Listed | Burger King Portfolio | Baltimore, MD
Tag: cap rate
Restaurant Development, Construction Costs, and Sustainable Expansion in Casual Dining
The restaurant sector continues to grow aggressively. From new trendy concepts popping up and gaining traction to well-established concepts expanding into other markets in order to capture more market share, restaurants remain bullish on development. Sometimes, however, more isn’t always better. When it comes to scaling any business, from franchisees just getting off the ground to well-established corporate structures, it is important to understand your bandwidth and how to scale under the premise of sustainability versus blind and rapid expansion that can lead to disaster. BJ’s Restaurants, Inc. is a prime example of this philosophy and how sometimes taking what seems like a step back can be a wise move toward a future two steps forward.
BJ’s Restaurants, Inc. is an American restaurant concept that operates under names such as BJ’s Restaurant and Brewhouse, BJ’s Pizza & Grill, and BJ’s Restaurant & Brewery. The first BJ’s concept opened in Orange County, California back in 1978 and in 2017, BJ’s Restaurants, Inc. plans to add 10 locations totaling 197 restaurants operated in 24 states across the nation.
Developing 10 locations in 2017 is light compared to the 17 locations that were developed two years ago. Plans for 2018 are even lighter. According to Nation’s Restaurant News (NRN), CEO Greg Trojan plans to add six more stores next year, stating, “The slower pace of expansion has allowed us to focus operationally on many new initiatives…It’s helped drive more management tenure, adding more local knowledge and team familiarity to our sales-building efforts.”
Recent trends in development has caused construction costs to rise, which has made a number of developers think twice about how to make the numbers work. Net-leased development in general remains the key driver of overall retail construction, accounting for more than 46 million square feet of the 60.4 million square feet delivered over the past year. Single tenant construction has averaged 45 million square feet over the past three years. Developers have been focused on net-lease property development amid labor market strength and extremely low unemployment. According to Marcus & Millichap’s Net-Leased Research Report for Fall of 2017, builders have been constructing projects favoring single tenant concepts, particularly in the quick-service restaurant, pharmacy and dollar-store segments. Further, net-leased deliveries have accounted for more than 80 percent of retail development since 2009, up from below 70 percent before the recession. According to the Turner Building Cost Index—which measures costs in the non-residential building construction market in the United States— the third quarter 2017 index increased to a value of 1044, which is a 1.26% increase from the second quarter 2017 and a 4.92% annual increase from the third quarter 2016. In fact, costs all around have seemed to tick up a bit as the restaurant sector has been heating up, employment has improved, and supply and demand plays its part in the sector.
Although these rising costs have played into some of the slowing development of certain concepts, it also appears that the top level management at BJ’s Restaurants, Inc. simply has a strong understanding of their bandwidth and capacity for growth. By taking a step back and slowing development, they are allowing themselves to settle into their new stores giving those stores an opportunity to mature and build steam. Just like everything else, there is an ebb and flow to growth. It is no wonder that cap rates for real estate assets backed by the publicly traded company have compressed in the recent past. Based on our research data, the average cap rate for BJ’s occupied property in the past 12 months has been 5.27%, while the average BJ’s leased property is on the market at a 5.00% cap rate. Compare that to the average cap rate across full-service restaurants for the past 12 months: 5.79%. The graph below highlights the 2016 average cap rate across a number of the top casual dining concepts in the sector.
That means BJ’s occupied property has performed over 50 basis points more aggressive than the average full-service nationally recognized brand. That is impressive. Many investors have expressed concern for the full-service casual dining sector as a whole. With many concepts failing to meet sales expectations and consumer preferences changing, some investors worry that the casual dining sector is disappearing altogether; however, as consumer preferences continue to demand customer experience, there is opportunity for the casual dining sector to evolve with consumers and technology in a way that is bound to keep the industry alive. Many champion leaders of the industry are already taking a proactive approach to these consumer changes adopting new technologies, catering to more take out and delivery services, while providing guests with the offerings and experiences they desire in order to get ahead of this evolution and remain relevant. Both QSR and Casual Dining real estate tends to adhere to certain core characteristics; main thoroughfare traffic, hard corners, visibility, ingress/egress, strong parking ratio, etc.
The fact is, from a real estate standpoint, the casual dining sector also provides investors with many benefits over quick service restaurant concepts:
- Generally Larger Parcel Size for Future Development
- Larger Building Footprint
- Higher Guest Ticket Prices Equate to Higher Sales Volume Per Unit
- Higher Guest Volume and Sales Equate to Higher Rental Figures
- Larger Price Points to Place, Build, and Leverage Equity
The disappearance of the entire sector would eliminate an entire tier of investments from both a price point and a cash flow stance. Ultimately, there is inherent value in the experience the casual dining sector provides consumers from a social environment to the variety and quality of food it can provide over quick service concepts.
Do I expect the sector to disappear?
No.
Do I expect the sector to evolve?
That is inevitable.
Investors would be wise to identify these front-runner brands, such as BJ’s Restaurants, and opposed to avoiding the sector altogether, invest in concepts that are up and coming in addition to scaling in a sustainable way.
If you are an investor interested in taking advantage of some of the up and coming concepts in the casual dining sector, I am happy to share my insights and help you find a deal that meets your investment criteria. Whether you are looking to invest in the sector, gauge your current holdings, or build a strategy around how to maximize the value of your assets, I welcome the opportunity to learn more about your individual situation and what I can do to help.
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 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.
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.
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.
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.
Closed | Starbucks | New Port Richey, FL
National Net-Leased Report | 2017 Outlook
The outlook for 2017 remains strong. Restaurants are still hanging on to some of the lowest cap rates across the net-leased sector, which bodes well for existing investors’ values. One would think that these low returns would deter buyers, but with all of the exchange capital floating around and the stability of restaurant net-leased investments, buyers still view these long-term investments as a hedge against inflation.
Check out the cap rate comparison graph below showing the most recent cap rate ranges by both sector and major brand:
Overall, positive economic momentum has carried into 2017 and it is being driven by confident consumers. Although rising interest rates have sparked a slight investor re-calibration, there still seems to be some runway left in this market. The spread between cap rates and the 10-year treasury is maintaining a steady gap and although we would anticipate interest rates to go up at some point, they appear somewhat stable for now.
Net-leased properties recorded a 23.9 percent advance in the average asking rent last year, which has more than doubled the pace of multi-tenant shopping centers over the same period. A lot of this is due to strong corporate backed tenants or franchisees getting aggressive to secure additional sites and locations. The good news is that asking rents in net-leased properties are still below the pre-crisis peak with an average tenant paying $19.62 per square foot nationwide.
For 2017, store openings will be led by the dollar-store segment, however consistent expansion in the fast-food sector will continue over the comping year. From all angles, I see this year shaping up to be a busy one across the entire net-leased sector!
If you would like more specialized insight or research in regard to your current investment portfolio or more information around what restaurant net-leased investments are currently available on the market, feel free to contact me directly at 813-387-4796.
Restaurant Market Update | Cap Rate Trends
Net leased restaurants had a home-run year in 2016!
Although net-leased inventory increased over the past twelve months, more buyers entered the market and the inventory could not keep pace with the demand, which had a positive impact on both cap rates and values. The fact is that property values are higher today than they were at the last market peak and it is not entirely due to higher rents. The average cap rate in 2016 is over 130 bps lower than the historical 10-year average. As interest rates begin to creep upwards moving into 2017, it is expected that cap rates will rise as a result. However, although cap rates across the board are expected to rise between 25 bps and 50 bps over the next 12 months, demand for net-leased restaurants is expected to remain, which should yield another busy year in 2017.
Check out the trailing 12 stats below for some of the strongest QSR brands in the marketplace today.
McDonald’s and Chick-Fil-A maintained the lowest cap rates in the marketplace, while Starbucks held the highest price per foot on a sale, which is closely tied to the high rents they are willing to pay for their locations. Quick Service Restaurants as a net-leased investment continue to be in high demand for investors primarily due to their passive nature and small price point. High performing QSR brands like McDonald’s and Chick-Fil-A are aggressively traded because in addition to the strength of their guarantees, they maintain a business model that affords a fairly low rent per square foot. This allows an investor to replace the cash flow stream if the property were ever to become vacant.
Although full service restaurants operate under a variety of business models with various preferred demographics, the average cap rate for some of the biggest and best performing brands landed around the same range (See graph below for details). Carrabba’s (Bloomin’ Brands) and Red Lobster (Darden) held the highest price points in 2016 sales, while IHOP maintained some of the highest paid rents across the sector. The larger footprint of these buildings yields a higher rent, which is why the price point on full service restaurant net-leased deals is typically double the price point on QSR properties. Over the past year, most of these transactions were all cash deals because despite the low interest rate market, financing often times created negative leverage.
Demand remains strong in the restaurant net-leased sector and although the average rent per square foot has crept upward over the past 12 months, new long-term leases being signed are being closely critiqued by tenants to ensure they do not spread themselves too thin in the event of another downturn. Values remain the highest they have ever been, while cap rates remain more compressed than in the last market peak. Both buyers and sellers should remain bullish in the current market as prices in this market are still extremely aggressive compared to the historical 10-year average and the net-leased opportunities on the market offer a long-term passive cash flow stream often with a hedge against inflation via regular rental increases.
Whether or not you plan on transacting in 2017, I am always available a specialized restaurant net-leased expert and resource for market information. It is my mission to ensure you have the tools necessary to proactively plan your long-term investment strategy. For more detailed research specific to your property or market, give me a call directly to discuss how I can help.