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.

Hurricanes Irma and Harvey: How Natural Disasters Can Impact the Market

Hurricanes Irma and Harvey: How Natural Disasters Can Impact the Market

I remember a few years ago, taking a phone call in front of our large conference room window. I was looking out at the downtown skyline of Tampa Bay, discussing deal points with a client on other end of the phone. Most of the office had cleared out to prepare for a brewing hurricane. The skies were blue and the sun was beaming, but grocery store parking lots were gridlocked as swarms of people flooded the aisles in search of water and canned goods. There was no indication that the storm would even continue heading our direction, but everyone was up in arms about being prepared for the worst. It turns out the Category 3 storm that was headed straight for us took a last minute detour and we maintained blue skies for the bulk of its passing.

Preparation, or non-preparation, becomes a double edged sword. Nine times out of ten, you will over prepare for a storm that never happens, but that one time you decide to overlook your preparations is when you will be hit the hardest. This year, hurricane season has been in full force. First it was Hurricane Harvey, which slammed coastal Texas with devastating power. Homes and businesses were flooded and cars were swept off the roads. The category 4 storm had 130 mph winds that ripped through the Texas coast overnight. At the end of it all there had been as much as 20 inches of rain in some places leaving over 300,000 people without power.

That type of devastation affects not only the residents, but the surrounding businesses, the infrastructure, and the real estate. Darden Restaurants, Inc., the parent company of a number of well known full-service restaurant brands such as Olive Garden, LongHorn Steakhouse, The Capital Grille, Bahama Breeze, and the newly acquired Cheddar’s Scratch Kitchen, reported the storm hurt same store sales and earnings in its fiscal first quarter. Between forced store closures, power outages, and other unfortunate circumstances, their earnings per share took a hit. The Cheddar’s Scratch Kitchen concept was hit particularly hard because of their strong presence in Texas according to Nation’s Restaurant News (NRN).

Hurricane Irma was expected to have a similar impact on Florida markets. With its last minute shift causing a direct hit on the entire state of Florida, there were many Florida markets that were hit hard as a result. The day after all the devastation, our team was out driving the market to help owners assess damages to their properties. Many of the coastal flood zones flooded some houses and businesses. Most of Tampa Bay, however, was able to weather the storm with minimal damage, although many businesses went without power for over a week in addition to having difficulty acquiring supplies to keep their doors open. Some businesses were raking in the sales and taking advantage of being the only restaurants open among some of the densest counties in Florida. One Taco Bell I visited was slammed with guests, but still struggling to save face in the wake of not being able to get the supplies they needed. A guest asking for a spork was met with a manager’s apologetic eyes:

“We don’t have anymore. I might have to go down the street and see if we can get some plastic forks from Publix”

Most of Central Florida, although arguably hit the worst, weathered the storm fairly well. Aside from debris and a few fallen trees paired with a massive loss of power, most structures stayed intact. Many of the restaurants maintaining power served to feed those residents who were going on 5 days without power in their homes.

Other Florida markets, however, were hit harder than they would have wished. South Florida markets on both coasts and everything in between were met with some tough times; properties flooded, power grids out for weeks, infrastructure ruined. Many markets are still working to recover their physical structures, not to mention swallowing the pill of lost sales during the times of closure. Franchisees have been forced to close doors on a number of stores and some have even abandoned specific locations that they deemed too much of a capital expense to get back up and running.

In terms of net-leased investment sales, these factors impacted the market there too. Some properties that were hit the hardest were actually under contract at the time of devastation. Many of the potential buyers in the midst of 1031 exchanges ended up dropping those contracts. We saw an influx of offers shifting from south Florida markets to West and Central Florida inventory we still had available. Investors were looking more critically at hedges against catastrophe than they had previously. In addition, a number of owners had never considered the potential risk of a natural disaster or at least never considered it a risk significant enough to impact their investment. Some owners have had to spend thousands to tens of thousands of dollars on repairs, while others made it out with little or no damage, but now have considered selling due to the increased perception of risk.

These storms have been eye opening for many people in a variety of ways, including the other side of the coin where there are many investors now looking hard at Florida markets trying to identify the opportunities to scoop up some of these properties that may suddenly have value to be added. At this point, most businesses are back up and running in most major markets, and while many are still recovering, everyone is working hard to move forward. Ultimately, though, it is amazing how resilient the market is. For every owner wanting to exit Florida markets for fear of the next natural disaster, there are three buyers looking to buy in the income tax free state.

The show must go on…but now it may just come with a higher price tag for flood insurance.

Starbucks, New Leases, & Termination Options

Starbucks, New Leases, & Termination Options

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

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

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

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

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

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

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

cap rate versus guarantee vs lease term graph

Here is the problem:

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

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

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

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

That’s Net-Lease Investor Gold.

You can find more details on this specific Starbucks Offering Here

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

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

National Net-Leased Report | 2017 Outlook

National Net-Leased Report | 2017 Outlook

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

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

Cap Rate Comparison Across Sectors

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

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

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

Access the Full Report Here

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