Net Leased Restaurants
Learn Why These Net Leases Are Popular & What To Be Cautious Of

Single tenant net lease

• The vast majority of restaurants operate under an absolute triple net lease which translates to the landlord having no responsibilities of the property. Such net leases are commonly referred to as “coupon clippers” or “arm chair” investments. All you have to do is open the mail box and deposit the check. In this day of modern technology, it’s common for the tenant to have an automated direct deposit to the landlord’s bank!
• Since everyone must eat, like it or not and society as a whole is consumed with work the populous eats out. The National Restaurant Association claims there are close to 940,000 restaurants in the US as of 2007 with $538 Billion in sales from $323 Billion in 1997 and only $202 Billion in 1987. Unlike net leased video chains such as Blockbuster and Hollywood video which is competing with companies such as Netflix, restaurants will always be around to serve the public.
• restaurant owners know their properties are well maintained by the national tenants, since customers won’t put up with dirty facilities or un-kept premises and they are regulated by state health standards.

Nevertheless, commercial net lease restaurants are not all created equal from an investment standpoint.

Independent Operators vs. National Franchisees

With regard to franchise restaurant operators, the franchisee pays a one time franchisee fee usually in the range of $25,000-$60,000 plus a royalty fee based upon sales revenue which runs between 3-13%. In return, the franchisee will be able to operate under a National brand, obtains training on how to establish the business and run a tested and flourishing business without having to bother with a marketing business plan.

Consequently, a franchisee restaurant operator will attract customers as soon as they display their “open for business” banner. The largest net lease franchisee operators today are McDonalds with a 47% market share of fast food restaurants and Burger King with a 15% market share.

Independent restaurants In general, local non chain restaurants are a much riskier investment and you should only consider it as an option if the return is considerably higher and the real estate has an outstanding intrinsic value in case you need to find another tenant.

Net Leasing & Rent Assurance Guarantees

Most restaurants will commit to a 15-20 year absolute triple net lease with annual rent increases. Many franchisees will personally guarantee the lease with both their personal and business assets. Often, you will find smaller restaurant franchisees create a parent company to own all the restaurants. Then they spin off each restaurant into its own single entity LLC in order to protect it from additional accountabilities. These net leased deals are not worth as much as a corporate guarantee. If this single entity restaurant doesn’t have strong sales, they could easily shut that single store down and you are out of luck now looking for another tenant

Financing Concerns

Normally, the interest rate on single tenant triple net lease properties are slightly higher than multi-tenant properties due to the tenant possibly going bankrupt, the landlord looses 100% of the rent. However, this isn’t the case with high credit companies such as McDonalds. Banks will provide much better rates for National Chains and many banks won’t consider a loan for a mom and pop restaurant. If you are an out of state buyer and the net lease investment property is situated in small town America it will be even more difficult to obtain a loan.

Due Diligence
It would be very prudent to heed these considerations before deciding to move ahead with the acquisition of a net lease facility:

1. Always critique the profit and loss (P&L) reports if attainable with your accountant.
2. Parking spots: Restaurants are inclined to have a greater number of parking spaces because customers congregate a couple of times a day within a narrow time frame. The essential required spots are at least 8 parking spots per 1,000 Square Feet. Fast food restaurants may require up to 20 parking spaces per 1,000 Square Feet.
3. Some net leases provide the NNN leased tenant a choice to terminate the lease should there be a fire. Obviously, this is not advantageous for the landlord. Reading the NNN lease in detail is essential for the purchaser to view any termination clauses the triple net tenant may enjoy.
4. Price per square foot: The investor should consider paying about $225-525 per square foot for the building. In California the prices are always much higher which could easily be in the $1,000 price per square foot range as land and construction is extremely high priced. If you end up paying more than $525 per square foot for a net leased restaurant, make sure you can substantiate for doing so by checking the current and future net lease rents of the area.
5. Rent per square foot: Preferably you want to purchase a net leased property which has a low rent per square foot. This will give you an opportunity to receive a higher rent in the future. Additionally, the low rent will most likely ensure the tenant’s business success and also prevent him from looking elsewhere when the net lease expires. Companies such as Starbucks have a tendency to pay a premium rent since the store is generally situated at a premium location with tremendous traffic and high visibility. If you are intending to purchase a net lease restaurant in which the tenant pays more than $36 per square foot, make sure you could defend your decision with a thorough analysis.
6. Restaurant Location: A poorly run restaurant may do terrific at a solid location. Yet, a restaurant with an excellent menu may flop at a mediocre location.
7. Risks versus Reward: Like all net lease investors, you love to see high returns in the 8.0%-9.5% cap range. Thus you may be attracted to a new franchised net leased restaurant offered for sale by a developer. The developer is contracted to build the restaurant including all the interior fixtures based on the specifications of the franchise operator. The restaurant franchisee will sign a 20 year absolute triple net lease paying a very high rent per square foot in the $50-$60 per square foot range. The new franchisee is cooperative because he or she doesn’t have to provide any additional cash to open a business. Net lease investors are thrilled with the high cash flow, however, this is considered a very high risk investment. The only certain profit maker in the above scenario is the real estate developer. During tough times, the franchisee may not be able to keep afloat and since he doesn’t have any equity in the property, he can simply declare bankruptcy and you are left with a vacant building with no income. Moreover, since the tenant was paying an inflated market rent, your return will be reduced when the next tenant is paying ‘market’ rent.
8. Check out the Track Record: An operator with only a few recently established restaurants is a much higher risk than someone in business for 15+ years with numerous locations.

Sale-Leaseback Net Leasing Opportunities

It is not uncommon to have a restaurant operator wishing to sell his building and lease back for 20 years with another 20 years in option periods. Please refer to our article on Sale-Backs how sale-leasebacks perform with NNN properties.