Freeway Insurance - A perfect Guide For restaurant Real Estate Investments
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Restaurants are a popular market asset for many investors because:
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Tenants often sign a very long term, e.g. 20 years absolute triple net (Nnn) leases. This means, also the rent, tenants also pay for asset taxes, insurance and all maintenance expenses. The only thing the investor has to pay is the mortgage, which in turn offers very predictable cash flow. There are either no or few landlord responsibilities because the tenant is responsible for maintenance. This allows the investor more time to do prominent thing in life, e.g. Retire. All you do is take the rent check to the bank. This is one of the key benefits in investing in a bistro or single-tenant property.
Whether rich or poor, people need to eat. Americans are eating out more often as they are too busy to cook and cleanup the pots & pans afterwards which often is the worst part! agreeing to the National bistro Association, the nation's bistro manufactures currently involves 937,000 restaurants and is foreseen, to reach 7 billion in sales in 2007, compared to just 2 billion in 1997 and 0 billion in 1987 (in current dollars). In 2006, for every dollar Americans spend on foods, 48 cents were spent in restaurants. As long as there is civilization on earth, there will be restaurants and the investor will feel comfortable that the asset is all the time in high demand.
You know your tenants will take very good care of your asset because it's in their best interest to do so. Few customers, if any, want to go to a bistro that has a filthy bathroom and/or trash in the parking lot.
However, restaurants are not created equal, from an venture viewpoint.
Franchised versus Independent
One often hears that 9 out of 10 new restaurants will fail in the first year; however, this is just an urban myth as there are no conclusive studies on this. There is only a study by connect Professor of Hospitality, Dr. H.G. Parsa of Ohio State University who tracked new restaurants placed in the city Columbus, Ohio during the duration from 1996 to 1999 (Note: you should not draw the conclusion that the results are the same anywhere else in the Us or during any other time periods.) Dr. Parsa observed that seafood restaurants were the safest ventures and that Mexican restaurants palpate the top rate of failure in Columbus, Oh. His study also found 26% of new restaurants ended in the first year in Columbus, Oh during 1996 to 1999. also economic failure, the reasons for restaurants conclusion contain divorce, poor health, and unwillingness to commit weighty time toward performance of the business. Based on this study, it may be safe to predict that the longer the bistro has been in business, the more likely it will be operating the following year so that the landlord will continue to receive the rent.
For franchised restaurants, a franchisee has to have a positive minimal amount of non-borrowed cash/capital, e.g. 0,000 for McDonald's, to qualify. The franchisee has to pay a one-time franchisee fee about ,000 to ,000. In addition, the franchisee has conduce royalty and advertising fees equal to about 4% and 3% of sales revenue, respectively. In turn, the franchisee receives training on how to set up and control a proven and victorious business without worrying about the marketing part. As a result, a franchised bistro gets customers as soon as the open sign is put up. Should the franchisee fail to run the business at the location, the franchise may replace the current franchisee with a new one. The king of franchised hamburger restaurants is the fast-food chain McDonald's with over 32000 locations in 118 countries (about 14,000 in the Us) as of 2010. It has .2B in sales in 2011 with an midpoint of .4M in wage per Us location. McDonald's currently captures over 50% market share of the billion Us hamburger bistro market. Its sales are up 26% in the last 5 years. Distant behind is Wendy's (average sales of .5M) with .5B in sales and 5904 stores. Burger King ranks third (average sales of .2M) with .4B in sale, 7264 market and 13% of the hamburger bistro market share (among all bistro chains, Subway is ranked amount two with .4B in sales, 23,850 stores, and Starbucks amount 3 with .8B in sales and 11,158 stores). McDonald's success apparently is not the supervene of how yummy its Big Mac tastes but something else more complex. Per a survey of 28,000 online subscribers of buyer record magazine, McDonald's hamburgers rank last among 18 national and regional fast food chains. It received a score of 5.6 on a scale of 1 to 10 with 10 being the best, behind Jack In the Box (6.3), Burger King (6.3), Wendy's (6.6), Sonic Drive In (6.6), Carl's Jr (6.9), Back Yard Burgers (7.6), Five Guys Burgers (7.9), and In-N-Out Burgers (7.9).
Fast-food chains tend to detect new trends faster. For example, they are open as early as 5Am as Americans are increasingly buying their breakfasts earlier. They are also selling more cafe; latte; fruit smoothies to compete with Starbucks and Jumba Juice. You also see more salads on the menu. This gives customers more reasons to stop by at fast-food restaurants and make them more spirited to separate customers.
With independent restaurants, it often takes a while to for customers to come nearby and try the food. These establishments are especially tough in the first 12 months of opening, especially with owners of minimal or no proven track record. So in general, "mom and pop" restaurants are risky venture due to introductory weak revenue. If you choose to spend in a non-brand name restaurant, make sure the return is proportional to the risks that you will be taking.
Sometimes it is not easy for you to tell if a bistro is a brand name or non-brand name. Some bistro chains only operate, or are popular in a positive region. For example, WhatAburger bistro chain with over 700 locations in 10 states is a very popular fast-food bistro chain in Texas and Georgia. However, it is still unknown on the West Coast as of 2012. Brand name chains tend to have a website listing all the locations plus other information. So if you can find a bistro website from Google or Yahoo you can fast behold if an unfamiliar name is a brand name or not. You can also derive basic buyer information about roughly any chain restaurants in the Us on Wikipedia.
The Ten Fastest-Growing Chains in 2011 with Sales Over 0 Million
According to Technomic, the following is the 10 fastest growing bistro chains in terms of wage turn from 2010 to 2011:
Five Guys Burgers and Fries with 1M in sales and 32.8% change.
Chipotle Mexican Grill with .261B in sales and 23.4% change.
Jimmy John's gourmand Sandwich Shop with 5M in sales and 21.8% change.
Yard House with 2M in sales and 21.5% change.
Firehouse Subs with 5M in sales and 21.1% change.
Bj's bistro & Brewhouse with 1M in sales and 20.9% change.
Buffalo Wild Wings Grill & Bar with .045B in sales and 20.1% change.
Raising Cane's Chicken Fingers with 6M in sales and 18.2% change.
Noodles & business with 0M in sales and 14.9% turn from.
Wingstop with 2M in sales and 22.1% change.
Lease & Rent Guaranty
The tenants often sign a long term absolute triple net (Nnn) lease. This means, also the base rent, they also pay for all operating expenses: asset taxes, insurance and maintenance expenses. For investors, the risk of maintenance expenses uncertainty is eliminated and their cash flow is predictable. The tenants may also certify the rent with their own or corporate assets. Therefore, in case they have to close down the business, they will continue paying rent for the life of the lease. Below are a few things that you need to know about the lease guaranty:
In general, the stronger the guaranty the lower the return of your investment. The guaranty by McDonald's Corporation with a strong "A" S&P corporate rating of a collective business is much great than a small corporation owned by a franchisee with a few restaurants. Consequently, a bistro with a McDonald's corporate lease ordinarily offers low 4.5-5% cap (return of venture in the 1st year of ownership) while McDonald's with a franchisee guaranty (over 75% of McDonalds restaurants are owned by franchisees) may offer 5-6% cap. So form out the amount of risks you are willing to take as you won't get both low risks and high returns in an investment.
Sometimes a multi-location franchise will form a parent business to own all the restaurants. Each bistro in turn is owned by a single-entity minuscule Liabilities business (Llc) to shield the parent business from liabilities. So the rent guaranty by the single-entity Llc does not mean much since it does not have much assets.
A good, long guaranty does not make a lemon a good car. Similarly, a strong guaranty does not make a lousy bistro a good investment. It only means the tenant will make every exertion to pay you the rent. So don't judge a asset primarily on the guaranty.
The guaranty is good until the corporation that guarantees it declares bankruptcy. At that time, the corporation reorganizes its operations by conclusion locations with low wage and holding the good locations, (i.e. Ones with strong sales). So it's more significant for you to choose a asset at a good location. If it happens to have a weak guaranty, (e.g. From a small, incommunicable company), you will get duplicate benefits: on time rent payment and high return.
If you happen to spend in a "mom & pop" restaurant, make sure all the principals, e.g. Both mom and pop, certify the lease with their assets. The guaranty should be reviewed by an attorney to make sure you are well protected.
Location, Location, Location
A lousy bistro may do well at a good location while those with a good menu may fail at a bad location. A good location will create strong wage for the operator and is primarily prominent to you as an investor. It should have these characteristics:
High traffic volume: this will draw more customers to the bistro and as a supervene high revenue. So a bistro at the entrance to a regional mall or Disney World, a major shopping mall, or colleges is all the time desirable.
Good visibility & signage: high traffic volume must be accompanied by good visibility from the street. This will minimize advertising expenses and is a constant reminder for diners to come in.
Ease of ingress and egress: a bistro placed on a one-way service road running parallel to a freeway will get a lot of traffic and has great visibility but is not at a great location. It's hard for inherent customers to get back if they miss the entrance. In addition, it's not inherent to make a left turn. On the other hand, the bistro just off freeway exit is more suitable for customers.
Excellent demographics: a bistro should do well in an area with a large, growing people and high incomes as it has more people with money to spend. Its business should create more and more wage to pay for addition higher rents.
Lots of parking spaces: most chained restaurants have their own parking lot to adapt customers at peak hours. If customer cannot find a parking space within a few minutes, there is a good opportunity they will skip it and/or won't come back as often. A typical fast food bistro will need about 10 to 20 parking spaces per 1000 quadrilateral feet of space. Fast food restaurants, e.g. McDonald's will need more parking spaces than sit down restaurants, e.g. Olive Garden.
High sales revenue: the yearly gross wage alone does not tell you much since larger--in term of quadrilateral footage--restaurant tends to have higher revenue. So the rent to wage ratio is a great gauge of success. Please refer to rent to wage ratio in the due diligence section for added discussion.
High barriers to entry: this simply means that it's not easy to replicate this location nearby for assorted reasons: the area simply does not have any more developable land, or the devotee plan does not allow any more building of market properties, or it's more high-priced to build a similar asset due to high cost of land and building materials. For these reasons, the tenant is likely to renew the lease if the business is profitable.
Financing Considerations
In general, the interest rate is a bit higher than midpoint for restaurants due to the fact that they are single-tenant properties. To the lenders, there is a perceived risk because if the bistro is ended down, you could potentially lose 100% of your wage from that restaurant. Lenders also prefer national brand name restaurants. In addition, some lenders will not loan to out-of-state investors especially if the restaurants are placed in smaller cities. So it may be a good idea for you to spend in a franchised bistro in major metro areas, e.g. Atlanta, Dallas. In 2009 it's quite a challenge to get financing for sit-down bistro acquisitions, especially for mom and pop and regional restaurants due to the tight prestige market. However, things seem to have improved a bit in 2010. If you want to get the best rate and terms for the loan, you should stick to national franchised restaurants in major metros.
When the cap rate is higher than the interest rate of the loan, e.g. Cap rate is 7.5% while interest rate is 6.5%, then you should consider borrowing as much as possible. You will get 7.5% return on your down payment plus 1% return for the money you borrow. Hence your total return (cash on cash) will be higher than the cap rate. Additionally, since the inflation in the near hereafter is foreseen, to be higher due to rising costs of fuel, the money which you borrow to finance your purchase will be worth less. So it's even more beneficial to maximize leverage now.
Due Diligence Investigation
You may want to consider these factors before deciding to go forward with the purchase:
Tenant's financial information: The bistro business is labor intensive. The midpoint worker generates only about ,000 in wage annually. The cost of goods, e.g. Foods and supplies should be nearby 30-35% of revenue; labor and operating expenses 45-50%; rent about 7-12%. So do retell the profits and loss (P&L) statements, if available, with your accountant. In the P&L statement, you may see the acronym Ebitdar. It stands for wage Before wage Taxes, Depreciation (of equipment), Amortization (of capital improvement), and Rent. If you don't see royalty fees in P&L of a franchised bistro or advertising expenses in the P&L of an independent restaurant, you may want to understand the speculate why. Of course, we will want to make sure that the bistro is profitable after paying the rent. Ideally, you would like to see net profits equal to 10-20% of the gross revenue. In the last few years the cheaper has taken a beating. As a result, restaurants have experienced a decrease in gross wage of nearby 3-4%. This seems to have impacted most, if not all, restaurants everywhere. In addition, it may take a new bistro some years to reach inherent wage target. So don't expect new locations to be profitable right away even for chained restaurants.
Tenant's prestige history: if the tenant is a incommunicable corporation, you may be able to derive the tenant's prestige history from Dun & Bradstreet (D&B). D&B provides Paydex score, the business equivalent of Fico, i.e. Personal prestige history score. This score ranges from 1 to 100, with higher scores indicating great payment performance. A Paydex score of 75 is equivalent to Fico score of 700. So if your tenant has a Paydex score of 80, you are likely to receive the rent checks promptly.
Rent to wage ratio: this is the ratio of base rent over the yearly gross sales of the store. It is a quick way to resolve if the bistro is profitable, i.e. The lower the ratio, the great the location. As a rule of thumb you will want to keep this ratio less than 10% which indicates that the location has strong revenue. If the ratio is less than 7%, the operator will very likely make a lot of money after paying the rent. The rent guaranty is probably not prominent in this case. However, the rent to wage ratio is not a correct way to resolve if the tenant is development a profit or not. It does not take into inventory the asset taxes price as part of the rent. asset taxes--computed as a division of assessed value--vary from states to states. For example, in California it's about 1.25% of the assessed value, 3% in Texas, and as high as 10% in Illinois. And so a bistro with rent to wage ratio of 8% could be profitable in one state and yet be losing money in another.
Parking spaces: restaurants tend to need a higher amount of parking spaces because most diners tend to stop by within a small time window. You will need at least 8 parking spaces per 1000 quadrilateral Feet (Sf) of bistro space. Fast food restaurants may need about 15 to 18 spaces per 1000 Sf.
Termination Clause: some of the long term leases give the tenant an option to cease the lease should there be a fire destroying a positive division of the property. Of course, this is not desirable to you if that division is too low, e.g. 10%. So make sure you read the lease. You also want to make sure the insurance policy also covers rental wage loss for 12-24 months in case the asset is damaged by fire or natural disasters.
Price per Sf: you should pay about 0 to 0 per Sf. In California you have to pay a premium, e.g. 00 per Sf for Starbucks restaurants which are ordinarily sold at very high price per Sf. If you pay more than 0 per Sf for the restaurant, make sure you have justification for doing so.
Rent per Sf: ideally you should spend in a asset in which the rent per Sf is low, e.g. to per Sf per month. This gives you room to raise the rent in the future. Besides, the low rent ensures the tenant's business is profitable, so he will be nearby to keep paying the rent. Starbucks tend to pay a selected rent to 4 per Sf monthly since they are often placed at a selected location with lots of traffic and high visibility. If you plan to spend in a bistro in which the tenant pays more than per Sf monthly, make sure you could elucidate your decision because it's hard to make a profit in the bistro business when the tenant is paying higher rent. Some restaurants may have a division clause. This means also the minimum base rent, the operator also pays you a division of his wage when it reaches a positive threshold.
Rent increase: A bistro landlord will ordinarily receive either a 2% yearly rent increase or a 10% increase every 5 years. As an investor you should prefer 2% yearly rent increase because 5 years is a long time to wait for a raise. You will also receive more rent with 2% yearly increase than 10% increase every 5 years. Besides, as the rent increases every year so does the value of your investment. The value of bistro is often based on the rent it generates. If the rent is increased while the market cap remains the same, your venture will appreciate in value. So there is no key benefit for investing in a bistro in a positive area, e.g. California. It's more prominent to choose a bistro at a great location.
Lease term: in normal investors favor long term, e.g. 20 year lease so they don't have to worry about looking new tenants. during a duration with low inflation, e.g. 1% to 2%, this is fine. However, when the inflation is high, e.g. 4%, this means you will technically get less rent if the rent increase is only 2%. So don't rule out properties with a few years left of the lease as there may be strong upside potential. When the lease expires without options, the tenant may have to pay much higher market rent.
Risks versus venture Returns: as an investor, you like properties that offer very high return, e.g. 8% to 9% cap rate. And so you may be attracted to a brand new franchised bistro offered for sale by a developer. In this case, the developer builds the restaurants completely with Furniture, Fixtures and tool (Ffes) for the franchisee based on the franchise specifications. The franchisee signs a 20 years absolute Nnn lease paying very kind rent per Sf, e.g. to per Sf monthly. The new franchisee is willing to do so because he does not need to come up with any cash to open a business. Investors are excited about the high return; however, this may be a very risky investment. The one who is guaranteed to make money is the developer. The franchisee may not be willing to hold on during tough times as he does not have any equity in the property. Should the franchisee's business fails, you may not be able to find a tenant willing to pay such high rent, and you may end up with a vacant restaurant.
Track records of the operator: the bistro being run by an operator with 1 or 2 recently-open restaurants will probably be a riskier investment. On the other hand, an operator with 20 years in the business and 30 locations may be more likely to be nearby next year to pay you the rent.
Trade fixtures: some restaurants are sold with trade fixtures so make sure you document in writing what is included in the sale.
Fast-food versus Sit-down: while fast-food restaurants, e.g. McDonalds do well during the downturn, sit-down family restaurants tend to be more sensitive to the stepping back due to higher prices and high expenses. These restaurants may palpate double-digit drop in year-to-year revenue. As a result, many sit-down restaurants were shut down during the recession. If you consider investing in a sit-down restaurant, you should choose one in an area with high wage and large population.
Sale & Lease Back
Sometimes the bistro operator may sell the real estate part and then lease back the asset for a long time, e.g. 20 years. A typical investor would wonder if the operator is in financial problem so that he has to sell the asset to pay for his debts. It may or may not be the case; however, this is a quick and easy way for the bistro operator to get cash out of the equities for good reason: business expansion. Of course, the operator could refinance the asset with cash out but that may not be the best option because:
He cannot maximize the cash out as lenders often lend only 65% of the asset value in a refinance situation.
The loan will show as long term debt in the balance sheet which is often not viewed in a positive light.
The interest rates may not be as suitable if the bistro operator does not have a strong balance sheet.
He may not be able to find any lenders due to the tight prestige market.
You will often see 2 separate cash out strategies when you look at the rent paid by the bistro operator:
Conservative market rent: the operator wants to make sure he pays a low rent so his bistro business has a good opportunity of being profitable. He also offers conservative cap rate to investors, e.g. 7% cap. As a result, his cash out amount is small to moderate. This may be a low risk venture for an investor because the tenant is more likely to be able to afford the rent.
Significantly higher than market rent: the operator wants to maximize his cash out by pricing the asset much higher than its market value, e.g. M for a M property. Investors are sometimes offered high cap rate, e.g. 10%. The operator may pay of rent per quadrilateral foot in an area where the rent for comparable properties is per quadrilateral foot. As a result, the bistro business at this location may suffer a loss due to higher rents. However, the operator gets as much money as possible. This asset could be very risky for you. If the tenant's business does not make it and he declares bankruptcy, you will have to offer lower rent to an additional one tenant to lease your building.
Ground Lease
Occasionally you see a bistro on ground lease for sale. The term ground lease may be confusing as it could mean
You buy the building and lease the land owned by an additional one investor on a long-term, e.g. 50 years, ground lease.
You buy the land in which the tenant owns the building. This is the most likely scenario. The tenant builds the bistro with its own money and then typically signs a 20 years Nnn lease to lease the lot. If the tenant does not renew the lease then the building is reverted to the landowner. The cap rate is often 1% lower, e.g. 6 to 7.25 percent, compared to restaurants in which you buy both land and building.
Since the tenant has to spend a immense amount of money (whether its own or borrowed funds) for the building of the building, it has to be duplicate sure that this is the right location for its business. In addition, should the tenant fail to make the rent payment or fail to renew the lease, the building with immense value will revert to you as the landowner. So the tenant will lose a lot more, both business and building, if it does not fulfill its obligation. And thus it thinks twice about not sending in the rent checks. In that sense, this is a bit safer venture than a bistro which you own both the land and improvements. also the lower cap rate, the major drawbacks for ground lease are
There are no tax write-offs as the Irs does not allow you to depreciate its land value. So your tax liabilities are higher. The tenants, on the other hand, can depreciate 100% the value of the buildings and equipments to offset the profits from the business.
If the asset is damaged by fire or natural disasters, e.g. Tornados, some leases may allow the tenants to derive insurance proceeds and cease the lease without rebuilding the properties in the last few years of the lease. Unfortunately, this author is not aware of any insurance associates that would sell fire insurance to you since you don't own the building. So the risk is immense as you may end up owning a very high-priced vacant lot with no wage and a huge asset taxes bill.
Some of the leases allow the tenants not having to make any structure, e.g. Roof, repairs in the last few years of the lease. This may wish investors to spend money on deferred maintenance expenses and thus will have negative impact on the cash flow of the property.
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