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Restaurants hold a special allure for investors, and it’s easy to see why. With long-term leases that can stretch up to 20 years, absolute triple net (NNN) leases, tenants are not only responsible for paying rent, they also cover property taxes, insurance, and all maintenance expenses. This leaves the investor with only the mortgage to pay, offering a steady and predictable cash flow. Plus, the investor can enjoy the freedom to focus on other important aspects of life, like retirement. You simply take the rent check to the bank, and that’s it. This is just one of the many advantages of investing in a restaurant or single-tenant property.

The demand for restaurants is always high because, let’s face it, people need to eat. Americans are dining out more frequently these days because they are too busy to cook and clean up afterward. Let’s be honest, the worst part is often dealing with the pots and pans! According to the National Restaurant Association, the restaurant industry in the US is flourishing, with 937,000 restaurants and projected sales of $537 billion in 2007. These numbers have risen significantly from $322 billion in 1997 and $200 billion in 1987. In 2006, 48 cents out of every dollar spent on food by Americans went toward dining out. As long as civilization exists, there will always be a demand for restaurants, making it a safe bet for investors. And you can rest assured that your tenants will take excellent care of your property because it’s in their best interest to do so. No customers want to step foot in a restaurant with a filthy bathroom or trash-filled parking lot.

However, not all restaurants are created equal when it comes to investments. Franchised restaurants differ from independent ones in several ways. You may often hear the urban myth that 9 out of 10 new restaurants fail in their first year, but this has never been conclusively proven. A study by Dr. H.G. Parsa of Ohio State University focused on new restaurants in Columbus, Ohio, from 1996 to 1999. Dr. Parsa found that seafood restaurants were the most successful ventures, while Mexican restaurants had the highest failure rate in Columbus. His study also revealed that 26% of new restaurants closed within the first year. Reasons for closure included not just economic failure, but also divorce, poor health, and a reluctance to commit vast amounts of time to business operations. Therefore, it’s safe to assume that the longer a restaurant has been in business, the more likely it will continue operating the following year, ensuring that the landlord continues to receive rent.

For franchised restaurants, potential franchisees must meet certain financial requirements, such as a minimum amount of non-borrowed cash or capital, like $300,000 for McDonald’s. A franchisee also pays a one-time franchisee fee, typically ranging from $30,000 to $50,000. Additionally, franchisees are responsible for ongoing royalty and advertising fees, which amount to about 4% and 3% of sales revenue, respectively. In return, franchisees receive training on how to establish and run a successful business without the burden of marketing. Consequently, franchised restaurants attract customers as soon as they open their doors. If a franchisee fails to run the business properly, the franchise has the option to replace them with a new franchisee. The fast-food giant McDonald’s, for example, has over 32,000 locations in 118 countries, generating $34.2 billion in sales in 2011. It captures over 50% of the $64 billion US hamburger restaurant market and has seen a 26% increase in sales over the past five years. Surprisingly, a survey of 28,000 online subscribers of Consumer Report magazine ranked McDonald’s hamburgers last among 18 national and regional fast food chains. Even though taste might not be its strongest suit, McDonald’s manages to thrive due to other factors. Fast-food chains are quick to adapt to new trends, such as offering breakfast options as early as 5AM to cater to early risers. They have also introduced items like cafe latte, fruit smoothies, and salads to compete with chains like Starbucks and Jamba Juice. These adaptations make fast-food restaurants more attractive to a broader range of customers.

Independent restaurants, on the other hand, face a tougher road, particularly in their first 12 months of operation. Customers often hesitate to try a new establishment, especially if the owners have little to no proven track record. These “mom and pop” restaurants pose a higher risk due to their initial weak revenue. If you choose to invest in a non-brand name restaurant, be sure that the potential return is commensurate with the risks involved.

Determining whether a restaurant is a brand name or not can sometimes be challenging. Some restaurant chains are only known or popular in specific regions. For instance, the WhatABurger chain boasts over 700 locations in 10 states and is immensely popular in Texas and Georgia. However, it remains relatively unknown on the West Coast. Brand-name chains typically have websites that list all their locations along with other information. So, by conducting a quick Google or Yahoo search, you can determine if an unfamiliar restaurant name is a brand name or not. You can also find basic consumer information about almost any chain restaurant in the US on platforms like Wikipedia.

Below is a list of the ten fastest-growing restaurant chains in 2011 with sales exceeding $200 million, according to Technomic. The rankings are based on revenue change from 2010 to 2011:
1. Five Guys Burgers and Fries – $921M in sales with a 32.8% change.
2. Chipotle Mexican Grill – $2.261B in sales with a 23.4% change.
3. Jimmy John’s Gourmet Sandwich Shop – $895M in sales with a 21.8% change.
4. Yard House – $262M in sales with a 21.5% change.
5. Firehouse Subs – $285M in sales with a 21.1% change.
6. BJ’s Restaurant & Brewhouse – $621M in sales with a 20.9% change.
7. Buffalo Wild Wings Grill & Bar – $2.045B in sales with a 20.1% change.
8. Raising Cane’s Chicken Fingers – $206M in sales with an 18.2% change.
9. Noodles & Company – $300M in sales with a 14.9% change.
10. Wingstop – $382M in sales with a 22.1% change.

When it comes to leasing and rent guarantee, tenants of restaurants typically sign long-term absolute triple net (NNN) leases. This means that in addition to base rent, they are responsible for all operating expenses, including property taxes, insurance, and maintenance. This arrangement eliminates the risk of uncertain maintenance expenses and ensures predictable cash flow for investors. Tenants may also guarantee rent payments using their personal or corporate assets. If they are forced to close the business, they are still obligated to pay rent for the duration of the lease. However, it’s important to note that the strength of the guarantee affects the return on investment. For instance, a restaurant with a McDonald’s Corporation lease, backed by a strong “A” S&P corporate rating, offers a lower cap rate (return on investment in the first year) compared to a small corporation owned by a franchisee with only a few restaurants. So, before you invest in a non-brand name restaurant, consider whether the potential return outweighs the risks involved.

In conclusion, restaurants can be a lucrative investment opportunity due to their long-term leases and predictable cash flow. With the demand for dining out always high, investors can feel confident that their property will remain in high demand. While franchised restaurants offer the benefits of established branding and established customer bases, independent restaurants can be riskier in terms of initial weak revenue. As an investor, carefully consider your options and ensure that the return on investment aligns with the level of risk involved. By choosing wisely, you can reap the rewards of investing in the ever-thriving restaurant industry.
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Ihab Salloum