Truth Be Told
Debunking today’s real estate myths
Read some of today’s business headlines, and one might think that franchisees are reveling in a tenant’s market where landlords are practically giving away space. True, many landlords are in a tight spot in the current economy, but space is far from free. This article digs through some of the myths, misconceptions and downright falsehoods surrounding franchise real estate, and strives to set the record straight so that readers can have realistic expectations when it comes to leasing, buying and building new stores in the current market.
Myth: Franchisees are cashing in on the commercial real estate crisis. There is a nugget of truth to this statement. Retail, office and industrial markets across the board are struggling with both higher vacancies and flat or declining rents. Retail vacancies are expected to reach 10.6 percent by the end of 2010, with effective rents falling 4.2 percent for the year. On the office side, vacancies are projected to increase to 18 percent by the end of 2010, while effective rents fall another 3.5 percent, according to data from Encino, California-based Marcus & Millichap.
But those national numbers don’t mean much to individual lease deals. There is a huge disparity in market conditions when a franchisee looks at a particular city, neighborhood or property. “There is definitely some softness in the market, but especially for major metros, there is still good demand,” says Navin Nagrani, a senior vice president at Hilco Real Estate in Northbrook, Illinois. But there is no one-size-fits-all in this market.
Myth: Franchisees can find bargains even on top-quality properties. In most cases, this is false. There aren’t any cheap deals on high-quality real estate. “The fact of the matter is that quality real estate always retains its value in good times and bad,” says Michael Parkhill, a senior vice president and director of real estate at Jersey Mikes Franchise Systems.
Myth: All tenants are going to find the same bargains. Yes, even small mom-and-pop retailers who had a hard time getting the time of day from landlords two years ago are seeing doors open to them. However, that does not mean a tenant with a low credit score and weak track record will find the same favorable terms as more established, national firms. “Landlords are definitely risk-averse. They don’t want to hand out money to poor credit tenants,” Nagrani says. There is still the opportunity to get free rent and tenant improvement dollars from landlords, but the landlord wants to know that the tenant isn’t going to close its doors in six months, he adds.
Myth: Capital markets are still frozen. Financing is still constrained with large national lenders on the sidelines. However, there has been somewhat of a thaw among smaller community and regional banks that are willing to make loans to franchisees, especially if a bank has a strong relationship with a borrower. “Lenders are just looking for better debt coverage ratios, a little more equity than previously required and strong lending relationships,” says Jason Keen, a principal at Verdad Real Estate in Southlake, Texas. “Lenders are really becoming better investors by underwriting unit-level economics and working with proven capital providers and operators.” In addition, SBA lending has continued to be a viable source of financing for many franchisees.
Myth: Franchise credit isn’t trading in the 1031 investment market. This is false. Franchise credit is trading, just at a slightly higher cap rate, which translates to a lower sale price. Cap rates for even quality-credit tenants such as Burger King and Walgreens have increased 100 to 200 basis points in the past 18 months. Brand recognition seems to be critical at this time, and investors are looking for tier-one brands to invest in. The supply is down for real estate investments priced below $2.5 million, which has created more demand for investment opportunities and helped stabilize the cap rates.
Myth: It’s not a good time to build. The reality is that construction costs have dropped dramatically — 20 to 30 percent — in the past 18 months. Due to the drop in construction activity, there is less demand for both raw materials and quality contractors. Contractors too busy to take on smaller franchise jobs two years ago are now competing for those same jobs with more reasonable bids.
Myth: There isn’t new construction financing available. Actually, community and regional banks are seeking quality borrowers with a proven track record of developing and they are more focused on underwriting the unit-level economics. “Lenders still need to make loans,” Keen says. Lenders tend to favor solid deals with proven operators that are typically priced under $2 million.