Real estate business

Restaurant owners, don’t rush to be in the real estate business – yet

There is an infamous saying that is often attributed to the driving force behind McDonald’s rapid expansion, Ray Croc: “We are not in the restaurant business; we are in the real estate business. I don’t think there is another quote in the real estate industry that is more repeated or more misused, except maybe “If you build it, they will come. After 15 years of working in commercial retail real estate, I regularly hear both sayings.

I too often hear the first quote to justify why restaurateurs insist on owning their own real estate. Convinced that this is the real business they find themselves in and therefore non-negotiable in the site selection process, some restaurateurs will sacrifice the opportunity in the pursuit of ownership. The reality, however, is that the strategy of owning the real estate in which their business operates could not only limit their growth, but stop it altogether – or at least put them at unnecessary risk.

Mcdonalds is in the field of real estate; that cannot be discussed. In its 2018 annual report, McDonald’s explains that the rental of real estate, equipment, furniture and decoration is a primary business operation. Additionally, McDonald’s is both a franchisor and an owner to which franchisees pay rent in addition to franchise fees, service charges (no less than 4% of sales), etc. Typically, the rent that franchisees pay drops to just under 8.5% of total gross sales for each location. It is McDonald’s – the franchisor, not the restaurateur – who owns the property.

The full thought of McDonald’s comes from its former CFO, Harry Sonneborn, who reportedly said, “The only reason we sell 15-cent burgers is because they’re the biggest producer of income, from from which our tenants can pay us our rent. That same 2018 report found that the company owned around 80% of its restaurant buildings and that 85% of restaurants were operated by franchisees.

Owning real estate works for the franchisor who re-leases it to franchisees with huge margins, but it doesn’t offer the same benefits to a franchisee or an independent restaurateur. Here are a few reasons why:

1. Restaurant returns generally exceed real estate returns. If restaurant returns exceed the market capitalization rates of brand-leased real estate and restaurant credit, your equity is underutilized. In a healthy economy, this statement holds true for most restaurants.

2. Limited diversification of investments. No diversification exists in the strategy in which an operator invests massively in an asset whose value is directly linked to the performance of the other assets in the portfolio, in this case, the operation of the restaurant business.

3. The best sites are usually not for sale. As a result, site selection is limited to lower quality locations which has a direct impact on sales and future growth. The locations with the highest traffic and the highest sales potential are rarely available for purchase. Strict adherence to an ownership strategy leads operators to open in inferior locations or to limit openings all together.

For the aforementioned reasons, many concepts are developing, whether they are owners, tenants or tenants of the location. The real way to make money in real estate is in another cliché: location, location, location. Smart concepts put the location of real estate above all other decision points because of its ability to drive sales. Even more decide to sell the property immediately after opening the location. Why would they do such a thing? Redeploy capital in a higher yield area of ​​the business: operations.

For example, let’s say that a restaurateur already owns the real estate on which the company operates. They plan to keep it and use the real estate as a way to retire when they sell the business. For the sake of a simple mathematical example, let’s say they bought real estate and built a building for a total of $ 1 million. At this location, they generate gross sales of around $ 1.2 million per year. If they set their rent at the industry standard of 8.5% of sales, they would have to pay about $ 102,000 a year in rent. Assuming their concept and credit cap rates are 7% (most concepts currently trade more favorably than that) for a 15-year leaseback, they could sell the property for almost $ 1, $ 5 million. This would allow them to liquidate the $ 500,000 of equity created as well as redeploy the additional equity invested when signing a long-term lease at the time of sale. This equity can be used for further expansion, working capital, or profit. It is for this reason that many concepts will make leaseback as a profitable and tax-efficient growth strategy for nationwide expansion.

So if a restaurateur wants to get into real estate investing for the long term, how should he go about it?

Using knowledge of the submarkets that generate superior sales for restaurants. It is these sales that drive up rents for the rental of space for other concepts and create opportunities for development and redevelopment in these submarkets. This allows a restaurant owner the best of both worlds by leveraging their insider knowledge gained in day-to-day operations to generate superior returns in real estate while maintaining higher returns and diversification of their overall portfolio.

So yes, restaurant operations can be a business owner’s ticket to investing in real estate after all. But that requires looking beyond their own pitches to take full advantage of the investment strategy.


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