How many times have you had a conversation about 1031 Exchange on a commercial property, and someone says “Let’s think Chain Restaurants as an option”?
Not too often, unfortunately.
Restaurants, gas stations, and convenience stores (even motels fall into a “mixed-asset” 1031 exchange) are the usual preferences for a 1031 Exchange.
This leaves very few people competing for properties that would be interesting for fast food restaurants. And this is why we’ve decided to focus on explaining how fast food real estate makes for a good 1031 investment opportunity.
A Brief History Of 1031 Exchange
The 1031 Exchange was included in the IRS code back in 1921. Section 1031 of the Internal Revenue Code states that, if a taxpayer sells a property (such as a restaurant property), and then gets another “like-kind” replacement property, then taxation on the profits of the sale can be deferred.
The properties, under these conditions, are exchanged, and the owner does not get any cash in the transaction. In simple terms: no cash, means no tax.
So how does a 1031 Exchange work with properties?
The tax on the return of the relinquished property (the first real estate asset) is deferred to a date when the like-kind replacement property is sold without a further exchange.
Learning from McDonald’s Own Real Estate Strategy
McDonald’s owns their restaurants, so we can’t speak of them in terms of actual investment opportunities. But, we can still learn a lesson about investment in restaurant locations.
Have you ever considered that McDonald’s does not really make that much money from selling burgers? Yes, that’s true.
Many people are not aware that McDonald’s does not only represent a fast food chain. If you look deeper, you will realize that, beneath the burger-flipping facade, lies an impressive real estate company.
A former Chief Financial Officer of McDonald’s stated: “We are not technically in the food business, but rather in the real estate business.” He explained that the reason behind selling cheap hamburgers is that they are the best producers of income and an opportunity for tenants to pay rent!
What you won’t find floating on the internet as a somewhat-obvious information, is that foot traffic increases the value of the property. So by creating a business model that gets people passing through the property, McDonald’s has found the perfect property appreciation mechanism. And it’s been using this model for decades!
McDonald’s purchases the properties and leases them out to tenants at high markups. Despite receiving rental income, the corporate entity also takes a percentage of each shop’s gross sales.
So, how does McDonald’s make its money in real estate?
Basically, it uses three steps:
1. Its subordinate company finds attractive commercial property deals,
2. Locations appreciate thanks to steady traffic and cash-flow,
3. It collects rents from the franchise locations.
As an investor in a restaurant property, you will want to focus on finding a property that is a diamond in the rough. A place that is in a location that should soon see expansion, so you get both the NNN cashflow AND property appreciation.
Once the property appreciates in value, you use a 1031 Exchange to scale up from that location into another, larger one, which will create more cashflow.
Fast Food Properties As Solid 1031 Opportunities
Now that we have learned from the fast food giant, McDonald’s, let’s consider how we can use a property-appreciation investment strategy that involves fast food restaurant properties.
Just like any other business, fast food franchises also face risk. The restaurant business is tough, and they may be forced to terminate the lease agreement. But despite stiff competition restaurants in prime or booming locations keep on growing. This is why it is crucial to step into a deal with caution, and most importantly, with experienced, expert guidance.
Simply because a location looks interesting on paper, doesn’t mean that its future is just as nice. Demographic shifts, urban planning, expansions, companies moving out of the area… all these changes can turn a prime location into a money sinkhole.
And it works the other way around. If a property looks terrible on paper in terms of cashflow, it doesn’t mean that it’s a bad investment. New zoning rules, new planned construction sites etc. can directly affect and even create a blooming future for such a place. And you’ll want to find these places before everybody else sniffs them up.
You should definitely consider purchasing and owning restaurant property through the 1031 setup. Let’s keep learning about this.
Let’s review what we’ve learned so far:
1. First, a fast food restaurant property can make for solid commercial property investment. A good location can deliver in the areas of tenant-reliability and tenant prospecting.
2. Second, fast food restaurant properties can be used in a 1031 exchange. So, if you are looking to make an exchange, a possible property might be as close as your nearest drive-through.
3. Finally, 1031 allows you to defer taxes on “gains” if those gains are properly folded into a new-to-you property (like an existing fast food property).
As a side note, there are multiple chains which can make a good 1031 investment opportunity. Consider KFC, Burger King, Taco Bell, or even Buffalo Wild Wings.
What Makes A Good 1031 Exchange Of A Fast Food Property
Before you jump into a 1031 Exchange mindset, make sure you cover a few bases so you don’t end up getting burnt. Commercial Real Estate as an industry is very competitive, and you will find yourself up against seasoned investors and companies similar to McDonald’s.
Picking the Right Location
We can learn a lot from chain and franchise restaurants and how they pick their locations.
A few years ago, the global economic crisis affected fast food companies. As real estate values were plummeting, many decided to invest their capital in expanding to new locations that they perceived to be promising.
Fast food chains take into considerations variables such as:
● Traffic: how much of it at the moment, and how does the trend look like for a 5-10 year period;
● Consumer demographics: how many people live in the area that could be a potential market, and how will this number change in the next 5-10 years;
● Safety information: what do police reports say about the area, how safe citizens feel in the area, where does the trend go;
● Business diversity: how many office/business locations are around the place, what’s the location’s capacity to attract people during lunch break;
● Look/Feel of the surroundings: how visually appealing is the area for people to walk to or drive to for a lunch break, and will this change soon?
This is just a handful of key questions that will help you gain enough foresight to make a move on a promising location that restaurant owners would love to lease.
Some organizations even use in-house mapping or a business intelligence platform to glean data and make informed decisions. These platforms allow companies to evaluate nearby retail development, public transportation stops, and neighborhood demographics.
For promising restaurant properties, prices usually vary from $1 million to $3 million. Usually, as a buyer, you could need some help in plotting out the funding path in order to submit a serious Letter Of Intent.
Many times, selling agents will go with a letter of intent sent by a reputable Buyer’s Agent that is well known for sending properly funded offers.
Some agents, in a rush to put together a good offer, will leave the Funding issue almost intact. Then, when a selling agent acts on the letter of intent, buyers may find themselves in a position of not being able to pull the needed funds in time to close the deal.
This is why it is important to address the Funding issue on time.
It’s good to keep in mind the benefits-oriented numbers such as:
● The lease term is between 10 and 20 years,
● Average increases of 10% every 5 years.
● Corporate lease guarantee is corporate,
● CAP rates range from 5.5% and 6.5%.
But also keep in mind that all these nice numbers are still not YOUR figures. You will need to make the numbers work prior to purchasing the property.
Including A Trusted Third Party In Concluding A 1031 Transaction
Every business transaction in the US is subject to certain laws and regulations, and commercial property 1031 exchanges are no exception. These exchanges are subject to strict guidelines.
Fast food property exchanges require the involvement of a third party. A Qualified Intermediary (QI) is needed when the relinquished asset is sold to a buyer, and the replacement asset is bought from a seller.
Because of legal limitations, the QI cannot be your current attorney, accountant, investment broker, etc. Basically, you need a “new” third party to conclude the deal.
This QI’s role is succinctly explained as:
“The QI enters into a written agreement with the taxpayer where QI transfers the relinquished property to the buyer and transfers the replacement property to the taxpayer pursuant to the exchange agreement. The QI holds the proceeds from the sale of the relinquished property in a trust or escrow account in order to ensure the Taxpayer never has actual or constructive receipt of the sale proceeds.”
Here’s how the 1031 Exchange works with a QI:
1. The taxpayer assigns rights in the sale and purchase agreement to the Qualified Intermediary. Since the QI has the right to get the new property, the QI is also able to take the title of the relinquished property from the taxpayer. Also, the QI can move the title of the replacement property to the taxpayer.
2. Despite the assigned rights to the Qualified Intermediary, the taxpayer may make a direct transfer of the asset by the bill for sale. Or the taxpayer can take the relinquished asset from the buyer and get the replacement asset by direct transfer from the seller.
3. The Qualified Intermediary receives the money when a sale occurs. You must specify the property within 5 days and assign a written form to the QI.
4. After the sale of the property, the Qualified Intermediary will purchase the replacement property with the money obtained from the sale. The new property must be closed on within 180 days of the sale of the old.
Keep in mind that you must choose a new property within 45 days, and you will be left with 135 days to close on the new property.
Basically, this Qualified Intermediary is a needed third-party that makes the 1031 transaction possible. Without this person/party, you cannot conduct a 1031 Exchange.
Buyer’s Agents usually take care of this need too.
Finding a Reliable Buyer’s Agent
Usually, a 1031 Exchange represents a serious financial move. Because of the inherent risk of such a large transaction, it is very important to have an experienced partner who can guide you throughout the entire process. Such a partner should have deep knowledge of the market, and that partner should also have excellent negotiating skills to put together a solid 1031 exchange deal for you.
The tight timelines and strict rules of a 1031 Exchange require that you have a partner who can successfully navigate the legal maze, and make the 1031 Exchange a successful transaction.
The great thing about working with a Buyer’s agent is that you as a buyer, get this service free of charge. Buyer’s agents split the commission with the selling agent. And both agents are paid by the seller.
So from a buyer’s perspective, there’s really no need of worrying about expenses. On the contrary, you have all the benefits stacked in your favor by getting a Buyer’s agent do all the leg-work for you.
How Does A 1031 Exchange Look Like When Using A Buyer’s Agent?
As you can see, a 1031 Exchange with a property that’s suitable for a stand-alone or a franchise restaurant, is accompanied by an overwhelming complexity.
All the regulations, all the money involved, all the parties involved… seems enough of a headache to just walk away on the idea.
The good thing is that Buyer’s Agents do this every day, for years and years, and it doesn’t cost you anything to use their experience to your advantage.
In our 18 years of experience, Westwood Net Lease Advisors have worked with many fast food restaurant locations that became prime property for chain restaurants later on. Restaurant chains such as KFC, Taco Bell, Chick-fil-A, Burger King, and Carls Jr.
Westwood Net Lease Advisors specializes as a Buyer’s Agent for NNN properties for 1031 exchanges across the entire United States. We have a high level of expertise and a dedicated team focused on client satisfaction. We have managed to provide many buyers with excellent 1031 deals.
Here’s how the process would look like when you use a buyer’s agent agency like Westwood:
1. We hear out your wants and needs, your budget, your cashflow, your preferred location.
2. We put together a short-list of locales with high potential foot traffic, within your budget, within your expected cashflow etc.
3. After you pick the best location from the shortlist, we help you handle the work regarding the legal and financial process.
4. We go over the numbers with you and submit a formal Letter of Intent.
5. The Selling Agent acts on our offer, you gain ownership of the new location, we get paid by the seller. Everybody’s happy.
Since we’re in this business for a very long time, selling agents love working with Westwood. Our Letters of Intent are as good as a closed deal because we help buyers with all the legal and financing hurdles. We make sure all the bases are covered, and when we submit a Letter of Intent, selling agents know that this is a serious offer. Most of the times, we win the deal for you even if there are other, higher bids than ours.
Some Final Thoughts And A Few More Details To Know
A tax-deferred exchange is possible with fast food real estate properties. But be careful: 1031s aren’t simple, and not all assets qualify.
Because big players are in the restaurant 1031 Exchange game, you’re facing stiff competition who have tons and tons of insight behind their bid. This is why some homework around the location of interest is a must. This goes well beyond driving by the location a few times a month. Figures like population size, demographic insights, growth projections etc. are crucial details to have.
As the 1031 process is heavily regulated, you will need to involve a third-party, and in some states, this QI can be required to hold a license.
Lastly, and perhaps the key information for you, is that you do have the benefit of getting guidance from a professional Buyer’s Agent without it being an expense for you.
Buyer’s Agents like Westwood Net Lease Advisors are working for years, representing the interests of the buyers just like you. We do the heavy lifting needed to conduct the research, gather key details about the property, and then negotiate a good deal for you, the buyer. All this is free of charge for you because buyer’s agents and seller’s agents divide the 6% paid by the seller of the location.
Interested in Taking the Next Step Toward your 1031 Property?
If you are looking for a fast food property for a 1031 Exchange that can meet your specific requirements, please don’t hesitate to contact Westwood Net Lease Advisors. Our agents will work with you and make sure that the deal is solid and that it meets your expectations.
We would be more than happy to help you throughout the entire process and to make the transaction smooth and clear for you. Regardless of the circumstances, we will work to find you a good location and to seal a deal within a specified timeframe.
Our experience and expertise have produced many satisfied clients. Our staff is constantly looking for new, attractive deals on the market, and we have an extensive list of potential fast food restaurant properties.