Appetite for Restaurants Stays Healthy, Despite Volatility

Notwithstanding some hiccups, like declining revenue in the fast-food sector, the market for net-leased eateries has never been stronger, Matthew Berres and Scott Bailey of JLL explain.
Matthew Berres of JLL
Matthew Berres of JLL

The restaurant business has always been fickle. Capital-intensive, heavily leveraged, and highly sensitive to ever-changing consumer desires, restaurants often find themselves straddling the line between profitability and vulnerability. Over the past 24 months in particular, the restaurant industry has seen its fair share of headlines ranging from bankruptcy announcements to store opening announcements. For every Chick-fil-A and Raising Cane’s revealing a new wave of locations, there seems to be a Logan’s Roadhouse and Old Country Buffet announcing a bankruptcy or the shuttering of locations by the dozen. For the net lease investment market, however, the news seems to have fallen on deaf ears as cap rates have continued to compress in the face of rising volatility.  

It’s no secret that people go out to eat. Over 90 percent of Americans ate out in last six months, according to ESRI. In fact, according to Ibisworld, the chain restaurant industry’s revenue has grown from $87.5 billion in 2010 to a projected $112 billion in 2017. Yet, despite growing industry revenues, comparable stores sales for fast casual, family dining and casual dining have reported negative sales for the past five quarters, according to TDn2K, a restaurant data provider that aggregates data based on a sample of 41,000 restaurants across 155 brands. Even fast food, which has been considered the darling of the restaurant industry, has been experiencing headwinds since the beginning of 2017. Only fine dining and upscale casual have demonstrated positive comparable sales trends in recent quarters.

For net lease investors, though, the outlook is much more encouraging. The average cap rate for single tenant restaurant assets bought in 2010 was approximately 7.75 percent. By comparison, the average cap rate for assets falling under the same criteria has been approximately 5.75 percent so far in 2017. So, if there’s such mixed feelings about the restaurant industry, why are net lease investors paying up for restaurants?

For one, credit is king. Companies like Starbucks and McDonald’s, for example, have phenomenal credit profiles and guarantee leases with the parent or holding company’s investment grade balance sheet. Despite concerns over the longevity of restaurants in general, corporately guaranteed leases appeal to investors looking for stability and safety. Secondly, downside protection. While every restaurant has their own prototype, many buildings can be backfilled relatively easily and inexpensively compared to other assets due to their easily adapted layouts and locations in retail trade areas.

Lastly, the 1031 exchange buyer is undoubtedly driving this investment market. Of the 400 sales comps evaluated for the above analysis, nearly half were purchased by an individual in a 1031 exchange, according to CoStar. These tax-motivated investors generally seek well-located assets with long-term (10 or more years) leases and contractual rental increases. Restaurants, more often than not, fit the bill and give the added comfort of familiarity—that is, most people can easily compare one concept against another without having to be an expert.

Despite hiccups in the restaurant industry, the market for net leased restaurants has never been stronger. As the supply of 1031 exchange dollars remains strong, expect restaurant cap rates to remain competitive, despite overall fluctuations and volatility in the industry itself.

This column first appeared in the CPE Capital Markets newsletter. Not receiving it yet? Subscribe today!