Cap rates in the net lease quick service restaurant (QSR) sector declined to 5.70% in the second quarter of 2016 representing a compression of 10 basis points from the prior year.
Cap rates for properties leased to franchisees declined by 10 basis points to 5.80% while cap rates for corporate leased properties experienced a 20 basis point decline to 5.45%. While cap rates decreased, the supply of QSR properties increased by approximately 26% year over year.
The QSR sector differs from other net lease retail sub-sectors as almost three-quarters of the properties are leased to franchisees rather than corporate entities. Cap rates for QSR properties leased to franchisees are influenced by the strength of the guarantor that can range from a one unit operator to a franchisee with hundreds of restaurants. Cap rates for corporately guaranteed QSR leases achieved a 35 basis point premium over franchisee backed assets during the second quarter of 2016. 1031 and private investors tend to pay a premium for corporate guaranteed leases as there is less perceived risk. The cap rate spread between corporately guaranteed and franchisee guaranteed leases increased by 10 basis points in the second quarter due to a higher concentration of upper end credit tenants like Panera and Starbucks. Corporately guaranteed ground leases to tenants including Chick-Fil-A and McDonalds represented the lowest cap rates in the sector of 4.00% and 4.10% respectively.
1031 and private investors continue to dominate the acquisitions of net lease assets priced below $10 million. In the second quarter of 2016, the median asking price for single tenant QSR properties was $1.83 million. QSR properties garner strong demand from investors as they offer a viable alternative to dollar stores for 1031 exchange buyers with low equity requirements (below $2 million). The attractive qualities of QSR properties include leases which typically feature recognizable tenants with long lease terms, no landlord responsibilities and rental escalations.
The low cap rate environment for net lease properties including QSR has made sale leaseback transactions attractive to franchise operators. In turn, franchisees are able to secure favorable value for their real estate to aid in expansion plans, existing store remodeling or existing debt paydown. Due to the attractiveness of the market for sale leaseback transactions, the recent supply of properties in the QSR sector has increased.
The single tenant net lease QSR sector will remain active as supply remains abundant for assets with long term leases. The attractive sale leaseback environment for QSR operators will continue to add supply to the market. Lower price points, rental escalations and typical NNN lease structures of this asset type continue to attract private and 1031 exchange investors.
About the author: Randy Blankstein is President of net lease advisory firm The Boulder Group.