Will QSR Tenants Renew?

While on a road trip last week through Georgia and Florida, I noticed the dining room of every quick service restaurant (QSR) along the route was closed. Even in states like Florida, where many joke about the relaxed or almost nonexistent Covid regulations, what does this mean for renewals and future property values?

Worker shortages, pandemic precautions, and the shift towards online ordering and third-party delivery services are making everyone question the future and necessity of QSR dining rooms. While many QSRs have done well throughout the pandemic, the concern for investors is whether dine-in facilities with only one drive-thru lane will become functionally obsolete.

Online Ordering and the Drive-Thru

According to a QSR Magazine article by Danny Klein, 43% of patrons said they prefer to place their order by mobile phone, and only 14% of customers sat in the dining room (through September 2021), a decrease from 28% pre-pandemic. According to another Danny Klein article, major QSR companies are already adjusting the layouts and floorplans.

Some restaurants have already started rolling out adaptations to their traditional stores. Starbucks is opening dozens of pick-up only locations. Burger King is opening locations with two and three-lane drive-thrus, including one lane exclusively for online orders. Dunkin’ Donuts is rolling out its “Next Gen” store format which features a dedicated mobile order pick-up area. Wendy’s has created a delivery-only layout with no in-store dining called the “Ghost Kitchen.” KFC’s new “Express Store” is only 1,800 square feet and doesn’t feature a dining room. The new Taco Bell “Defy” is a two-story concept with four drive-thru lanes.

Mason Smoot, SVP and Chief Restaurant Officer at McDonald’s, reported in McDonald’s investor transcript, “We’re taking steps to accelerate our phenomenal drive-thru advantage [as] customers’ desire for convenience, speed, and ease will only grow.” Some fast casual restaurants are also branching out to capture some of this market share of customers who order online or only use the drive-thru.

For example, 60% of new Chipotle locations will have a drive-thru lane, and some layouts, called “The Digital Kitchen,” will only offer pick-up and delivery options. Shake Shack, previously dine-in only, has begun opening drive-thru locations for the first time and features three drive-thru lanes.

Investor Considerations

Developers are constructing facilities meeting the new demands of QSR tenants, including sites with multi-lane drive-thrus and smaller dining areas. As these new facilities are attracting QSR tenants, owners of existing quick service restaurants may be faced with the cost of rebuilding their facilities to secure lease renewals.

The lucky investors with big enough sites may get away with adding a drive-thru lane to the existing structure, however, Global Restaurant Consultant, Aaron Allen, reported the cost of adding a drive-thru lane alone can rise to $200,000. But most sites are tight, especially in high-density areas where QSR tenants like to rent, and demolition is usually required to rebuild the facility with a small dine-in area, if at all, to fit the number of drive-thru lanes necessary to facilitate delivery orders and online pick-ups.

The cost of rebuilding comes with a high price tag. After a demolition permit is granted and all special requirements are met, the cost of demolition alone, according to Hometown Demolition, averages $10,000 to $45,000 depending on municipality disposal costs, construction material being removed, and cost of living in the area. As for rebuilding the facility, RSMeans estimates the average QSR costs $1,100,000 to $1,400,000 to construct, with location being the biggest variable in determining cost.

Many tenants will not like the idea of shutting down their restaurants for the time required to facilitate a demolition and rebuild, and many may find moving to a newly constructed facility nearby when the lease comes up for renewal a more attractive option.

Options

Get ahead of the issue. If you own QSR-tenanted properties, consider selling and exchanging into properties with higher renewal probabilities while the lease still has suitable term left. For an analysis of opportunities to match your goals, reach out to Michael Bull, CCIM 404-876-1640 x101.