The COVID-19 pandemic has changed how consumers live, work and dine out. Due to the virus, Americans have flocked to fast-food drive-throughs for inexpensive menu options with little contact.
Net lease investors have taken notice and demand for quick-service restaurants (QSR) is as high as for McDonald’s Big Macs or Popeyes’ chicken sandwiches.
As COVID-19 cases continue to spike nationally, some states have imposed new coronavirus-related restrictions, including limiting restaurant capacity or closing in-door dining altogether. This has accelerated the demand for QSRs, which are flourishing during the health crisis, due largely to drive-throughs.
“This sector is very popular right now,” says Camille Renshaw, CEO and co-founder of net lease-focused investment brokerage firm B+E. “We experienced in March and April that the music sort of stopped and investors wondered what was coming next. What all of this really meant. They wondered what tenants would come back and ask for additional rents or TI or something that they weren’t anticipating, so a lot of investors froze, just to reserve dry powder for problems.”
However, as soon as investors figured out which QSR players were going to succeed during the pandemic, they started investing heavily again in the sector. “In particular, they have a love for drive-throughs,” Renshaw notes.
For many fast-food chains, their drive-throughs accounted for as much as 70 percent of their revenue pre-pandemic. Many chains were already beefing up their drive-through infrastructures, but those plans have been expedited.
Post-pandemic, the sector is waiting to see where the drive-through sales numbers settle, she adds. Renshaw expects a continued boom in this part of the business, since “we all feel safer in the drive-through.”
Demand for QSRs continues to be quite strong, especially for assets with drive-throughs, agrees Lanie Beck, director of corporate research at Stan Johnson Co., which specializes in net lease investments.
“Virtually, all concepts had to react quickly to a shifting environment back in March, which resulted in most QSRs closing their dining rooms completely, and instead, focusing on drive-through and carry-out volume,” Beck says. “Fast-forward a few months, and many brands, including Taco Bell, KFC and Burger King, are exploring new store concepts with double and triple drive-through lanes.”
These additional lanes are dedicated for mobile pick-ups, a trend that has accelerated due to the health crisis. Experts say drive-through and mobile ordering are here to stay post-pandemic.
“Other restaurants, like Shake Shack, that historically have been dine-in and carry out-only plan to incorporate drive-throughs into future builds,” Beck notes. “As these brands build new restaurants in 2021 and beyond, investors will have outstanding opportunities to acquire the latest concepts with long-term leases in place.”
Investor demand is high
Investors’ interest in net lease assets has held up throughout the pandemic, says Randy Blankstein, president of The Boulder Group, a real estate investment firm specializing in single-tenant net lease properties.
“Drive-throughs have allowed many operators to help offset the loss of in-store dining,” Blankstein says. “Brands like KFC saw their drive-through sales in the U.S. increase by 60 percent in the third quarter of 2020 when compared to the prior year.”
While the QSR space has fared relatively well through the pandemic period, net lease investors turned their focus to the stronger credits in that space and longer-term leases, he adds. That was especially true for 1031 exchange transactions and private buyers, who have made up more than 80 percent of the market for QSRs year-to-date in 2020.
There will likely continue to be a bifurcation between properties operated by corporate/large franchisees and smaller franchisees as a flight to quality continues in the sector, according to Boulder’s Second Quarter 2020 QSR Net Lease Report. Institutional investors will remain primarily interested in sale-leaseback portfolios in order to achieve economies of scale.
Where are cap rates?
For the strongest credit tenants, it’s not uncommon to see individual properties transact at sub-4 percent cap rates, according to Stan Johnson Co. Research. (The company’s methodology includes single-tenant sale transactions for a rolling 12-month period and properties with 10-plus years of lease term remaining).
“We have six concepts, including Chick-fil-A, Starbucks and McDonald’s that have traded in the last 12 months with individual cap rates in the 3-percent range,” Beck says.
Last year at this time, five restaurant concepts had traded in the 3-percent range, so not that much has changed, she notes.
Stan Johnson has seen average cap rates for some tenants stay very flat year-over-year. For example, Hardee’s and Bojangles both have seen their rolling 12-month average cap rates hold steady at about 6 percent in the last year.
Cap rates on Popeyes restaurants have also stayed flat at about 5.9 percent, with Taco Bell at 5.4 percent, and Starbucks holding at around 4.8 percent, according to the firm’s data. Average cap rates for Dairy Queen-occupied properties have risen from 5.8 percent to 6.2 percent.
Average cap rates have also compressed across a few brands, including McDonald’s (from 4.5 percent to 4.0 percent), Chick-fil-A (4.3 percent to 4.0 percent), and Wendy’s (5.6 percent to 5.3 percent).
“The quick-serve retail industry as a whole has weathered any type of economic or other external event,” says Christopher Maling, principal of retail capital markets for real estate services firm Avison Young.
“When the economy is going great, QSRs just chug along and do fine. When the economy goes south, you have QSRs that actually accelerate and see a spike in sales. Why’s that? Look at the price point of your average cover. At KFC, for example, you can feed a family of four for $20. It’s about survival.”
Additionally, during the pandemic, QSRs have realized there isn’t a desire to dine in (or it’s not even allowed in certain states or counties). So they no longer need a full-time staff to wide down tables, mop floors and clean the restrooms every 30 minutes, according to Maling. “That saves salary expense and a lot of overhead for the operator, and it all goes to the bottom line. If you have a drive-through that’s constantly busy with eight cars, and you’ve got your Postmates orders and people picking up using the mobile app,” business is strong without the dine-in capacity.
In fact, Yum! Brands, which owns Taco Bell, KFC, The Habit Burger Grill and Pizza Hut, is one large QSR operator reevaluating its restaurant footprints, according to Maling. “They’re asking, ‘Hey, do we need this footprint anymore? Do we need interior dining? This petri dish playhouse for the kids? It’s like no!’”
Maling expects QSRs to continue to roll out new prototypes over the next five years. For some, that could mean eliminating all inside dining. Starbucks, Burger King and Del Taco are either planning or building seat-less restaurants and other fast-food chains could follow. The sector will likely see more drive through-only and teller walk-ups for consumers who order via a mobile app. And that strategy could accomplishe something else for real estate investors.
“Because the footprint has been reduced, they’re able to get into infill locations where they had barriers to entry and were supply-constrained,” Maling says. “They didn’t have the acreage for their standard footprint. Now we’re going to see them pop up on a 12,000-sq.-ft. parcel at the killer corner.”
While many of these trends were already in the works, the health crisis has accelerated them. Taco Bell, for example, has a new Taco Bell Go Mobile app and “you can custom order your taco 4,000 ways,” Renshaw says, adding that many of their locations’ drive-throughs are already open 24/7 for added convenience. Taco Bell’s first Go Mobile restaurant is slated to open in first quarter 2021, featuring new digital adoption to improve the customer experience.
“We’re speeding up trends that already existed within the fast-food space, and it feels like the future is really safe for investors,” Renshaw notes.
Maling agrees. “In my opinion, quick-serve retail is the number one investment class for single-tenant properties,” he says. “It will trump drugstores, grocery stores, automotive and others. Plus, your price point is between $750,000 and $3.5 million.”