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.