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.

 

Checkers and Rally’s: Leveraging Modular Development

Checkers and Rally’s: Leveraging Modular Development

Checkers is one of the largest double drive thru chains in the United States. Having served hamburgers, hotdogs, French fries and milkshakes since 1986, Checkers today is headquartered in Tampa, Florida and operates over 850 locations in 29 states. Rally’s, a similar concept out of Louisville, Kentucky, was purchased by Checkers in 1999. Since the acquisition, Rally’s has began adopting design from Checkers and the two concepts look virtually identical aside from the name on their signs.

Despite construction costs ticking up and some concepts pulling back on development, Checkers is pushing forward hard. Checkers is slated for a future 30 new locations in the D.C. area; a future 30 new locations in Houston; With over 60 locations around its headquarters in Tampa, even franchisees local to Tampa Bay are still growing.

What is enabling the company to pursue such aggressive expansion? A big factor seems to be the modular design they are using for their new construction. Modular construction involves an off-site process where buildings are constructed under a controlled environment. Although the same codes and standards employed under traditional construction are adhered to throughout the process, the construction can be completed in half the time. The buildings are built in sections, which are then put together like Legos, on site. Not only can the buildings be built in half the time, but modular buildings are typically stronger than conventional construction since each portion of the building is built with its own structural integrity to withstand the stress of travel. The process also includes a number of other benefits including safe and secure storage of construction materials, reducing site disruption from weather or pedestrian traffic, and reduced waste for a more sustainable construction process. With the new prototype designed by Checkers, building each modular location ends up being 20% cheaper in addition to being much faster. With the nimble flexibility of popping a location up faster to avoid “dead rent” periods and a cheaper upfront capital injection for new locations, it is allowing Checkers corporate and franchisees the opportunity to expand into denser, higher rent, competitive markets where barriers to entry are high. Another model includes Checkers re-using shipping containers for constructing their new prototype, which is also both cost effective and sustainable.

As a real estate investor, this can be good news if you are eyeing Checkers as an investment, which tends to have a higher cap rate when compared to other concepts in the QSR sector. It can build confidence around an investment into Checkers as a tenant, who appears to be making shifts in technology to take advantage of the evolving landscape, while also adapting in ways that are allowing them to expand the concept and capture more market share. Like anything else, investors should also be aware of the risks associated with these deals. The Checkers prototype can go as small as an 800 square foot building, while the average QSR concept operates in 2,800 square feet. This can present a potential metric of risk to watch. The average unit sales volume for Checkers was around $970,000 in 2016; about the same volume as the average KFC ($999,500), Captain D’s ($1.04MM), and Arby’s ($1.07MM), but operating with a building square footage almost 2,000 square feet smaller than the other above referenced concepts. This can equate to a higher rent per square foot paid by Checkers; a high rent per square foot in markets that are generally lower income areas where the Checkers concept thrives.

Why is this a potential pressure point?

The average rent per square foot paid by QSR concepts was $35 per square foot in 2016, while Checkers, on average, was paying $47 per square foot in rent with an average square footage in 2016 of 1,800 SF. That rent per square foot could be inflated even further with their 800-1,000 SF prototype design. I have seen investors purchase new construction Checkers locations and after a few years, Checkers had decided to vacate. While Checkers may still be paying their rent obligation in these scenarios, the realization may set in that replacing $40-$50 PSF in rent will be impossible in a market where the average rents may be as low as $10-$15 per square foot gross due to the demographics and household income capacity. Now, with the new smaller footprint and an aggressive campaign to secure urban locations by getting competitive with rent, some new Checkers leases are approaching $80-$100 per square foot in rent. These very well may be slam dunk locations and great investments, but it cannot be argued that these deals also bring exposure to risk in rent sustainability. Pair that risk with the fact that Checkers is one of the few concepts that can develop on 0.25 acres of land, which does not provide many future opportunities for redevelopment, and the risk in these deals must be weighed accordingly.

All in all, there are positive things happening for Checkers as a concept as they remain bullish on further expansion. Investors looking to take a dive into the concept should look at every deal on a case by case basis. If you have a deal you are currently looking at and determining how to underwrite the deal to hedge against risk, but also remain aggressive in securing the asset for purchase, I am happy to walk through the details of the deal with you and help you determine your best strategic move. As always, I’m available to help wherever it makes the most 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.

Applebee’s: Good or Bad Investment?

Applebee’s: Good or Bad Investment?

It was November of 1980 in Decatur, Georgia when the doors opened for T.J. Applebee’s Rx for Edibles and Elixirs. Six years later, the concept changed names to Applebee’s Neighborhood Grill and Bar to reflect the original vision for the concept being a local place that everyone could call home. Fast forward 20 years later and Applebee’s had grown large enough to attract the attention of DineEquity, formerly IHOP Corporation, which acquired Applebee’s for $2.1 Billion in 2007 to create the largest full-service restaurant company in the world.

Now we are in 2017 and times are changing! Fast casual concepts have been picking up steam since the early 2000’s. With consumer preferences continuing to shift towards a larger variety of tastes along with a desire for healthier choices, fast casual as a segment has began to take market share from both casual dining and quick service restaurant concepts with the rise of trendy concepts. In light of these changing consumer preferences, Applebee’s made a number of shifts over the past few years in strategy, offering, marketing, etc. in order to maintain that market share and recapture their customers.

Even still, the company has seen regular declines in same-store sales recently and it has hurt the perception of Applebee’s as an investment. The average cap rate for Applebee’s sold in 2016 was 5.90%; year to date 2017, the average cap rate is 6.21%. That means that over the past twelve months, cap rates have climbed over 30 basis points.

That doesn’t sound too bad…

The recent announcement that DineEquity would close up to 135 locations in fiscal 2017 is what has really created the most recent shift in perception and cap rates. The average cap rate for on-market Applebee’s properties right now is 6.73%; over 80 basis points from the 2016 average. Further, the average cap rate for Applebee’s properties hitting the market since August is 7%. That is over 100 basis points lower than where cap rates were for a comparable asset 12 months prior. This is not happening across the board for restaurant net-leased assets. The restaurant sector actually continues to see some of the most compressed cap rates across all other net-leased food groups; staying about 40-50 basis points lower than other comparable net-leased assets in other sectors. This is a direct result of buyer perception and an influx of inventory hitting the market.

So as a buyer, you should stay away, right?

Not necessarily.

Many argue that now is the time to enter the Applebee’s concept and take advantage of these inflated cap rates for a proven concept with a long-term lease in place. Applebee’s has been on a steady decline, however, recently there have been a number of changes within executive management and they are shaking things up. What they did not tell you prior to rolling out the breaking story of all the anticipated location closures was that they had identified most of these closures quite some time ago. In fact, half of the stores they plan to close have likely already shut their doors. According to Nation’s Restaurant News (NRN), the Applebee’s brand president, John Cywinski, said this was a strategic move and many of the store closures are stores that “need to close and perhaps should have closed a long time ago”. In addition, Applebee’s has vowed to get back to their American roots. Instead of continuing the attempt to capture a new demographic, they are going back to listening to what their core demographic is asking for. According to Inc.com, Cywinski made this statement regarding their new focus:

Now, let’s shift attention to our guests and perhaps one of the brand’s strategic missteps. Over the past few years, the brand’s set out to reposition or reinvent Applebee’s as a modern bar and grill in overt pursuit of a more youthful and affluent demographic with a more independent or even sophisticated dining mindset, including a clear pendulum swing towards millennials. In my perspective, this pursuit led to decisions that created confusion among core guests, as Applebee’s intentionally drifted from its — what I’ll call its Middle America roots and its abundant value position. While we certainly hope to extend our reach, we can’t alienate boomers or Gen-Xers in the process. Much of what we are currently unwinding at the moment is related to this offensive repositioning.

Applebee’s is upgrading image, equipment, and focus. They have embraced technology and begun implementing tablets into their POS systems. They have adjusted the menu and pricing strategies under new executive management. To top it all off, they are getting back to the roots of their core demographic and are revved up to crush it out of the park. Good or bad investment? It depends on your threshold for risk and your hunger for return. For every seller looking to transition from Applebee’s to a different asset or net-leased sector, there are three buyers trying to take advantage of the inflated cap rate environment around the concept.

Like any long-term net-leased investment, it is important to weigh all the factors heavily before moving forward. Ultimately, anything can happen over the next 15-20 years. If you are concerned with maintaining your cash flow for the extent of the new 15 year Applebee’s lease you are looking to purchase, then get critical of the guarantee behind the lease and weigh the risk that it holds. If you would rather take a 7% return when all other restaurants are trading 100 to 200 basis points lower, then simply assume they will vacate at the end of the lease and evaluate the core real estate for the future. If the financial strength of the guarantee holds weight and you are positioned on over an acre of land, on a decent thoroughfare, in a growing area, then a dive into an Applebee’s bottom might be your smartest move; worst case scenario you re-tenant after the base term with a growing concept after collecting an average of 7-8% on a passive net-leased asset…the upside, though, is that you could enter into the monster concept on a downswing and get to ride it back up through its transformation.

Church’s Chicken: A Work in Progress

Church’s Chicken: A Work in Progress

Church’s Chicken is an American chain of fast food restaurants specializing in fried chicken. The chain was founded as Church’s Fried Chicken To Go by George W. Church, Sr., on April 17, 1952, in San Antonio, Texas, across the street from The Alamo. The company, with more than 1,700 locations in 25 countries, is the third-largest chicken restaurant chain behind KFC and Popeyes Louisiana Kitchen.

Church’s is known for thriving in tough markets housing lower income demographics. Many investors actually prefer these investments because there is a sort of hedge against risk in these markets. The perception is that regardless of what hardships hit these markets, they will always need to eat cheap and Church’s is there to provide that service. In the recent past, however, with the chicken market exploding, Church’s has had some tough competition. Church’s as an organization has made serious strides towards improving their competitive position.

According to the organization itself, burger joints and grocery stores are stealing their thunder lately. It could be argued, however, that their biggest competition is the local shop across the street. Even they agree that the business is a battle of street corners. Essentially, it is all about real estate…Who has the hard corner with the highest traffic counts? Who is most likely to pull customers in from the street and capitalize on their impulse for dinner?

Admittedly, Church’s as an organization is working on both variety of offering and also increasing volume through drive-through efficiency. According to Nation’s Restaurant News (NRN), Church’s has been ramping up their technological offering in an attempt to improve their drive through experience.

Who is the drive through competition though?

Chick Fil A, Raising Cane’s, Zaxby’s…There is some tough competition out there. Church’s has clocked their drive-through time in at just over three minutes and 30 seconds, which is impressive, but you also have to get the order right. According to recent data published by QSR Magazine on the accuracy of QSR fast food joints, some of the top contenders include Raising Cane’s topping the list at over 97% accuracy…Chick Fil A pulling 3rd with over 93% accuracy…and Zaxby’s clocking in at over 90% accuracy. Church’s Chicken unfortunately did not make the top 15 on the list.

With a dinner oriented business, focused on a lower income demographic and catering to the entire family, there is still little competition for the type of value their $5 Real Big Deal brings. It is hard to beat a deal that cheap that can feed the family while also offering choices that allow you to customize your meal.

When it comes to Church’s Chicken as a real estate investment, there are certain characteristics the deal holds that you cannot ignore:

  • Like many QSR properties, the real estate tends to maintain core desirable properties:
    • Hard Corner
    • Main Thoroughfare
    • Good Ingress/Egress
  • The rents are low
    • With rents averaging around $20 PSF as a concept, if the demographics were to shift in a landlord’s favor, there could be some generous upside in rent appreciation.
  • Demographics have a sustainable need
    • The target demographic, although thrifty, has proven to spend money on convenience. The concept works and is typically recession-proof. Even when there is a downturn, the main household income for this demographic will not shift as dramatically as other higher income areas. Because the demographic is self-sustainable, they can often replicate the disposable income necessary to spend money on eating out more readily than other economically hard-hitting areas.

Over the past twelve months, Church’s Chicken has had an average cap rate of 7%. Similar to the story above regarding the sustainable demographic, the cap rate has also remained fairly stagnant compared to other concepts. Why? Mainly because while the risk or perception of risk in other concepts varies greatly around market traction, the perception of risk for these types of assets remains fairly the same over time. The guarantee has not shifted much; and although the demographics will never demand a certain amount of sales, the demand for the concept and product is there. The density of the population and demand from the surrounding population will sustain the concept.

The challenge for an owner is: what happens if they leave?

If you own a Church’s Chicken and the lease term is approaching, a major question is: Will they stay or will they go? As an owner with this question in mind, you hold significant risk. Although compared to other net-leased investments, the average Church’s Chicken pays a fairly low rent per square foot, the sustainability of the cash flow stream can still be unclear. The nature of the target demographic is a pro in the fact that it is in constant need of the product, but a con in the fact that even though the base rent is low, if Church’s left, you would be stuck trying to lease to a local tenant likely at half the market rate. Your cash flow would be cut in half. If you are a savvy investor and have enough tenant relationships to redevelop the parcel or sit on it until it can be redeveloped with a stronger tenant, then you are in good shape.

Most of us, however, are not in that kind of position.

I urge clients to look at their investments critically and evaluate their options on a regular basis. I am here to help. I’m evaluating risk, cash flow, equity, and future value for clients on a daily basis and I’m happy to do the same for you. As you plan your long-term investment strategy, it is imperative that you look at how your existing portfolio fits into your long-term plan. An investment like Church’s Chicken has its pros and its cons; it can certainly be a strong part of a comprehensive portfolio, but my point is that nothing should be left to chance. If you are not looking at these investments with a strict magnifying glass and comparing them to the rest of your long-term plan, then you need to re-evaluate your investment strategy. I am happy to help wherever it makes sense, so please reach out if you are curious about your existing portfolio, looking to diversify, or simply wish to keep a pulse on what is happening in the market and how you can best capitalize on the recent market changes.

Dunkin’ Brands Shaking Things Up

Dunkin’ Brands Shaking Things Up

With the rise and plateau of the Fast Casual sector, consumer preferences changing, millennials consuming all the avocado toast, and all the other craziness of 2017 (See @RealDonaldTrump for Details), many restaurant concepts are making executive level shifts and reconfiguring their business models.

Dunkin Brands is no different. Dunkin’ Donuts opened their first shop in Quincey, Massachusetts in 1950 and since has grown to 12,300 locations worldwide with over 8,500 locations here in the United States. Recently, Dunkin’ Donuts announced they were considering a rebranding initiative to remove the…donuts. Don’t grab the tissues. The donuts are not going anywhere for now, but soon the brand may be known simply as Dunkin’. They are expected to make a final decision sometime next year after rolling out a few test stores, according to CNN Money. If they go through with it, it would mean removing the word “Donuts” from thousands of stores including signage and marketing materials. Dunkin’ Brands, with the pastry market already cornered, is looking to capitalize on the consumer preferences leaning heavy on the beverages.

That is why they are also shaking things up with their doughnut inventory. According to Nation’s Restaurant News (NRN), the Dunkin’ brand is “getting its doughnut mojo back”. Their plan is to reduce the variety of doughnuts offered, while simultaneously introducing more “artisanal” options that have proven success with consumer preferences in the recent past. They plan to land at around 18 different doughnut options including a maple doughnut with bacon bits on top; maybe taking a page out of Voodoo Doughnuts’ recipe book out in Portland, OR.

In addition to shrinking their doughnut variety, Dunkin’ will look to expand their beverage variety experimenting with a number of new beverage options. Their hope is to rebrand and capture more of the beverage heavy consumers from their immediate competitors. All in all, it is a lot of major change happening fast. Some say they are putting the “nuts” in Donuts, but if profits jump and it appears they are making more money by capturing more market share from their competitors, they may be simply replacing one kind of dough for another ($$$).

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.