to bring the property back to the market, you will be able to demand a more aggressive cap rate having a larger, stronger operator having taken over your location.

That’s the potential upside!

Although Corporate will still back leases, most Burger King locations are owned and operated by the franchisee and provide a lease guarantee to match. As an investor, this is a benefit because your tenant has significant skin in the game, while also operating under a proven concept with monster support from its corporate parent. You are able to secure a long-term passive net-leased asset, but with upside in the future acquisition from a larger regional franchisee. This is why even a property housing a small franchisee operating under the Burger King umbrella can demand extremely aggressive cap rates in the investment sales arena. These deals should not be overlooked by investors looking to purchase or exchange into a net-leased restaurant property.

For more detailed information regarding Burger King properties, franchisees, or lease language and how it can impact the value of your investments, feel free to contact me directly at 813-387-4796. I am working with property owners, restaurant operators, and developers on a regular basis to connect the dots around where they are today and what they are trying to accomplish in the future. Even if there is no immediate business, I welcome the opportunity to learn more about your current investment situation and what I can do to help you maximize the value of your assets.

Does The Guarantee On Your Restaurant Net Lease Have Upside or Downside?

Does The Guarantee On Your Restaurant Net Lease Have Upside or Downside?

One of the biggest metrics investors look at when purchasing a single-tenant net-leased asset is the guarantee behind the lease. It is a major factor in weighing risk vs. return when it comes to net-leased assets.

It can also be a major factor that is misunderstood or overlooked without careful investigation.

For example, let’s say you are considering the purchase of a Taco Bell net-leased asset:

You perform a quick Google search to discover that Taco Bell is S&P rated BB and operates 7,000 locations!

That is quite a strong concept!

Hold on…You also learn that Taco Bell is actually a subsidiary of Yum! Brands, which owns Taco Bell, KFC, and Pizza Hut comprising of over 43,000 locations!

That must be a risk-free investment then…

Well, not necessarily.

Thinking this is the best investment since sliced bread, you put the property under contract. During the due diligence period, you investigate the lease to learn that it is actually only guaranteed by an entity named “Taco Bell 5 FL Tacos, LLC”…

What does that mean?

Come to find out, the franchisee operating this Taco Bell only has 5 stores…and only ONE of their stores is backing this lease through the referenced entity…

It is easy to see how an investment backed by corporate Taco Bell holds drastically different risk factors than an investment backed by a 5-unit franchisee only offering a 1-unit guarantee on their lease. These are important risk factors that have significant impact on the values you can demand for your investment property and the return you can expect to yield from purchasing one of these properties.

These are also important factors that your broker/investment advisor should be making you aware of and helping you analyze, not only prior to a purchase, but prior to a contract for purchase.

With that in mind, existing guarantees can have upside or downside tied to the strength of what is backing the lease.

The typical rule of thumb in any investment is:

The Higher The Risk, The Higher The Return!

A corporate 20-year Taco Bell lease may sell for a 4.5% cap rate, while a 5-unit Taco Bell lease with just 3 years remaining might sell for an 8% cap rate. With a weaker guarantee or lesser lease term comes more inherent risk, but also more reward.

This can be especially true for your guarantee.

You may take on more risk purchasing the 5-unit franchisee backed lease, but what if a larger 200-unit operator is considering buying out that smaller franchise? If that 200-unit operator buys out your tenant and decides to guarantee the lease with the entire lot of their locations, you could easily gain 100-200 basis points worth of value overnight.

That is what some like to call upside.

KBP Foods, a large franchisee of Yum! Brands concepts, recently acquired 78 KFC locations. According to Nation’s Restaurant News (NRN), this was just one of many recent acquisitions that have helped the operator reach 530 locations in 20 states. One of those purchases was an acquisition as small as four locations in Lawrence and Topeka, Kansas. These units were purchased from franchisees and the investors owning the real estate under those operations must be popping the champagne right about now because their small franchise tenant just evolved into a powerhouse operator and one of the largest Yum! Brand franchisees in existence. Even without a change in the guarantee, the perception of now having a very strong operator can alone impact the value and equity of the investment.

My warning is that it can work in the opposite direction as well.

Part of KBP Food’s feeding frenzy in acquiring locations included 41 locations in Texas directly from Corporate KFC. This is not unexpected. Last year, Yum! Brands announced they would shift the ownership of their stores drastically into the hands of franchisees; taking their 10,000 corporate run stores and shrinking that number to fewer than 1,000 by the end of 2018, according to USA Today.

Those investors that had a corporate KFC lease just had a change of tenant…From Corporate run to franchisee run…overnight. While in some lease structures, the landlord is protected for the life of the lease, there is certainly downside when it is time to re-up and your new tenant has a fraction of the net-worth your previous tenant came to the table with. In the KBP Foods scenario, the downside in equity may not be as dramatic; a tenant shift from Corporate run location to a 530-unit operation, although a sure hit in the risk department, is still a pill you can swallow. Some leases, however, allow for corporate guarantees to revert to franchisee guarantees as small as 10 or fewer units…

That  is where there can be downside.

Which scenario strikes a chord with your current portfolio?

Do you have upside or downside?

If these are factors you actively consider when looking at deals, then you are ahead of the game and I would be happy to take you to the next level with the specialized insight I can provide. If you were unaware of these factors or fail to consider them on a regular basis, you and I should connect immediately.

Please reach out and I will make myself available.

I’m helping clients all over the Nation evaluate their upside/downside on a daily basis; analyzing property value, risk, and equity to help clients get clear on their options at any given time within the market and execute on a proactive strategy around these seemingly reactive assets. Feel free to reach out to me for more specific insight around your restaurant investments as I welcome the opportunity to help you do the same even if there is no immediate business to be had on the horizon.

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.

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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.