McDonald's is a real estate company

[Aimless]

It's been nagging at me for a while and while reading up on the rent issue for the minimum wage thread I decided to finally just look it up. And whaddaya know...

http://seekingalpha.com/article/1029...e-burger-sales

...

The adjusted EBITDA for 2011 shows $4.9B in Franchisee Rent & Fees (44.9% of total) versus 3.6B for Company-Operated Restaurants (32.3%) and 2.5B (22.8%) for Franchisee Royalties. By far, the lion's share of McDonald's earnings is directly related to property.

What Does This Mean?

So you may be asking yourself, who cares? The tenants, i.e. McDonald's franchisees, still need to operate a profitable business to pay rent, right? They still sell burgers and a portion of that sale goes to rent. While that's true, the details are what makes the case for McDonald's strategy true genius.

Consider for a moment that suddenly half of McDonald's current traffic started going to KFC or Subway. A franchisee of 20 years would take a huge hit and would probably go out of business. The franchisee is forced to close down operations and an empty shell of a building is left. McDonald's then says "Sure, that is bad luck, but we now have a building/land that is nearly or completely paid for, that we can turn around and sell... to KFC or Subway, at a premium". So what's that worth?

McDonald's currently has about 31,000 restaurants worldwide. About 15% of those are operated by the company. That leaves 85%, or 26,350 that are operated by franchisees, where McDonald's still owns the property in the vast majority of cases. McDonald's earns $4.9B in Franchisee Rent & Fees, which averages out to $185,958 per restaurant, per year. Borrowing a term from real estate investing, capitalization rate (also known as cap rate), if we assume a moderate cap rate of 10%, then the average McDonald's property is worth $1.85MM.

So the property is one piece of the puzzle - what about the royalties? McDonald's earns 2.5B annually in Franchisee royalties, which divides out to about $94,876 per restaurant, per year. If a franchisee goes out of business, this is lost.

So let's tie this all together. The 20-year franchisee goes out of business, and the property takes 5 long years to sell. During that 5-year period, $474,380 in royalties are lost, as is $929,791 in rent. That totals $1,404,171. However, McDonald's is able to sell the property for $1,850,000, a difference of $445,829 to the positive.

Summing it Up

McDonald's has a win-win strategy with owning the properties their franchisees use. They developed a tried-and-true business model that franchisees can follow to earn themselves a decent income, of which McDonald's takes a piece in both rent and in royalties. The franchisee has "skin in the game" by risking some of his own capital to start the franchise, and by directly benefiting with increasing sales. This keeps them motivated and, historically, franchised restaurants do better than company-owned facilities. It's a fact that McDonald's is actively trying to spin off the locations it currently operates to franchisees, in part for this very reason.

Plan A for McDonald's is simple: Find a franchisee willing to work hard for their business, using a proven business model, while McDonald's collects rent and royalties.

Plan B for McDonald's is almost an insurance policy: Take the equity built over time in a given location to cushion the impact of a franchisee going out of business. They can either find a new franchisee to take over, or simply divest the property and be at a net gain within a reasonable time frame.

Along the way, properties only take so much time to pay off. McDonald's then earns rent on a paid-for property free and clear, adding even further to their bottom line.

My thoughts are - with a solid strategy in place where a primary business plan works well, and a backup insurance policy is in place, how can you go wrong buying the world's largest restaurant chain, with a great dividend history, especially at near 52-week lows?

http://seekingalpha.com/article/7353...estate-company

Frickin' brilliant! This may also explain the peculiar albeit almost-delicious characteristics of the hamburgers

[Loki]

You didn't know this? It does show that the ones who'll be most affected by increases in the cost of labor are the franchise owners, who aren't exactly living the high life.

[Aimless]

Not having seen the numbers I'd just assumed that most of the company's income came from royalties and whatnot Interesting that the company can set the rents for its franchisees, this changes everything

[RandBlade]

There's a world of difference between the Franchisee and the Franchisor. McDonald's is the Franchisor, the ones who'd pay dramatically increased wage bills will be the Franchisee.

Guess who'd struggle the most to make ends meet?

[Aimless]

There's a world of difference between the Franchisee and the Franchisor. McDonald's is the Franchisor, the ones who'd pay dramatically increased wage bills will be the Franchisee.

Guess who'd struggle the most to make ends meet?

If you re-read the text of my last post you'll note that I said "the company can set the rents for its franchisees". What that means is that, in a crazy Twilight Zone world, if the wages went up, McDonald's could lower the rents it charges some of its franchisees to offset some of the costs.

[Loki]

So McDonald's would just cut its own profit for no reason...

[Aimless]

So McDonald's would just cut its own profit for no reason...

No reason other than keeping its franchises in the US alive and kicking you mean

[RandBlade]

No reason other than keeping its franchises in the US alive and kicking you mean

You think the rents in a billion dollar industry are arbitary and not set in contracts?

[Dreadnaught]

You post good threads.

Interesting. I didn't know they had so much real estate. This is why I never quite understood franchising. Beyond some level of HR managment and daily hands-on management, it seems like you don't really control much of the business.

[RandBlade]

I know a lot about the franchise model and I can assure you it makes bloody good sense for the franchisor. The franchisee is a completely different matter. There are serious advantages, disadvantages and risks to both franchisor and franchisee. Franchisees going bankrupt too is far, far more common than people would realise who just see a giant monolithic company which is more myth than reality.

[Dreadnaught]

Indeedy, I meant that I don't see what's in it for the franchisee. It seems like a rich deal for the franchisor as long as they don't fuck up the marketing and establish good supply chains.

[Aimless]

You think the rents in a billion dollar industry are arbitary and not set in contracts?

I think that if both parties wanted to they could, under extraordinary circumstances such as a sudden, significant and legally mandated increase in wages, sit down at a large table and renegotiate the contract in order to avoid a mutually disadvantageous situation.

[RandBlade]

Indeedy, I meant that I don't see what's in it for the franchisee. It seems like a rich deal for the franchisor as long as they don't fuck up the marketing and establish good supply chains.

Off the top of my head advantages for franchisee:
Business support and expertise.
Training and development.
A well recognised brand.
Magnified marketing power.
Latent demand.
Existing supply chains.
Recognisable business model.
Quality enforcement controls.

Franchising can be far less risky than starting your own independent from scratch. Some of these advantages are double-edged swords, phrased differently could be on the risks column, but are also advantages.

I think that if both parties wanted to they could, under extraordinary circumstances such as a sudden, significant and legally mandated increase in wages, sit down at a large table and renegotiate the contract in order to avoid a mutually disadvantageous situation.

That is naively simplistic then. For one thing there are not two parties, there is one goliath party and hundreds of other parties - who compete with each other as much as co-operate with each other. To re-write the franchisor/franchisee contract is nearly impossible as it'd require the agreement of hundreds of interested parties all with their own agendas. Some of the bigger franchisees not being too upset at the bankruptcy of smaller franchisees as they can snap up the franchise (or some of it letting other parts go bust) for a song.

Even that overly-simplifies the relationship as there are even more interested parties and complicated relationships.

[Aimless]

That is naively simplistic then. For one thing there are not two parties, there is one goliath party and hundreds of other parties - who compete with each other as much as co-operate with each other. To re-write the franchisor/franchisee contract is nearly impossible as it'd require the agreement of hundreds of interested parties all with their own agendas. Some of the bigger franchisees not being too upset at the bankruptcy of smaller franchisees as they can snap up the franchise (or some of it letting other parts go bust) for a song.

Unless McDonald's charges all of its franchisees all over the world the exact same rent regardless of their location I think there must be at least one portion of the universal declaration of franchisee rights that varies and must be open for negotiation, namely the rent. It would be interesting to know if this really isn't the case.

[RandBlade]

Unless McDonald's charges all of its franchisees all over the world the exact same rent regardless of their location I think there must be at least one portion of the universal declaration of franchisee rights that varies and must be open for negotiation, namely the rent. It would be interesting to know if this really isn't the case.

It varies from company to company but the initial rent would typically be set upon the creation of the franchise agreement (founding of the business) and then be subject to pre-set rent review arrangements. Another common model is to charge the higher of a minimum rent or a fixed percentage of sales on top of the percentage of sales going as royalty payments and the percentage of sales going to the marketing fund.

If they wanted to support franchisees there's far easier ways to do it than mess with rent.

[GGT]

You didn't know this? It does show that the ones who'll be most affected by increases in the cost of labor are the franchise owners, who aren't exactly living the high life.

Where'd you get the notion that McDonald's franchise owners aren't 'living the high life'? It requires about a million bucks to acquire a single McDonald's franchise, and many US franchisees own/operate more than one restaurant under LLCs.

This kind of thing isn't limited to McDonald's, btw. Our newest Arby's is owned and operated as a subsidiary of a local energy (oil and gas) company. They used to own/operate a small gas station by the highway....until it was swallowed by highway expansion. During the expansion, McDonald's (and a competing gas station + convenience store) set up shop exploiting exit ramps and construction detours. They were able to use their RE holdings to "corner" the fast-food/gas station market for highway travelers for almost five years. They even "owned" the exit signs, cross lights, and sidewalks.

On the flip side, that local energy company was paid quite well for losing their RE income under eminent domain. Of course, they had a team of lawyers to negotiate for top dollar "market value". Not true for local homeowners who saw their home values plunge, while their bills doubled for road maintenance/water/sewer/police/fire.

[Loki]

Unless McDonald's charges all of its franchisees all over the world the exact same rent regardless of their location I think there must be at least one portion of the universal declaration of franchisee rights that varies and must be open for negotiation, namely the rent. It would be interesting to know if this really isn't the case.

You've yet to give a single sane reason as to why anyone would willingly give up money that they are legally entitled to (and will otherwise receive).

[Aimless]

You've yet to give a single sane reason as to why anyone would willingly give up money that they are legally entitled to (and will otherwise receive).

Hey Loki if you had to choose between continuing to make a modest profit for many years and making a modest profit as a one-time thing which would you prefer?

[Loki]

Except franchisees are easily replaceable (if you're McDonald's anyway), and it's unlikely that a hike in labor cost would fully bankrupt existing ones. The McDonald's corporation would get their money in the long-term no matter what. There really is no incentive to hurt one's own bottom line just to help someone else's. I would be willing to bet that if McDonald's did try to do something like, the board of directors would veto the move, fire all the executives, and those executives would never get a job again.

[GGT]

....and it's unlikely that a hike in labor cost would fully bankrupt existing ones.

FFS, make up your mind.

[Loki]

Clearly a policy is not so bad if it doesn't fully destroy everyone it affects.

[Lebanese Dragon]

15 dollar minimum wage, is clearly too high. 8 or 9, might be doable, especially if it's a federally set minimum wage meant to apply to all companies. The way you can get McDonald's and the people running the franchise to co-operate is to tax the profits they earn, this way they are still encouraged to maximize profits. This is because they are paid so much they never feel it not-worthwhile to keep trying their best. An average worker working for 7.75 an hour may feel it not worthwhile to work at a certain point, because their value of an hour may exceed 7.75 at some point.

Hey Loki if you had to choose between continuing to make a modest profit for many years and making a modest profit as a one-time thing which would you prefer?

Edit: The mother company, McDonald corporate would take some of the costs as well, because Minx is right if the cost of running the business goes up this will discourage people from going into McDonald's franchises, and or leaving franchises, which would lose McDonald's money in the long run, so to make their franchise still competitive, and worthwhile they will have some sort of state by state contract change for all affected McDonald's.

Perhaps they'll take a smaller percentage of profits, or just have some sort temporary cost increase compensation program.

[Loki]

Are you people living in the real world? How often do you see companies go "oh, the economy isn't doing too well right now; here, have some free money."

[Aimless]

True dat I've only seen it done by the fed

[Veldan Rath]

Yes, it's nice doing that with other people's money without fiduciary responsibility. (: