Why Invest in Restaurant Net-Leased Assets

Why Invest in Restaurant Net-Leased Assets

There are plenty of investment options to choose from in the single-tenant net-leased sector and they all come with their own pros and cons. Drug Stores tend to be on high traffic hard corners backed by solid credit, but house a large box with a cash flow stream to match that may be difficult to replace if it ever became vacant. Dollar Stores come with great credit, but often times in tertiary markets. The auto sector can provide higher returns and high rents for specialty buildings, but can also be on odd shaped parcels with their own potential environmental concerns, while banks can provide the same high rents for a specialty building backed by excellent credit, but tout the same replace-ability issue if they ever became vacant.

So Why Invest in Restaurant Net-Leased Assets?

The variety of price points paired with long-term leases, rental increases, and well-known popular brand name concepts make the restaurant sector especially attractive to investors. Many 1031 exchange buyers look to the sector for a passive place to park their money because many of the factors just named provide a certain sense of security and perceived safety in an investment world riddled with risk. A few years ago the market was labeled one of the biggest peak markets we have seen in the past 10 years, which rang true. Since 2015, cap rates for restaurant net-leased properties have continued to compress, further than most other net-leased sectors, stabilizing on average somewhere between 50-65 basis points lower than other similar net-leased assets. Because of the high demand and increased equity in these types of investments, corporations and franchisees operating business on these parcels of real estate have been actively taking advantage of the market by accessing the built up equity under their operations through sale-leasebacks and using the proceeds to grow into more units, remodel existing units, and pay down debt among other things. In an environment where investment supply is limited, the additional deal inventory is driving transactional velocity even further for the many selling investors who then become 1031 exchange buyers.

Investors also choose to place their money in the restaurant sector because it has been perceived to be somewhat recession proof. “Recession-proof” is stated with a grain of salt as the more high-end casual dining segment may take a hit when the economy is down and consumers have less money in discretionary spending, but ultimately people need to eat. While some casual dining concepts are recently struggling, due to changing consumer preferences, they are working to increase their sales by changing up business models, implementing new technologies, and utilizing delivery and online ordering services. The overall sentiment in the marketplace is that “most of them will figure it out”. The casual dining segment provides some benefits over the QSR segment in that the price points tend to be higher since the footprints are larger and rent per square foot remains fairly the same. However, the segment provides risk in that lower discretionary spending could hurt a higher end casual concept during a downturn. That is why many investors look to the quick service restaurant segment as a hedge against the inherent risk of recession. Many QSR concepts have a focus on a cheap and fast food offering that can feed an entire family for a very reasonable price. Even concepts with middle of the road average ticket prices ebb and flow through the ups and downs of the market. In addition, the industry as a whole provides jobs at fairly cheap labor, which remain a necessity in a downed economy.

Then there are the core aspects of real estate to consider. Most restaurant sites provide the benefit of adhering to many of the core retail necessities when it comes to desirable core real estate. Restaurants tend to be located on hard corners with frontage on high traffic corridors. They tend to have strong parking ratios in high density metro markets on parcels with great ingress/egress. Restaurants simply tend to be on good core real estate sites. If the restaurant were ever to leave, these aspects of the remaining real estate could provide you with more options to redevelop the property than a small specialty building such as a quick lube oil change facility might provide.

There is also the tenant base and the market for restaurants in general. Although investment supply in general is lacking compared to the large pool of buyers out there, compared to other sectors, restaurant inventory is in plenty supply and has transactional velocity over most other triple net property segments. Restaurants tend to be a high demand asset sector, which bodes well for owners when it comes time to exit or exchange their investment. Why is the restaurant sector in such high demand? Well when it comes to restaurants, you have a plethora of well established strong credit tenants. You also have two sub-segments of QSR and Casual Dining, which together provide a very wide range of price points, business models, and rent structures. An investor choosing an investment in the restaurant segment is like throwing a kid into a candy store full of different gum ball machines and saying,

“Which type of gum ball would you like to receive every month?”

You can also find a wide range of risk and return. You have corporate credit grade investments that could trade for as low as 3% or 4% cap rates, while also having the upside of taking on smaller operators or franchisees with similar lease terms but at double the returns or higher. With these smaller operators and franchisees comes the opportunity for even an unsophisticated landlord to structure a blend and extend for added value. Smaller operators have the flexibility to get creative in their holdings, operations, and business growth opposed to some of the larger corporate structures that stick by strict policies and standards. There are numerous reasons to invest in the restaurant sector and any investor building a diversified portfolio of net-leased investments would be wise to include a healthy number of restaurant assets into their mix.

The downsides? The downsides include all the many risks associated with any real estate investment. Each tenant, lease, property, and market has its own inherent risks, challenges, and pressure points to watch out for. I would encourage you to use the information you gather here to your advantage, but also seek advice from your trusted real estate advisor to ensure you understand the intricacies of each deal, how they might affect your investment decisions, and to gain a comprehensive understanding of all your options when it comes to your long-term investment strategy.

If you have any specific questions regarding an asset, a concept, or your current investment situation, feel free to reach out to me directly at 813-387-4796 as I welcome the opportunity to help you in any way that makes sense for you.

 

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.

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.

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.

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.

Restaurant Sector More Bullish Than Others

Restaurant Sector More Bullish Than Others

A brand-new Taco Bell just sold for a 5.5% cap rate in Fleming Island, Florida! If you know where cap rates have been trading across product types in the net-leased sector, this may not appear to be too surprising. Cap rates have compressed in the net-leased sector as far as 120 basis points from where they were at the last market peak, but this go around, the restaurant sector has compressed even further than other net-leased product types. That means that values today are some of the highest we have ever seen, especially in the restaurant sector.

As a frame of reference, 2007 saw one of the hottest historical markets ever; values peaked and buyers were bullish. In that market, brand new 15-year to 20-year Taco Bell leases were trading at 7% cap rates. These long-term Taco Bell deals were typically backed by 50+ unit operators. The Taco Bell in Fleming Island that just sold was a new 20-year lease backed by a 19-unit guarantee and traded for at a 5.5% cap rate. That is a 150-basis point spread from the last market cycle and it’s not an exception.

dunkin representative photo

Just last month, we sold a brand-new Dunkin Donuts with a shorter-term lease and a smaller guarantee at a 5% cap rate. The deal was a brand-new 10-year Dunkin Donuts lease backed by a 13-unit guarantee in St. Petersburg, Florida. Within only a few weeks of bringing it to market at a 5% cap rate, we had sourced multiple offers. The competition created ultimately resulted in a 36-day closing at full list price. Only 12 months ago, 10-year Dunkin Donuts deals were trading at an average cap rate of 6%. For further perspective, in 2006, the average cap rate for a comparable Dunkin Donuts was 7%.

We are seeing restaurant properties trade 25-50 basis points lower on a cap rate basis than most other net-leased sectors right now.

Restaurants are hot!

Even when faced with the potential risk of shifting consumer trends and the sales slumps of the casual dining sector, buyers understand that restaurants serving the general population are not going anywhere. Similar to how multi-tenant shopping centers are attracting more service based tenants to compete with online sales competition, restaurant brands are evolving to cater to these changing consumer trends and when the dust settles, people will still need to eat.

Because of the aggressive restaurant cap rates versus other sectors, owners in the restaurant sector have been weighing their options and crafting a strategy for how to take advantage of these recent trends. For our clients, the biggest concern is where to put the money and ensure a successful exchange. The initial thought is that you are trading into the same market and so the opportunity is perceived to be a wash, however, we have had success in moving our clients from the restaurant sector to other net-leased sectors where cap rates, although compressed, are not as bullish.

Often times, there are opportunities across other sectors such as drug stores and auto-related investments that can not only replace or improve our client’s current cash flow position, but also improve their real estate investment in general; better guarantee, longer lease term, or upgrading their core real estate to larger parcels or hard corners.

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, especially across other sectors.

Whether or not you plan on transacting in 2017, I am always available as 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.

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.