Investors are carefully monitoring how restaurants perform during reopening stages as cap rates rise. What exactly are they looking for?
The coronavirus pandemic has boosted the business of drive-thru, quick-service restaurants, but sit-down eateries have started falling out of investors’ favor.
In the first quarter, the national capitalization rate for single-tenant casual dining properties increased to 6.59%. That’s an increase of 27 basis points in the yield compared to the prior year.
Higher cap rates, the measure of a property’s income as a percentage of its price, are a signal of riskier investments. The overall cap rate for net-lease retail, where tenants pay some or all of taxes, insurance and maintenance on their properties, contracted by 12 basis points.
Casual dining tenants were hit hard by COVID-19 during the late stages of the first quarter as many were forced to shift focus to carryout and delivery. They saw sales volume drop significantly as dine-in services were suspended.
Investors have also paused on nonessential property categories, including sit-down restaurants, as many of these tenants have asked for some form of rent relief. That can complicate transactions, according to Marcus & Millichap. The firm shows up in CoStar data as the most active brokerage of casual-dining sales in the past three years.
Marcus & Millichap attributes the rise in cap rates to specific brands that have failed to keep up with changing consumer preferences. Examples included: Ruby Tuesday, which has permanently closed about 150 locations this year and Red Robin, which shrank its stores by 30 in 2019.
The main factor that could bring investors back to sit-down restaurants as markets come out of coronavirus sequestration are assets that were selling for cap rates of less than 7% before the downturn.
Casual dining properties with corporately guaranteed leases generated a cap rate of 6.25%. Franchisee-leased properties were less popular with a cap rate of 7%.
Investors will be seeking casual dining brands that have ongoing business models that can take advantage of the increased success of curbside services offered during the current COVID-19 period. They’re likely to carefully monitor how restaurants perform during reopening stages with limited seating capacity prior to making acquisitions.
Closer attention will be paid to in-place rents and sales performance, as wells as the strength of the lease guarantor and restaurant brand.