December 31, 2015

They Aren't Making McDonald's Real Estate Anymore

McDonald's investors and analysts have been salivating over the equity in McDonald's real estate portfolio for decades.

Many think that McDonald's should follow the lead of other companies and spin off their 
real estate assets into a real estate investment trust (REIT). Theoretically investors would 
buy shares in the REIT thereby "monetizing" McDonald's unrecognized McDonald's real estate values.

During the November 2015 meeting with analysts McDonald's management told investors
they had wisely decided there would be no REIT and as it just wasn't a good fit for the 
system. However, management did disclose that by the end of 2015 the company will have 
sold four McDonald's locations for about $130 million. This may be the first time in history
that McDonald's has publicly discussed such transactions. I assume past transactions were
detailed in financial disclosures but the specifics were not broadcast. 

When Ray Kroc and Harry Sonneborn developed their approach to McDonald's real estate 
it was with the intention that there would be a McDonald's store at any specific location in perpetuity. They knew they couldn't build much of a chain if established stores were to come and go every 20 or 30 years. They either bought the property or secured leases with extensive options. 

This strategy had an added benefit - franchises could be bought and sold with the buyer confident they were acquiring a long term business - creating more equity for the seller. 

But a real estate formula that's worked well for 50 plus years is changing and Operators 
should be aware of this evolution. 

I won't try to predict what McDonald's management will do but I know how Wall Street analysts think and MCD shareholders are pretty predictable. Going forward analysts will 
be expecting a certain amount of activity in McDonald's real estate sales. The substantial 
sale prices of the four locations in 2015 will be the baseline. If management doesn't 
produce a comparable annual line item analysts will ask "why not?". 

Individual McDonald's shareholders will now drive-by their local McDonald's wondering if 
that location shouldn't become a mixed-use office tower.

And the REIT issue will not disappear. When McDonald's share price has a downturn or is merely flat or dividends don't grow investors will again want to revisit the REIT idea. A management team and board of directors who are not getting results for shareholders 
might be unable to resist.

This not meant to alarm all McDonald's Operators since it will not involve a lot of stores. 
At least in the saturated USA McDonald's can't build total sales and income by shutting 
down stores in large numbers. And, while many McDonald's properties have increased in value, there will only be a few where the resale value exceeds the future income stream 
as a McDonald's restaurant. But, things are gradually changing.

2016 should be the year that McDonald's Operators become more involved and more know-ledgeable about the properties they are renting. Nothing could be worse for an Operator's equity than questions about a store's long term existence. Nothing could be worse for a store's cash flow than having the owners of an independent REIT making decisions about store rent and other occupancy costs.

Discussion?

Bloomberg reports on the November meeting HERE
.

8 comments:

Anonymous said...

Operator equity was taken away when nlc allowed mrps n rebuilds to have to be done at time of purchase with in 18 months. By the buying operator. That alone wiped out operators equity. Adding this,the future leasing of real estate on top. What's left for the Operator

Anonymous said...

Operator equity was taken away when nlc allowed mrps n rebuilds to have to be done at time of purchase with in 18 months. By the buying operator. That alone wiped out operators equity. Adding this,the future leasing of real estate on top. What's left for the Operator

Anonymous said...

If MCD sells real estate, it should sell locations to its franchisees. It will loosen the noose that MCD has over its franchisees' throats, but it will guarantee that the sites stay with the brand and strengthen the wealth and borrowing power of its franchisees.

Dunkin' Donuts did that for years, and created hundreds of now very wealthy franchisee families that have the assets to spread the brand westward without DNKN needing to spend to do it.

MCD should trust its best franchisees and sell them the real estate, but don't sell it to anyone else.

Richard Adams said...

Operators own the real estate? Not going to happen.

From "McDonald's:Behind The Arches" - 1986, by John Love

Profit was not the only contribution of Sonneborn's real estate play. Kroc and Sonneborn believed that control of the real estate also gave McDonald's the type of control over the franchisee that it wanted but could not get from a franchise agreement. .... What power did McDonald's have to discipline the recalcitrant in its operator community who did not want to abide by the rules and operating standards? In a battle with such malcontents, Sonneborn says, "I never thought the franchise contract was worth the paper it was written on. It appeared that it could never stand up in a legal action. It would be the big corporation against the little individual, and the corporation would never win that."

Anonymous said...

It amazes me that any thinking franchisee thinks that McD cares about operator equity at all!

Its ALL about the stock price, and shareholders.

Anonymous said...

If they were planning to sell off their real estate to a REIT or other investor, wouldn't it be easier if they had started with McOpCo instead of selling 10% of their owned stores to operators with new 20 year licenses?

Richard Adams said...

Those are two different issues. Selling (or "refranchising") McOpCos was driven by Wall Street and trends in the restaurant industry. It's amazing how few restaurant companies want to actually be in the restaurant business. McDonald's reduced the % of company operated stores because all the cool chains were doing it.

Since McDonald's is only selling the new 20 year franchise and not the real estate under those McOpCos it's not related to the idea of a REIT or that of selling McDonald's sites to real estate developers.

The only connection to McOpCo would be that if McDonald's has a site that's worth many millions and it's a McOpCo they are free to sell the site and terminate their own franchise.

It's far more complicated if a valuable site is occupied by a Operator with 15 years left on their franchise.

Anonymous said...

I have witnessed McD selling high valued real estate if not many years left on the franchise no big deal if many years left on the franchise, it is not eligible for MRP, rebuild etc. if old restaurant they tell you they won't be rewriting it at the end of the franchise lease term but they are willing to partner on a relocation now. They pocket big money now throw you a small bone and now you have a higher rent restaurant they make some crazy proformas that show your current M&R your new reduced M&R, better efficiencies increased sales and you will make the same or more money but their projected P&L never works out. They pocket 25mil for that property lease another use a small portion of the money they received now your 9% rent restaurant goes to 16% but now they say you have equity because before you would have had nothing at the end of your franchise term.

These corporate people don't really care about the franchisee anymore. I am not saying they are out to get us but at the end of the day they work for the corporation and what is good for them today and the corporation will influence their decisions not your long-term well-being.