E-commerce has hit retail tenants hard, causing thousands of businesses across the U.S. to close doors.
And the damage isn’t limited to mom and pop stores; even national giants like Office Depot, Macy’s and Guess aren’t immune. And with more than 3,591 stores out of business, they’re in good company.
In order to shield themselves from what some are calling “the Amazon Effect,” many investors are turning to experience-oriented brick and mortar stores. These types of assets offer experiences rather than pure products, making it difficult or impossible for online substitutes to take their place.
Hair and nail salons, Restaurants are one example of this asset type. But among net lease investors, one particular class remains a favorite: casual and budget dining STL’s. These single tenant net lease properties offer investors triple net leases and rental escalations throughout the duration of the lease and are also ideal replacement properties for 1031 buyers.
Larger corporations prefer higher returns than most casual and budget dining chains, but for private investors, these net lease properties offer a good balance between risk and acceptable return, particularly with regards to sale-leasebacks.
Why Is The Restaurant Sector In Such High Demand?
One reason casual and budget STL’s are so popular with commercial real estate investors is because they offer many of the benefits of a good retail commercial investment property.
They are located on solid sites with frontage on high traffic corridors, surrounded by plenty of parking and excellent entrance and exit points. Buildings are less specialized than other types of a commercial real estate so that in the event a tenant does go dark or the investor decides to sell the property, it would easy enough to exit or exchange the investment.
Strong Creditworthy Tenants
There are numerous industrial grade tenants in this space. Olive Garden and Red Lobster are two well-known national franchises, and On the Border, Romano’s Macaroni Grillm, and Chili’s are well-known companies with a rating between BBB and BBB-.
Due to the strong investor demand in this sector, many companies are using lease sale backs in order to access the equity in their properties to pay down debts, remodel existing units, or open new stores.
Most leases in this space are 15-20-year triple-net leases with renewal options tied to the end of the fixed term. Lease bumps tend to be at least 1-3% per year. In most major restaurant chains, there are both franchise and corporate-backed locations.
With the acquisition of Whole Foods by Amazon, no segment is immune to economic downturns. However, although higher-end restaurants may suffer more from consumers having less money to spend, in the end, everyone needs to eat, and most people enjoy eating out at least occasionally, particularly at restaurants that are reasonably priced.
Most casual dining properties are doing well, and are careful to stay on top of dining trends and customer preferences.
Exhibiting a fluidity that many in the retail segment have yet to master, both chain owners and franchise operators have already begun adapting new technology that allows them to blend delivery and online services in a way that enhances their businesses.
Investors should be careful to check parent corporations in addition to the individual franchise. Some parent corporations have below-investment-grade credit, though sometimes franchise owners have been able to do better than the average due to excellent management.
Smaller stores, in particular, are allowed more leeway as to how they manage their franchise, as larger corporations are much more likely to insist individual franchises follow rules to the letter.
Casual and Budget Dining SLR’s Are Ideal For Diversifying Portfolios
Whether you’re interested in safe investments with little risk or prefer accelerating your return with higher risk properties, the restaurant sector offers a wide variety of options.
Although this asset class – like any other investment – does have some inherent challenges, a detailed exit plan and careful choice of a tenant with an eye to market forces go a long way to ensuring a successful investment.