Every so often, an investor pushes McDonald’s Corp. to get rid of its real estate, and every time McDonald’s turns those efforts back.
That speculation has come up again fairly recently, amid speculation that an activist might target the Oak Brook, Ill., company and push for changes. Some believe that any activist would resurrect the idea of spinning off the company’s real estate into a real estate investment trust, or REIT.
At this point it’s probably unlikely an activist would target the chain, not after its stock rose 12 percent in the weeks since CEO Don Thompson announced his retirement. Today the stock closed at $99.51, near triple digits.
But even if an activist does get involved, we still don’t think real estate will be a serious issue, because McDonald’s relationship with real estate is complicated, and valuable.
McDonald’s is one of the biggest real estate companies in the world. It owns $28.4 billion worth of land and buildings, before depreciation. It also leases the land, the buildings or both on 15,000 of its restaurant sites. In most cases, the company controls the real estate regardless of how the site or the building is obtained. It then leases those sites to the franchisees, often at a big markup.
We spoke with Richard Adams, a franchisee who now operates as a consultant for other McDonald’s franchisees. He provided us with a little context.
One of the locations he owned was in a shopping center. McDonald’s paid that center $2,400 per month in rent. It then charged Adams 8.5 percent of revenues. Adams got his restaurant up to $2 million a year, which means he paid about $170,000 per year, or more than $14,000 per month, in rent.
That was years ago, but the strategy remains the same. And how much McDonald’s charges franchisees for rent is based upon how much the franchisor paid to acquire and develop the site, or the building, but ranges from 8.5 percent to 15 percent according to the company’s most recent franchise disclosure document.
It’s a profitable business. According to the company’s annual report, it collected $6.1 billion worth of rent from franchisees, or about twice as much as it collected in royalties. The company’s rent expense, or the cost of its leases for land or buildings or both, was $1.06 billion.
That’s a margin of 82.7 percent. While that doesn’t factor in capital expenses — the reason many investors hate real estate ownership in restaurant businesses — that’s still a substantial income stream.
By comparison, McDonald’s company-operated stores in the U.S. had a 17.4 percent margin last year, and 15.9 percent worldwide — which, as an aside, means that the chain will forever face pressure to sell those stores to franchisees.
Activist investors often push restaurant operators to sell real estate because the returns on that real estate are lower than are the returns on restaurant operations, and because they hate capital expenses. But McDonald’s is fundamentally different, acting more like a landlord and a real estate broker than a restaurant operator.
It’s not just the income, either. By controlling its real estate, McDonald’s can select the top sites regardless of how they are available, which is the best possible real estate strategy for any restaurant company. It then controls those sites, and exerts further control over its system. The company has long said that getting rid of that real estate would wreck its relationship with operators.
Indeed, in its annual report, McDonald’s noted that its ownership of real estate along with a “co-investment” by franchisees “enables us to achieve restaurant performance levels that are among the highest in the industry.”
Suffice it to say, don’t look for McDonald’s real estate strategy to change anytime soon.