Cap Rates



A Cap rate is also known as a capitalization rate and is the rate of return on a real estate investment property based on the income the property is expected to generate. If you are a franchisee who owns real estate, you probably get 5-10 calls a week (or so it seems) from companies who seemingly specialize in sale-leasebacks. These companies are seeking to list your real estate for sale, attempting to sell it in a big pay-day for a lease to a future buyer.

Hey, this is Rick Ormsby at Unbridled Capital. Today, I'd like to talk for a few minutes on cap rates. Cap rates stands for capitalization rate, which is the rate of return on a real estate investment based on the income that it generates. Cap rates are a critical component of figuring out the value of a franchise business, where a franchisee or operator owns the real estate. Cap rates have been at historical lows or near historical lows over the last few years as we've had continued low interest rates. Interest rates and cap rates kind of move in concert with one another. So as we were in a very low interest rate environment, cap rates are very low and it corresponds to very high values on real estate. We're expecting increases, slight increases over time in the interest rate environment and that will pull back the cap rates, making them higher and a lower real estate values as we move forward. And then one of the messages here is that you're at a very favorable time for your real estate.

You probably get four to five to 10 calls a week from sale leaseback providers and real estate investment trusts. And these type of people are interested in buying the real estate underlying your restaurant or franchise investments. On the large side, real estate investment trusts are big companies that own multi amounts of real estate all over the country. And that's their business model. On the small side, you'll have brokers that will be calling you representing an individual buyer who wants to buy a piece of real estate under a restaurant or a franchise. That person is typically come from a 1031 exchange situation, which is an IRS term called like-kind exchange, where they've sold, let's say a commercial building in New York. They're not wanting to pay taxes on that immediately, so what they're looking to do is roll that gain from that sale into another real estate investment without having to pay taxes. And that's been one of the key drivers of restaurant real estate cap rate favorability over the last seven to 10 years and certainly in the last 24 months.

What you're going to see about cap rates and we have all kinds of expertise in evaluating what the cap rate would be and the corresponding real estate would be in your various markets and in your brands is that cap rates fluctuate based on geography. You could have a great brand in Southern California where you could see cap rates in the low fives, all the way to a languishing brand in the Midwest that might be in the high sevens. And so that's a wide range, but it's very individualized analysis based on several key factors. Cap rates are one of the few things where you can actually get a higher price for your real estate individually, one by one then you can typically in a larger group because the 1031 exchange market is typically filled with individual buyers that want to buy one or two pieces of real estate, not these big REITs that aren't motivated by as much tax policy. And so they don't typically pay quite as favorable rates. This stuff can be complicated and we'd be honored to talk through what that means to you at any time.