Properties net leased to casual-dining restaurants, which before the first quarter had been seeing a softening of investor demand as a result of changes in consumer preferences, got hit hard during this year’s first three months.
Capitalization rates, or the yields investors require from their property purchases, were 6.59 percent in the first quarter, up 27 basis points from a year ago, according to Boulder Group, a boutique brokerage in Chicago that specializes in net-leased properties.
In contrast, cap rates for other net-leased properties actually declined by 12 bps to 6.15 percent during the quarter - 44 bps lower than that for casual-dining properties.
That 6.15 percent cap rate represents a 545-bp premium to the 10-year Treasury yield, while the 6.27 percent cap rate posted a year ago was only 386 bps more than the then-prevailing Treasury. So, investors have increased their risk premiums.
“Prior to the COVID-19 outbreak, the net-lease casual-dining sector was already hurting,” explained Jimmy Goodman, partner at Boulder. “A lot of tenants experienced high rent and low sales and were taking a hit.”
Properties leased to casual-dining operators and were backed by corporate guarantees traded with cap rates of 6.25 percent, showing investors’ confidence in those guarantees, while those leased to independent frnchisees sold for cap rates of 7 percent. But those rates vary by operator. Restaurants leased to Applebee’s franchisees, for instance, traded during the first quarter at prices resulting in cap rates of 7.35 percent, up 25 bps from a year ago.
The coronavirus lockdowns didn’t start en masse until the middle of March, near the end of the quarter, but the impact on businesses such as casual restaurants was felt immediately, Goodman said. As many casual-dining tenants were forced to shift focus to carryout and delivery, they saw sales volumes drop significantly as dine-in services were suspended. Accordingly, sales transactions involving properties net leased to casual-dining operators have, for the most part, disappeared.
“Demand in the next quarter will be lower,” Goodman predicted, which naturally would push cap rates higher. But because interest rates should remain very low, they likely won’t change much. “Demand will be for corporate-backed deals, as opposed to franchises,” he noted, adding that transaction volume also will be lower in the third quarter.
Goodman said restaurant operators’ ability to offer curbside pickups and deliveries were only a “band aid … At the end of the day, those sales will not make the companies profitable.”
Under triple-net leases, tenants are responsible for property operating expenses such as insurance, maintenance and property taxes.
Growing numbers of states have started loosening their quarantine restrictions in the last few weeks, but it’s too early to predict how long it takes before casual-dining establishments recover. Outside dining has been permitted in most areas, and some are allowing indoor seating with limited capacity. That’s likely to impact restaurants’ ability to operate profitably.
To learn more about the data behind this article and what Trepp has to offer, visit www.trepp.com.
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