In the real estate industry, properties that have Quick Service Restaurants (QSR) as tenants are commonly referred to as “coupon clippers.” These QSRs have NNN leases that require the tenant to pay for all taxes, insurance and necessary property maintenance. Essentially, the only job a landlord has after they acquire these properties is to watch the rent get wired into their checking account each month, or “clip the coupon.” Once acquired, these investments are quite simple to own. In contrast, the due diligence that is necessary before acquisition is not quite as simple.
During the downturn, property owners have been inquiring about what to do when either a tenant is looking for a rent reduction or a tenant has gone or is going out of business. As much as we have helped investors in these situations, what is more important are the preventative measures that can be taken when acquiring QSRs. By following the acquisition guidelines listed below, investors can protect themselves even in the worst situations.
Credit of the Tenant
The first item to consider when purchasing a QSR is the credit of the tenant. The guarantee can range anywhere from a publicly traded company to a sole proprietor. If it is a corporate guarantee, what is the firm's financial health? If it is a franchisee, have you analyzed its audited financials? At the height of the market, we saw many situations in which investors were paying similar cap rates on QSRs regardless of the strength of the tenant. The main objective is to acquire a property that has a tenant strong enough to continue to pay rent even if they close down your particular unit. If you are unsure of the credit of the tenant, do not buy the property.
Restaurant Sales
When looking at a QSR, it is a must to know the average sales of the concept. Second, you need to know the sales of the particular unit. For instance, an average McDonalds does $2.3 million in annual sales per unit, while an average Subway only does $445,000. Therefore, a McDonalds location that does $1 million in sales is a dog, while a Subway with sales of $1 million is a gem! If you can't gain access to sales data, you should pass and find another property.
Sales-to-Rent Ratio
Sales-to-Rent Ratio is computed by dividing annual rent by annual sales. This number should be below 10 percent. On a store that does $1 million in gross annual sales, the rent should not be more than $100,000 per year. When this number is more than 10 percent, it puts too much strain on the tenant’s bottom line and can force them to close their location or renegotiate the rent at your expense. If you are looking to acquire a QSR and this number is more than 10 percent, either attempt to negotiate a lower rent before acquisition or pass on the property.
Coming Tuesday: Part Two of Mitigating Quick-Service Restaurant Risk
— Geoff Faulkner is part of the commercial investment group in the Redwood City, Calif., office of Colliers International.