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In the real estate industry, properties that have Quick Service Restaurants (QSR) as tenants are commonly referred to as “coupon clippers.” These QSRs have NNN leases that require the tenant to pay for all taxes, insurance and necessary property maintenance. Essentially, the only job a landlord has after they acquire these properties is to watch the rent get wired into their checking account each month, or “clip the coupon.” Once acquired, these investments are quite simple to own. In contrast, the due diligence that is necessary before acquisition is not quite as simple.

During the downturn, property owners have been inquiring about what to do when either a tenant is looking for a rent reduction or a tenant has gone or is going out of business. As much as we have helped investors in these situations, what is more important are the preventative measures that can be taken when acquiring QSRs. By following the acquisition guidelines listed below, investors can protect themselves even in the worst situations.

Credit of the Tenant

The first item to consider when purchasing a QSR is the credit of the tenant. The guarantee can range anywhere from a publicly traded company to a sole proprietor. If it is a corporate guarantee, what is the firm’s financial health? If it is a franchisee, have you analyzed its audited financials? At the height of the market, we saw many situations in which investors were paying similar cap rates on QSRs regardless of the strength of the tenant. The main objective is to acquire a property that has a tenant strong enough to continue to pay rent even if they close down your particular unit. If you are unsure of the credit of the tenant, do not buy the property.

Restaurant Sales

When looking at a QSR, it is a must to know the average sales of the concept. Second, you need to know the sales of the particular unit. For instance, an average McDonald’s does $2.3 million in annual sales per unit, while an average Subway only does $445,000. Therefore, a McDonalds location that does $1 million in sales is a dog, while a Subway with sales of $1 million is a gem! If you can’t gain access to sales data, you should pass and find another property.

Sales-to-Rent Ratio

Sales-to-Rent Ratio is computed by dividing annual rent by annual sales. This number should be below 10 percent. On a store that does $1 million in gross annual sales, the rent should not be more than $100,000 per year. When this number is more than 10 percent, it puts too much strain on the tenant’s bottom line and can force them to close their location or renegotiate the rent at your expense. If you are looking to acquire a QSR and this number is more than 10 percent, either attempt to negotiate a lower rent before acquisition or pass on the property.

Lease Terms

Base Term:

The Base Term on these types of leases is generally 20 years with a 10 percent rental increase every 5 years. The exposure of a lease this long is that you may experience inflationary losses if inflation is greater than 2 percent per year (which it usually is). If you are negotiating a new lease in a sale-leaseback scenario, do your best to negotiate CPI increases. If there are not any increases in the rent in the base term, you may lose out to inflation.

Renewal Options:

The standard options for a QSR are 4- to 5-year options with a 10 percent increase in rent at the beginning of each renewal option. If a lease has renewal options that do not have any increases in the rent, you should avoid the property.

Sales Reporting:

It is imperative that a tenant is required to report their sales data. This requirement should be included in the lease. You should never consider buying a QSR without knowing what the sales are unless you are certain that you have another tenant that would be ready and willing to move in. Also, if you are buying a property that has a short base term (less than 10 years), be sure the sales are above average for the concept, as that is the greatest indicator of whether the tenant will elect to exercise its renewal options or not.

Landlord Responsibilities:

With a “coupon cutter,” there should be absolutely no landlord responsibilities. Ensure that the tenant is required to carry their own insurance, pay all property taxes (including any increases that may result in a sale, reassessment, etc.) and pay for all maintenance including the roof, walls and the parking lot. Keep in mind that if you have any maintenance requirements, you will need to either monitor the property yourself or hire a property management company.

Location

Ensure the demographics (traffic counts, median income and population density) are in line with the requirements of the tenant that is occupying the space. For instance, Popeyes Chicken requires there to be a minimum of 17,000 households within a 2-mile radius of each store location. If you were to consider a location that had fewer households, it could be a signal that the tenant will not renew its lease when at the end of the base term.

Competition

If you are looking at a Wendy’s, what other burger chains are in the vicinity? Basically, if Wendy’s went out of business and left, who could take its space? Are the demographics strong enough for another concept to consider the location?

It is imperative that an investor completes thorough due diligence in the acquisition of a QSR. When a tenant requests a rent reduction or proposes to close down its operation, you can point out every reason why it should either continue paying the agreed upon rent or keep the store open. In the worst case scenario, you will be positioned to quickly and efficiently engage the interest of a new tenant to occupy your property. Just like anything else, a good offense is a great defense.

Acqusition Guidelines for NNN Fast Food Restaurants

Acqusition Guidelines for NNN Fast Food Restaurants