Cap rates in the net lease quick service restaurant (QSR) sector reached 5.90% in the second quarter of 2015 for properties leased to franchisees. This represented a 35 basis point decline from the prior year.
Corporate leased QSR properties experienced a 10 basis point decline to 5.65% during the same time period. The QSR sector differs from other net lease retail sectors as the majority of the properties are leased to franchisees rather than corporate entities. However, the cap rate spread between corporate guaranteed and franchisee guaranteed QSR properties compressed from 50 to 30 basis points in the second quarter of 2015.
Investors have been increasingly willing to lower credit standards for increased yield in the QSR sector, especially in major markets or for properties with favorable lease structures (i.e. larger or more frequent rental escalations). McDonald’s ground leases continually represent the lowest cap rates for all QSR properties (3.95%) due to their superior credit rating (S&P: A), long term leases, low price points, reoccurring rental escalations and strong brand recognition. Cap rates for QSR properties leased to franchisees are influenced by the guarantor who can range from a one unit operator to a franchisee with hundreds of restaurants.
Franchisee backed QSR locations with major brands provide investors a security level, despite the lack of a corporate guarantee.
A surplus of 1031 exchange investors with low equity requirements are attracted to the QSR sector as these properties have a median asking price of $2 million. Additionally, QSR properties typically feature recognizable tenants with long lease terms, no landlord responsibilities and rental escalations. The median remaining lease term in the second quarter of 2015 in the QSR sector was 16 years. As a result, the premium for net lease QSR assets was 60 basis points over the entire retail net lease market. This represented a 10 basis point increase from the prior year.
Sale leaseback transactions by QSR operators have been able to increase supply and more specifically the supply of long term leased properties. In the current record high pricing environment, franchisees are able to unlock the value of their owned real estate and are able to use the capital for expansion, remodeling of existing locations or the paydown of existing debt.
The single tenant net lease QSR sector will remain active as the lower price points, rental escalations and typical NNN lease structures of this asset type continue to attract private and 1031 exchange investors. With cap rate levels at historic lows for net lease retail, investors have altered their investment criteria to include franchisee credit in their search for increased yield.
About the author: Randy Blankstein is President of net lease advisory firm The Boulder Group.