Rick Ormsby
Welcome to the restaurant boiler Room Season 6, episode 7. I'm your host, Rick Ormsby, managing director at Unbridled Capital, today in. The boiler room. I'll be digging into the state of the real estate market for franchise restaurants specifically and also commercial real estate generally. Joining me will be Crystal Mudo from Northmark. We will explore supply, demand cap rates, 1031 versus rate buyers, the impact of declining interest rates and the investment thesis for real estate investments overall. All the restaurant boiler room is one stop shop for multi $1,000,000 merger and acquisition activity and financial complexities affecting the franchise industry. We talk money deals, valuations and risk delivered to the front door franchisees, private equity firms, family offices, large investors and franchisors on a monthly basis. Feel free to find our content. Bridal capitals website at www.bridalcapital.com now. Let's enter the boileroom.
Rick Ormsby
General Market update. OK, so since the last time, you know you you've seen a podcast or or heard a podcast from us, I think we've had some deals closing in the KFC brand. We've had two deals closing and Wingstop brand one at Popeyes and then for the rest of the year at Unbridled Capital, I think works, projecting Closings and Taco Bell Burger King. KFC, Pizza Hut and Popeyes it's been. All told, probably what will be. I would say an average year for our company in terms of the volume of business that we're doing. But I'll tell you I think we've taken market share and I think the deals that we've got have been larger in size which which which I think we're skewing. Higher than everybody else, my guess is. The 2024 will be a down year for most people who would like us in this industry relative to even 2023 and maybe 2022 as well. It's been a pretty Slow Center part of the year from March to to now with new activity. But that's what. We have on the on on our docket there's. Still, a lot of kind of uncertainty with. Interest rates and presidential elections and things that all may shake out may make 2025 a bit of a more active year. We'll see how that goes as we get moving. I I just feel like. After three or four years, it kind of pent up demand of people wanting to buy and sell things. There are going to be sellers that come to the market in greater quantity of these QSR assets. It's just a matter of when it's probably going to happen in 2025. But but he knows you know, that's one. Kind of comment. The second comment that I'll make before we start is RFC is coming up restaurant. In development conference, it's at Le Fontaine Bleu, I guess is how you say it in Las Vegas in November. I'm doing a panel again for the third year in a row and this one's called accelerating growth strategies for franchising acquisitions. So if you come out there, you know, please attend. I think it's like 11:30 to 12/20 time slot on Tuesday. That's local Pacific Time local time and hang around before and afterwards. I'd, I'd love to say howdy to you and chat and answer any questions, you know, get to know you and I I certainly appreciate those of you who. Stopped me and say thank you. For these kind of. Things that we do during this webinar. If you have any questions, raise your hand. We'll see them and we'll try to answer them along the way. The way we've kind of fashioned this is we've got 10 questions I'm gonna ask if Chris and he's going to respond and then we'll send out a link to this webinar via e-mail afterwards A and then B, it will be. Be on our website at unbridledcapital.com. You could just go to the resources tab and you can find it after a couple of days and then see we will dub it to a podcast which will be Season 6, episode 7 of the restaurant boiler. So for those of you who are listening to this or will listen to this on the restaurant boiler and thank you. And what's up so with? That we'll kick on up. I will say hi to Crystal. Meadow of northman. I've known Chris for for several years. He's an old hat in the industry here with over 25 years of experience, so he's almost my age.
Chris Lomuto
As I said though, I'm very immature.
Rick Ormsby
Very, very immature. You act younger than you and some people say actually older than my age. Other but one of the things I've I've liked about Chris over the years of knowing him is that he is a very much a a. Tell it like it is person and he's very analytical and puts out a a really good amount, very specific analytical content. Those of you who know unbridled know that we are very analytical people, so I'm just naturally attracted to to that type of approach. So I think he brings a no nonsense approach to this and and and and I hope you'll find this this Lebanon real estate really informative. OK. So we'll jump right in. And so, Chris, welcome and glad to have. You aboard brother.
Chris Lomuto
I'm very excited to be here. You and I have been talking for a while. I I I we have a. I'll try not to get into the mutual admiration aspect of this, but I think you and I share, you know that affinity for the data and stuff like that. And so I think. We've we've clicked really well in that regard.
Rick Ormsby
For sure 100% and I'm excited. So here we go. Question #1. All right, so I pretended to turn my head as I read some of these questions #1. Is going to be what? Do QSR franchisees need to know about the state of the QSR real estate industry and specifically you know about sale lease back and value of real estate, so fire away and? And we're excited to hear. Answers.
Chris Lomuto
By the way, if it starts getting boring, just let.
Speaker
Me. Know you?
Chris Lomuto
Know we'll talk, make it a little more entertaining, but so here's my thoughts. What do they need to know about the, you know, like what are franchisees and need to know about the state, the. QSR real estate. I'm gonna give you the bad news first. No surprises here. Really. There's there's no escaping interest rates. The interest rate increases from 2020. In 2023, hit the real estate markets pretty hard. It was a pretty significant number of moves in a short amount of time. And as a result, the commercial real estate markets not, not just triple net not just QSR, but in general you know the commercial real estate markets have been pretty sleepy last year around this time. Cushman Wakefield, you know like another brokerage firm had put out some research saying multifamily transactions were down 72% year over year. Last year in October, which to me I I'm sure if we have some real veterans here, they could probably point to some other times in history. But to me, I can't remember a downturn that fast that significant before maybe during the height of the. Pandemic.
Rick Ormsby
72%.
Chris Lomuto
2nd, that's what Wall Street had published from Cushman wake of last year, Cushman said. By their count, multifamily transactions were down 72% year over year. That's astounding. Getting more current Globe St. last week published an article saying. From from you know someone in the industry that that said by their account, overall CRE, you know commercial real estate transaction volume was the lowest in July since the depth. Of the pandemic. So it's not been, you know, the most fun time to be a real estate broker. We're not, we're we're not meant to be a lot of millionaires in our industry. The last couple of years, but the good news, the good news is that realistically QSR is still in a lot of ways kind of annual when it comes to desirable. Triple net real estate and desirable real estate in general, it's it's still extremely popular for real estate investors. It's it's very, very liquid in terms of like getting in and getting out of it. It's very easy to own. It's it tends to be very reliable real estate in terms of like vacancy and and occupancy and stuff like that. There's not a lot of, you know, relative to like any other type of. We'll see. You can think of there's not a lot of vacancy in triple net in general, especially in QSR and then QSR has weathered a lot of storms and has done so better than a lot of other product types. So like demographic changes, demographic changes, in terms of people you know moving from from the suburbs to the cities and then back to the suburbs moving from. You know the center of the country to the coast, all that. Stuff the Amazon retail apocalypse several recessions. A pandemic work from home inflation. You know those those storms, you know, had a pretty significant impact on various types of real estate. And through all that, QSR has mostly come out smelling like a rose. And I think not only does the does the real estate. Industry understand that at this point, even people that are really not that tuned into commercial real estate have seen that now. So what are? What are franchisees need to know? Interest rates have affected all of us, but QSR real estate is still and why both king of the hill and I. Think a lot of people would probably agree with.
Rick Ormsby
It's funny you always your your perspective. Is that, you know, King of the Hill and and all this. Stuff, and certainly. It's been a fairly resilient industry. You know, I always tell people who are looking to invest in this. Business it's like. If you're not heading home lines in this industry, you're hitting singles and you're legging it out, sliding into second base for a double type of thing. It's fairly cash flow stable and such. But you know, we've had our own kind of bumps in the road on the operation side of the business across the country. I don't know the time frame, but I just saw a little article and yesterday was saying that QS, you know, like fine dinings down 6% same store sales. I don't know the time frame, I think it was, maybe that was fine and casual dining. Maybe it was, QSR was like plus 1 1/2, you know traffic and QSR down two or three. You know this this may not be representative of the whole country, may not be representative of, you know, of all the brands, but just to give you. Some perspective as you speak through this. You know, and for those of you who are listening, the traffic situation, heavy discounting. Lower traffic sales either flattish or modestly positive, but the industry is is trying to to bounce back itself, but given let's go to question #2, I think that was a. Great. First stop. But the first, then the next question is given that that. The net lease QSR. Real estate is still desirable. What has the impact? Been from these higher interest rates, so now everyone's kind of. Kind of juggling with. That what do you say, Chris?
Chris Lomuto
So from my point of view, there's there's been 2 main impacts, or at least that come to mind for me. So the first one is a pretty straightforward change in pricing kind of based on what I call like basic financial economics and. We have like a range of of people here today. You know, some CFO's and some that are really strong financially and others that are probably more operationally focused. So just for. Like quick refresher on context, when talking about like financial economy. That's so when banks we're talking about just everyday banks can park money at the Federal Reserve and earn 5% with no risk, which is kind of what the federal funds rate is telling you. Right. That risk reward relationship tends to filter through the entire financial system. And raises expectations on every other type of investment as well, right? Once once people start to see that you can earn a certain amount of award per unit of risk over here. That market forces will adjust the yields over here to bring things back into a into equilibrium. And so that's kind of like a fancy way of of saying a rising tide lifts all ships. So prices on investments that that have relatively fixed cash flows of which we can count, you know. Triple net real estate as one also mortgages and bonds and things like that, that those cash flows are pretty much fixed by a contract in our in like, in, in our case we're talking about. These investments, like that tend to be especially sensitive to higher yields because when your cash flows are fixed, there's really no chance of like raising the income in the future to get more yield out of that investment, right. You can't when you own a property with a lease, you can't just raise the rents, right, that that those rents are fixed in the lease. So the only way. Way to get more yield out of something with fixed cash flows. We can like get into all types of pedantics. If we have C, if we have. CFC's that are sitting here and share they would love to have a spirited debate, but practically speaking, for something with with like fixed known cash flows like a single tenant, you know real estate with a fixed lease. The only way? Practically speaking, get more yield out is to lower the acquisition price, so that impact. Is sort of. While it's unfortunate it is healthy and rational and expected, and I think anyone that. I mean anyone who who kind? Of understands basic finance would normally expect something. Like that so that that's. Sort of the first impact.
Rick Ormsby
To say it to simple man like myself, you know, if I could get 5% by jumping the money into a money market sign, why would I take all this risk and borrow money and do everything I gotta do to buy a piece of real estate for the same return, right? So so so.
Chris Lomuto
That's right. That's right.
Rick Ormsby
So and I.
Chris Lomuto
Would expect the.
Rick Ormsby
Premium to to do all of that. And what I bet you're about to tell me is that that premium is too small. You know, right now, therefore, things aren't selling really well. But. But go ahead. Yeah.
Chris Lomuto
Yeah. Yeah. That. Well, yeah. You you kind of already know that because you're on, you're on my market letter. So you already you kind of already seen that already, but yeah the, the, the second impact which is sort of more qualitative in nature, right, right. The first thing I'm I'm kind of I'm talking about like economics and finance and stuff like that. The second impact that is sort of. Like an unintended consequence of of rate chain. Is, and arguably what may be even more significant for our industry, like being the real estate industry is is demand destruction in the 10. 31 market. So 1031 exchanges are are way, way down. I I tried to get some data actually for this and I've been working with one of the big exchange companies to try to start quantifying what's going on with 1031 exchanges. But just take my word for it as a deal maker 1031 exchanges are are way down. There's really not enough 1031 buyers in the market right now to absorb all the deals that were sort of designed for 1031 exchange buyers. And I'm going to get a little financing here. Bear with me, that dynamic where we don't have enough 1031 buyers to absorb all the 10 quote UN quote 10. The one deals that's sort of pushing this bifurcated market back together like the these two different types of buyers that we call sort of the bifurcated nature of the market that's that's pushing them towards the convergence and that is to the benefit of buyers in the sense that it it's tending to lower prices and obviously to the detriment of sellers. So so what's the imp? Act of of rates lower prices relative to rents. And then we've got this demand destruction in the 1031 market which is which is like having this this compressing effect on the bifurcated market.
Rick Ormsby
Yeah, I'm sure you're going to tell us later when we ask another question, but because there's no not no 1031 buyers because they can't sell anything that they're trying to sell themselves, right? So in order to be at 1031 buyer, you have to have sold something and look to place it into a tax deferred vehicle and your lovely state of California that you know there's a lot of the lot of the buyers are 1031. Prayers I know historically just because your tax rates are so. High and let's. Go to #3 so question number. 3 is can you clarify?
Chris Lomuto
Can you clarify that bifurcated nature of the market and explain why why this matters? Good question, what do you think? Yeah. So at the end of the day, all we're really saying, I I hate the word bifurcation, but I I wasn't able to find a better word. It's it's it's so overused by brokers. But whatever the the bifurcation. Sort of cliche if you want to say that is kind of referring to. On the one hand, we've got these 1031 exchange, but. Players and on the other hand, we have kind. Of everyone else. And everyone else we can think of as as like it tends to be sophisticated real estate players of various sizes. You know everything from like pension funds to rates to family offices, it's it's it's sort of like it tends to be sophisticated. Real estate people. Who are sophisticated on investments and and have you know, decent amount of of funds to put into real? Estate so so. Those are kind of your two parties and that we now call like the bifurcated sort of dynamic of the market. So I would. Say the good news. On that is that at the sophisticated end of the market, which you know rates and pension funds and and people like that, that end of the market is actually really pretty healthy right now. When you're working in that end of the market doing deals, it's it's efficient, it's transparent, tends to be predictable, the deal makers. In that part of the market are are hungry. Yes, that part of the market has adjusted pricing because of interest rates they they had to. There was really no way around it. But but at the end of the market is still healthy. And I'll give you like a quick example it I brought 2A handful of. Sort of sophisticated buyers. A portfolio for QSR deals, you know, like 19 plus years remaining client that you had recommended to us, so small package of of QSR deals, it stabilized stuff and got immediate response from everyone that I presented the deals to. We had multiple offers. Within a week of of presenting it, the pricing fell right in line with expectation and and it was like clear proof of concept if. We needed proof. That, that, that end of the market is is functioning well. The other side of the bifurcated market is sort of where we have the challenge and these are the 1031 buyers and and you touched on this a little bit for background, these are tax motivated people, they're they're in a lot of cases avoiding. Really substantial tax liabilities like, you know, can be $1,000,000 or more of tax liabilities that they're avoiding. And the bottom line with these guys is like, you know you and you and I and everyone else on this webinar, you know, we look at a four and a half cap QSR real estate deal. And when you factor in rent bumps, OK, 4 1/2 gap deal. Like all other things being equal, we're probably talking about 6% returns once we factor in the rent increases. But the 1031 buyer looks at that same 4 1/2 squat deal and when they factor in their tax avoidance, that could easily be more like 7 to 8% returns for them, so. For them, 4 1/2 cap deal because they're getting tax avoidance is still very attractive, financially speaking. And in addition to, like their willingness to pay being a lot higher, they have very limited kind of negotiating leverage because as you know. They have this. 45 day clock. Ticking as soon as. They close their deal. They've got 40. Five days to commit. To a short list of of three properties, and so they end up being highly motivated. So when when? The market was really flush with 1030. One buyers you had this? Like large, steady volume of of buyers with with this like a distorted willingness to pay, you know, higher than everybody else. They were extremely competitive because they had a very short clock to work with. There was a lot. Of them, they. Had no negotiating leverage and as a result. You know these? 1031 guys were setting cap rates, tapping records like all over the place. So 515 market, it's your two buyer types, one being 1031 buyers and the other being everyone else and now you're starting to see as you already know because. You're on my market. Letter you can see now sort of like what? What the challenge is we all sort of became dependent on these 1031 buyers and they're just not as many as there used to be.
Rick Ormsby
OK, that's really good and it's helpful. I think this is going to be one of the key points of this webinar podcast. OK. So if you're watching or listening, we have two different markets turns as the buyers of real estate. If your franchisee one's going to be a 10/31 kind of buyer and the other is going to be at everyone else buyer. The 1031 markets really in left shape because people who are doing 1030 ones are tax motivated and they have to have sold something and are looking to exchange quickly. Well, they're not selling much right now because it's hard to sell things, especially commercial buildings and things like these that they might use to 1031 into and it's important to know that those same 1031. Tires are the ones that pay the best prices. Otherwise you have everybody else and everybody else is more of a rational buyer who buys based on current economics and current interest rates, and that market is pretty fluid right now, but the prices are different and I'm guessing different by 10 to 15% purchase price different. Let's jump into question #4, we got a couple of. Questions stack. That that was that was really well.
Chris Lomuto
And by the way.
Rick Ormsby
Ohh hey, hey. There you go. Thank you. Thank you. I. Don't know man. But #4 is. So you're saying the 1031 market at the moment it's kind of sort of crippled, let's just say, are we left with only one branch then right now? I mean, what, what, what? What's the storyline and and I know we're building up to cap rates, but we're going to be getting to cap rates and all these things that you're going to hear about here in about 5 or 10 minutes.
Chris Lomuto
Yeah. Yeah. In fact, I've got some charts and stuff like that that we can. We can look at current cap rates and trends and all that stuff that's coming up here in. In a little bit so. I would say that the. 1031 market is not. Dead. It's really not dead, but it is a much smaller buyer pool than it used to be, and that is part of the challenge. If it were completely shut down, it would, it might actually make things easier because the marketplace would be a lot more predictable and we could just say there's No 10. 31 buyers. Anymore, we have to go to the sophisticated players.
Rick Ormsby
The temp rate is 7 3/4 or 7 1/2 and just that's what you're going to take instead. You still see these emails that people are saying 5.75 or 6.25 cap rate and so people are confused, right? People are like what on Earth is going on here? I get this all the time and people ask me because we are.
Chris Lomuto
That's right. That's right. Right. That's exactly right. I I get it all the time. I I, I've. I've got stuff on the market and anyway we're gonna get into that later on here, but but you. But you you said it exactly. That's that's exactly part of the part of the town right now. Is that there are still 1031 buyers left. Meanwhile. Meanwhile, the supply of 1031 deals.
Rick Ormsby
Yeah, I'm sure you did.
Chris Lomuto
Has been ramping up and I've I've got some charts that we're going to look at later that will show that. But so, so it's like the supply has ramped up of quote UN quote 1031 tight deals and the deals that were. Were kind of built and underwritten and designed with the intention of of exiting to the 1031 market. Those types of deals have ramped up in terms of like the amount of inventory deals that are available that you know like are ostensibly 1031 type deals. Meanwhile, as we said, like the appetite will or the demand for those 1031 deals has. That's falling. So where is like the 1031? Market. For years, we all kind of got used to. Like this really liquid? Efficient, transparent, easy, you know, relatively easy to understand. Market being that being all these 1031 buyers now, it's like idiosyncratic. It's it's like inefficient. It's very hard to predict what's achievable in terms of price. It's hard to know like which deals will sell and which ones. Doing like looking at deal comps used to be a a really reliable predictor what was achievable. You know, assuming that you understood your market and you understood you know what buyer you know like how to push the buyer buttons you know the buy buttons and all that stuff assuming all that comps used to be all very, very reliable. Factor of what could be achieved. You know, selling a deal on the 1031 market now it's like if you put a dozen or two dozen very comparable deals on the market, you price them all similarly, some will sell, others won't. It's going to be very hard to predict in the 1031 market which ones will and which ones won't. It's very, very idiosyncratic. And it has a lot to do with who's in the 1031 market. At like any given point in time, and what pushes their buy button and a lot of times what pushes their buy button is like they have some connection to that real estate of some kind. They they went to College in that market, they grew up in that market. They have family in that market, whatever it is, they have some connection and a lot of times. That makes the difference between 2 deals that ostensibly look exactly the same, but you know ones on this side of Michigan, and this one's on the other side of Michigan, this little cell, because somebody resonated. That that deal resonated with somebody, whereas this one didn't.
Rick Ormsby
Interesting. There's not as much demand that you know and because of that, you're looking for a specific type of buyer which you can't apply to every piece of real estate that's that's there. And I'm going to move us forward if you don't mind the next. So the 5th question we had is given the new dynamic at the 1031. Market that you're referring. To here, what determines who gets a hit? The new strikes out, I mean, is it where I went to college is that if there's a property that pops up next to my. Drinking whole in college. I'm gonna buy it. Otherwise it it ain't gonna sell unless the price comes down by 10 or 15%.
Chris Lomuto
So part of this is, you know, like the real underlying drivers of triple net real estate that hasn't really changed and and that comes down to like what our former fearless leader of Seeing Dance Company before we were North Mark used to call the three legs of the stool, right. And the three legs of the stool were the dirt, the lease and the. In it. And so you, you know, like what, what drives value, what what's a large determining factor in whether deal gets done or not and and at what price it's it's sort of the quality of the dirt and and by that I mean real estate buyers tend to look at the same stuff that that the franchisees look at like demographics, what market is in like how good is the core. How does the? You you know the population density, traffic, all that stuff. So by looking at the the quality of the dirt, the lease, right, like how much turn was remaining on that lease, the more the better. So triple you know, triple that buyers and 1031 buyers have always. Loved 20 year leases. If they can get more than that, you know they love that too. And also on the lease are looking like expense treatments ideally you know absolute triple mat with the tenant you know paying everything and they're looking at how the rents of that lease compared to market. Hopefully you're under market not over market. And then the last leg of the stool is is the tenant right. So the dirt the lease. And it and the way that, that the buyers tend to think about the tenant is in the same way that lenders tend to think about borrowers, they want to understand like that tenants capacity to meet all their obligations and not just now, but also you know long into the future we're looking at potentially, you know 20 year lease term. And then 20 years of option, so the the buyers always want to make sure that that tenant like has the capacity to to meet all those up and and so so the the. So in addition to like the three legs. Of the stool. Now OK, dirt at least 10. Yeah. Now, now you've also got, like, luck, right? Is that 1031 buyer that for whom that your your deal resonates because you're you're on the the eastern side of Michigan not the western side of Michigan is that buyer in the market when you are that's part of it and then pricing is like more critically important than ever. Because as we said, there's there's more 1031 deals than there are buyers to absorb them all. And so with all else fails, you know you're looking at, OK, well, your last, your last letter to pull is is pricing.
Rick Ormsby
Let's let it go. Thank. You. Let's let's jump to. Question 6 and and and. Do probably time.
Chris Lomuto
For some charts, let's let's see some charts. But. Right going teeth up.
Rick Ormsby
Yeah, good, good, good. So the question specifically is for sellers currently looking to exit via the 1031 market. What does that look like? How does that compare with the sale to read? It's it, you know, the group of more sophisticated buyers. You know? So so, Chris, step us through that a little bit. If you call, you know, and bridal capital, we're just going to just kind of broadly tell you that the market is about a 7 1/2 to 7 3/4 cap environment. That's what we're going to tell you, you know, not knowing anything else. Geography, we're just going to just kind of give you that perspective and that is always the perspective of somebody who who buys it. If they're a sophisticated read an investor or a franchisee who would buy the the business as well, not the 1031 market. So here you go. Go forward, alright.
Chris Lomuto
So before I start running my app here like is it size running you can see. The charge, everything like that.
Rick Ormsby
I can't. Yeah, I guess. Yeah, yeah.
Chris Lomuto
Alright, So what we're. Looking at here is like listing activity per month across time. So in 2021 on average you were looking at like 63 QSR listings per month in terms of like deal flow onto the market of of of stuff. An offer and and I limited this to deals with like 15 plus years remaining on the lease so. Like new new sale lease. Back and and developer product and stuff like that. So big jump here in in 2022, in terms of like how much inventory was coming onto the market, I attributed that to like COVID backlog. You know stuff that got put on hold that came back online and appeared on the market in 2022. And and I also attribute this big spike to sellers like rushing their deals to market. As we were all starting to become aware that, like interest rates. Are headed up, but still even even. Looking at 2023 and 2024 year to date compared to 2021. What I'm saying right here is we're like at 137% of of what was coming to market in in 2021. So suffice to say a lot of inventory coming to market the last couple of years and that's continuing, you know into this year.
Rick Ormsby
Interesting. Interesting. I would have thought that. Thought inventory was lower but. Relatively high. Yeah. Keep this going. This is this is.
Chris Lomuto
Relatively high, yeah.
Speaker
Yeah.
Chris Lomuto
So the next question. You know, you kind of ask yourself, is. Like, OK so. We know there's a lot of inventory coming on to market and that's what this blue column is telling you. Again, it's it's going year by year, telling you you know of QSR deals, 15 plus years remaining on the lease, how many hit the market that year, that's the blue. The green is telling you.
Speaker
So.
Chris Lomuto
I'm going to caveat this here in a second, but the green is telling you how many sold and then the red is telling. You how many students sell?
Rick Ormsby
So I have not seen, I don't have actually. Have not seen these. Charts from you yet. Yikes. Look at 2024 on you today guys, 82% ain't selling. 18% are versus almost the opposite in 2021. Right.
Chris Lomuto
Now the thing I was sort of. Hesitating whether it was going to include 2024 or not. So here's the thing that. You need to know about 2020. This is gonna look a lot different a year from now and it's because a lot of the stuff that's come on to the market in 2024 these these 737. Listening so far. Lot of those that just had a. Closed. So I would say that my. Expectation is that when we look. Back at 2024, a year from now, it's probably going to look more like more like this. Can I don't? Know if you can see my cursor but.
Rick Ormsby
Yeah, I can. I can. Yeah. You're circling the 5050. So you're saying half of? Them sell half of them down. Maybe some of these deals in 2024 have it closed yet and the numbers will change some. I've got a random question. I got a random question that's off off topic. Is there an element of being damaged goods in the real estate market if you come out to the market with a price that's too aggressive and then you yank it off the market and then you go back onto?
Speaker
Go ahead.
Rick Ormsby
The market a. Year later, I mean, if you do that in our industry. We scream very hard on the front end to make sure clients have reasonable expectations, because if you put your business up for sale. And you've priced it too high and it doesn't sell. And then you come back to the market like a year later or you reduce the price. You know, there's this, like declining this, like cascading downward effect of the of the interest and pricing. What do you say and really Sir?
Chris Lomuto
I I think that's it can be a factor. I don't think it says. As much a factor for what we do, in the sense that the the real estate is is somewhat commoditized in the.
Rick Ormsby
This will be true.
Chris Lomuto
Sense. Where I think in your market probably there's more. My my guess is that there's more sense of like ohh you shop this around and no one wanted it and now you're back. So I have all the negotiating leverage. That's not so much of an issue on you know like in in what we do because the buyers tend to either like the real estate and they like the pricing or they don't. Whether someone else liked it or not isn't that valuable of information unless. Unless the feeling from the buyers is like, oh, there's something wrong with this. So for example, you know, like you, you shot the deal, you've had several buyers and none of them worked out. Then your next buyer is like, what's going on with this deal? Is there some? Is there some skeleton hiding that I'm going to discover later? And if I think that there is, do I want to invest my time, you know, like. And all the diligence only to realize that there's some issue that I wish I had known about on day one that killed it for everyone else. So I would say you don't like actively want to be like putting deals out that are, that are overpriced it. It doesn't really help you. But I don't think it's. As like urgent of an issue as it might be for what you.
Rick Ormsby
Guys do it it it is in our business, it is it is, it is and and it's one of the reasons why we accept far less than half clients who come to us. It's because I if I know that they're wanting more and wanting to price it's too high. I just I just it's just. Not worth it. And yeah, OK, very good. Keep going. With your charts, this is great stuff. I will, I will say I'll I'll make it.
Chris Lomuto
Quick, you know when the market was this? Like brokers and deal makers were. I think a lot more kind of accommodating in terms of like OK, you know, seller is a little bit unrealistic on price, but yeah, the absorption is so good. Like alright, let's throw it out there, you know and and and a couple of years ago like the market was really working in your favor. Like if you the cap rates were so we're going to look at. Cap rates here in. A second, but if if we go back to years past. You see, the cap rates were coming down, you know, cap rates, down prices up. So even if you came to market a little bit overpriced, if you waited six months, things were getting better you you might not have a buyer in in January, but in June you know suddenly that that five cap looks OK, so. But that that has changed now where I think brokers are a lot more reluctant to like make the investment into a deal if they really feel like it's overpriced. Because it it. Does it does start to get expensive after a while? You you know you list stuff and and you do make an investment and if and if there's no chance it's gonna sell because it's just way overpriced at some point. As as a deal maker, you. I just have to say no, it will happen at some point. Right. So I guess to tee up the next slide, the pattern HERE is like OK, 71% absorption, 55% absorption, 50% absorption. When we get to 24 numbers next year, like when all this when the dust settles on all these you know probably we're going to look something like this, half the deal sold half the deals didn't that's my guess. Pure speculation, by the way.
Speaker
We'll aim for. No.
Rick Ormsby
About another 15 minutes, Chris, before we kind of start, ask answer questions and wrap it up. So you you just go the way you feel like it's the best for me.
Chris Lomuto
Alright, so here we're just saying that in 2021 from the day you listed your deal to the day you closed, it was like 100 days. Now it's more like 200 days on. The average that's, that's just QSR stuff. So it takes longer to get these deals. The ones that do sell, it takes longer to. Get them sold.
Rick Ormsby
So 200 days versus 100 days and are just for those listening who are curious and interested, I would. Say you know. If you call us and you want us. To sell a company. For you and then we have a similar kind of trend here, but that but it's not as as extreme used to take us six months now it takes us eight or nine months probably so. We're not double the amount of time but, but I think it's indicative of just a harder environment, harder to borrow money, harder to find the right buyer, more contentious negotiations, the whole whole kit and. Thank you. Yeah.
Chris Lomuto
And then so this is my last one. And so this is telling us three things. The blue line is telling us what on average, what sellers we're asking for QSR deals with 15 years of. Term remaining or more. So the blue line is telling us what they were asking. The red Line is is telling us where those deals were trading. And then the gap between them is telling us sort of the the the bid ask spread and and how that's been evolving. And so when you look back in 2021? You could see like buyers and sellers were were pretty much pretty well aligned in terms of expectations of what things will work then, unsurprisingly, and I love it when the data works out this way, the data tells exactly the story you would think, which is when interest rates started going up in, in, in Q2 of 2022. All of a sudden you started seeing sellers telling buyers like. I'm not I I don't think I agree with you on on value there and it got you know fairly wide here. It got a little bit kind of narrow over 2023, this is. I think is sort of a quirk of the deals that have closed. I I kind of think that that this trend, you know like between these two lines I I kind of think that that's gonna end up kind of fairly consistent as we go forward in time but.
Rick Ormsby
But if we.
Chris Lomuto
Look at closing caps. The note I made here is is like over the last. Whatever it is three years 2 1/2 years. On average, you're looking at like 4 1/2 basis points per month has been sort of the rise in. Cap rates or? The rate of falling prices, cap rates up values down, and then the asking prices have been have been rising at about like 3 1/2 basis points per month on average.
Rick Ormsby
3 1/2 basis points. So today at this very moment, if I was to say hey, I've got an X YZ201 franchise in the middle of the country. For sale, just a spitballing, what would you tell the the the client? You'd you'd probably tell them you'd probably get us, and we'd probably get you a 7 1/2 cap rate from at least. What would you say you listed that you know kind of roughly, would you say 6.75 to 7 cap kind of range and be willing to negotiate downward kind of kind of thing? We're on the 1031 market.
Chris Lomuto
So it's it, it's. Gonna depend a lot on value drivers, so I'll I'll try to like give you a concise idea of the range. And and then we say we're talking about one. Unit or portfolio or did we say?
Rick Ormsby
I mean, I I'd love. To hear the answer, both honestly. But. I know we we don't have. All the time, you know, but let's. Just say 1 unit. Let's just be simple and say.
Chris Lomuto
OK, alright. So well, one unit deal you're probably going to the 1031 market like you know affected as it may be. You're probably still. Going to the 1031 market for that and your range on cap rates, assuming that we're talking about like you know, 15 to 20 year lease, that's the triple that all that stuff that the buyers. Like for like the best of the best. You know, for franchisee credit, you're probably talking about. You know, like if it's Florida, California, one of the preferred markets again best of the best franchising credit. You're probably shooting for somewhere in the floor caps. There's still a lot of inventory coming to market in the floor caps a lot. Of it's not. Moving, but again, you know, like the quirky, unpredictable nature of the 1031 market is. If you've got the time. And you've got the ability to like test the market, it's it's worth, it's worth testing it with the expectations are like OK, we don't know if if we're going to have our Goldilocks buyer or not, but but we might get lucky. So the best of the best of the best, yeah, you you're probably shooting for under 4 calf you may or.
Rick Ormsby
Now this this is, you know, this isn't most of the people listing most of the.
Chris Lomuto
May not feel it.
Rick Ormsby
People listening would be they own 30. Restaurants, they are the tenant. And so Billy, Billy, Billy Bob LLC is the tenant who operates the stores and is selling the real estate in Omaha, NE. OK, like just you know what I mean? So those have. Yeah.
Speaker
So that yeah, that.
Chris Lomuto
Yeah. So, so, so like, you know, small size franchisee personal guard. The.
Rick Ormsby
Yes.
Chris Lomuto
In Omaha, you're probably like 6 cap plus six and six and a quarter 6 1/2 something like that. You'll see most of your comparable deals are are trying to achieve like 6 cap. Now they're now they're starting to ask like 6 1/4, But they're probably closing at like 6 1/2 gap or something like that.
Rick Ormsby
That's good. See, this is that, that, that I think that's a probably a good good data point. Good, good perspective. At least let's keep going. We got a few more. Questions we can ask I. Know we're, I hope you. Guys have found this interesting so. For us, certainly have I mean anything more you want to say with the, with the, with the graphs or anything that we missed?
Chris Lomuto
No, no. Although if if people have. Questions I'm I'm happy to tackle them or we can go back to them.
Rick Ormsby
Let's go to interest rate cuts. Comments on interest rate cuts and and maybe also financing. How do you get financing for? These deals right now. So what do you? Think with the. Interest rate cuts environment. What's that going to do?
Chris Lomuto
So in the grand scheme of things, it's federal funds rate went up 500 basis points. They just paired it back by 50. So that's a 10% move. You know to the favorable side which is you know, quantitatively speaking it's not a huge move, but it's definitely good news. It lowered the cost of borrowed funds, which is important in commercial. Stay and it lowers benchmark yields, which you know like normally means. You know, lower yields, higher prices, so that's good. And then and then I. Think you know? Critical to this whole thing. Thing is, the Fed in the process of lowering Feds, I'm sorry. And in the process of lowering interest rates, the Fed made a real vote of confidence into the market in terms of like the inflation issue. And we've got that under control and and that is really critical and not talked about enough in the sense that uncertainty around inflation. And be like really troublesome and disruptive to to all financial markets, including the real estate market. So like is it like a light switch that's going to that's going to take us back to 2021? No. It's not, but it's definitely. It's definitely good news, and at least we're moving in the right direction.
Rick Ormsby
You would would you would anticipate some of these bigger buyers, these great buyers and these private buyers who are really pricing real estate on a day-to-day basis based on what they could borrow money for. That's where you probably would see some more immediate impact right on portfolio deals, multi unit deals, let's say you've got 10 pieces of real estate you're bringing to the market.
Chris Lomuto
That's alright.
Rick Ormsby
Those guys might actually. Give you a better price today than they did yesterday than they did last week. True or false?
Chris Lomuto
But yes, that is it. I think both logically true and demonstrably true. You know, like if we if we go look at what's happening with the offers and we go talk to some of those folks, some of whom I think are are on this webinar. I I think I'm I think it's acted to say yeah, they would. They would tell you like their cost of capital is a significant portion of of like how they how they value. Deals and stuff like that and so as cost. Of capital falls. Then it it positions them to be, you know, more competitive in, in terms of their offers and and get more aggressive on pricing.
Rick Ormsby
Did you see a? 50 point bid A50 basis point that interest. Big Cut eventually to those types of buyers. I mean, could that, could that mean their their offer on a portfolio piece of real estate or bunches of real estate could go from like a 7 1/2 to A7 and a quarter cap rate based on that 50 basis point move, could it? Could it drop by that much?
Chris Lomuto
You know, I think if we want to talk about like basic, you know, like just round concept conceptual level members. Yeah, it's a 15 point. How, like, what's that relationship between 50 basis points of of Fed change and and cap rate change. You know, I don't know. And it's probably different for each buyer and each buyer type. But so I think. Where we're probably. Safe. It's just saying, like in general it's good for it. It should be like credence to pricing for sellers that like interest rates are coming down. It it it? It should help the sophisticated buyers and and publicly traded buyers and lenders, too. It shouldn't help them to be like more able to accommodate higher prices. Than they were before. Exactly how much will depend on who we're talking about in circumstances.
Rick Ormsby
You know, this is a Rick Ormsby comment, but I bet when you comment on this that that that as cap rates start coming down or pardon me as uh interest rates start decreasing or declining. More people will become unreasonable about what they think their real estate is worth, and they look and they'll put their business and they'll put their real estate on the market and it'll sit at at prices that are too high because there aren't enough buyers to take down the real estate. And we actually might be in a position where the interest rate.
Chris Lomuto
God, I hope, I hope not.
Speaker
Yeah.
Rick Ormsby
Cuts themselves have no impact or a negative.
Chris Lomuto
Tax on the value of real estate for a short amount of time. What do you think? Yeah, I think that that psychology for sure exists in the market. And commercial real estate, you know, tends to have like you know it's it's more than its fair share of of sellers who kind of overestimate you know the the value of what they have. So yeah and I think you're spot on you know the the thing about commercial real estate and and and triple Matic QSR and all this stuff is that in the long run and you know this. I'm looking at my market letter every month. In the long run, like all the economic fundamentals and all that textbook stuff that that all. Proves to be. True, but it takes so much longer. So like in the in the in the stock market, you know, you look at the stock market, the bond market, those markets incorporate new information like instantaneous when, when, when we're in grad school, one of my professors played a video where they timed how long it took for the market to react to. To information like on Bloomberg and it was like 1 1/2 to 2 seconds, it was like you drop it into. Yeah, yeah, he's dropping now. Yeah. Is where is, where is like in the commercial real estate, where we're like 2 years into hiring. Trades and and sellers are are still like working their way to to like towards accommodating the market and all. That stuff it's. Just a really totally different.
Rick Ormsby
Animal. That's for another day. I would have liked to have gotten into the real the investment thesis for real estate, but that's the that's the side of it that I never quite understood as real estate. I mean as a finance guy by background, I understand. At for the. Liquidity that you get in the stock market, you're supposed to be able to, you know, expect a lower rate of. Turn. But when you have any liquid asset or one that doesn't reprice or is a little bit, you know like you're supposed to, it's supposed to be a little higher return. And yet in the real estate market, we don't always get that. See that see that kind of sensible relationship happening the same way you might see is investing in private equity illiquid but higher returning assets versus like stock market. Where you know that you're not going to beat the market, but you got liquidity, right and you've got transparency, but I guess that's what makes steel makers in the middle. Last question then before before we before we go to the questions would be what about financing, what do you say about financing, Chris, where are people getting their money these days?
Chris Lomuto
So I am. I'm gonna preface this by saying I'm I'm not the expert on, you know, like I'm not super close to the debt markets. I I I mostly look to our debt markets folks. You know, look. For that area of expertise. But I will say that you know, I'm happy to tell you what what they're telling me right now. Now, and what they're telling me is. Like you know, over. The up until this point, you know. A certain amount. Of the lender, pool had had sort of lost appetite for triple net real estate in general. You know they were somewhat overexposed to the sector. The lending rates were up, the sellers at the you know over the last couple of years were still trying to really low cap rates and that's. Kind of a tough environment to get deals done. You know it's it's, you know we talked about negative leverage where it's like, OK, every dollar you borrow kind of reduces your return because you're. You talk some. More to borrow with. Then you're getting out of the thing. You. Buying. So you you were looking at like negative leverage the the lenders were getting more conservative on loan to value because of what was happening to the values of the properties. There was more scrutiny on the credit from the lenders and that just made deals hard. So a lot of lenders. Had kind of. Put triple net in general on the back burner a bit financing was available, but. The smaller pool harder to get deals done now you know, as of as of a conversation I had. Today, with a loan broker that I really like working with, the feedback is that things are definitely getting better that there's like the appetite is coming back in as they as like that spread between cap rates and lending rates starts to improve. You know the appetite from the lenders is coming back. And so it's not, it's not so much that the lenders. Didn't want to. Didn't want the exposure to triple mat it's it's was more just an issue of like the numbers just weren't working and I and I think a lot of the lenders just said. Like it's just. It's for them. It wasn't like a a a good use of time. It wasn't a fruitful place to be. Lending was a AAA market because the numbers weren't working. And so meanwhile, just to kind of wrap up, you know, like the the lending aspect of it, what is still true now is that when you look at spreads and again, I'm just, I'm just kind of reiterating what, what? What my guys are telling me in recent memory like 200 to 250 basis points over the treasury rate. That was kind of what you expected from, you know, like your bank lenders and credit unions and stuff like that. And my guys tell me it's if that's still true, 200 to 250 basis points is like a good way to kind of guesstimate, you know, like where the financing rates are from, from banks and credit unions and. And so that would put you right now at like high fives. Low sixes maybe into the mid sixes on on the interest rate and then you know there's some. There's some like there's some range around that too where for certain deals certain circumstances certain types of lenders you may be able to dip into the low fives and mid fives right now or if you're like if you have a deal that needs to get created. Or really you need like like CMBS is your best lender than you may be looking at much higher rates than than I probably shouldn't say much higher rates, but you may be looking at sort of higher rates than. Than lower it's it's.
Rick Ormsby
Couple of questions. Thank you. I think as I look at the five or six questions we have here, most of the the the answer, but there's one that I that I like here which is what makes the difference state brands spot any comments you could make just specifically within QSR or outside? Territories areas of the country where things sell better than other places. Brands that are that are more, you know, exciting just minutes.
Chris Lomuto
Yeah. Yeah, this is a. This is a great question. I actually I did some data on this this month. Hold on, I'm pulling it up on my screen here.
Rick Ormsby
And if by. The way while he's doing this, if you guys are, if you're watching or listening and you have any questions, you know that that weren't answered. You want further information, just emailing you. You know how to give me and we'll try to plug into Chris and get questions answered for you along the way and you. Only so much you can do in one hour. We just got.
Chris Lomuto
Right.
Rick Ormsby
A couple of minutes here, yeah.
Chris Lomuto
I'm going to minimize my screen and then share this. Alright, so are you seeing my banded excel table here value and. All that, yeah. OK.
Speaker
Yes.
Chris Lomuto
So I looked at 3 value drivers to look at how significant they are now versus before. So like in 2021 if you compared. Deals over $3,000,000 to deals under $3,000,000 that this isn't so much cap rate as much as it is sell. Through or absorption. But in 2021, stay with me here, being under $3,000,000 was a 12% advantage in terms of your your odds of getting a deal done in 2023 was a 30% advantage. Being a small deal had like 30% advantage in terms of getting your deal done in 2024 so far being under $3,000,000. Over is a 76% advantage. Right. If you were, I looked at whether you're in a preferred market. So this goes to kind of yacht, whether whether you're in California or Florida versus you know Dubuque, IA or something, nothing else. Dubuque, IA but. But in terms of in terms of desirability of the market, same kind of results in in years past, yeah, you got a premium. Or or or you were better odds of getting absorbed, your deal getting absorbed, fewer in the preferred market. But as time has gone by. That's gotten more and more. Important. There's something weird going on here where in terms of how much lease term remaining, yeah, you can see the same as the others as time has gone by and we've gotten further into this stuff the last few years having the lease term has gotten more and more important in terms of whether you were able to sell your deal or not. There's something weird going on this year. See what what that is, but getting back to your question. Yeah, we can. We can quantify looking at comps like how significant is it to be. The you know preferred real estate market or or like the brand or the credit somewhere easier to quantify than others, but they definitely do make an impact which.
Rick Ormsby
Thank you for answering that. And I think that's a wrap for us. I hope you all found this Chris's discussion here, knowledgeable and informational. You know I I have. And so thank you for putting it together and being available. Thank you for everyone who's watching and who will watch. And thank you for for listening as well in the restaurant royal room. We'll get this information. Talk to you and on the website. I'll hope to see you at RF DC in in about a month and 1/2. Jeff and thanks again, Chris, you did a great job and we really appreciate.
Chris Lomuto
Alright, great. Yeah, anytime.
Rick Ormsby
Your time. Awesome. Thank you, guys. Appreciate everything. Take care. Thanks so much for entering the boiler room today. You can find our podcast on iTunes, Google Play, Stitcher, TuneIn and Spotify. If you like these podcasts, please listen, rate and review. I also encourage you to visit our website at www.unbridledcapital.com for the best franchise, M&A and financial resources in the industry. A website includes webinars, podcasts, videos, white papers, and a list of our past M&A transit. Questions. Please note that neither Rick Worms being normed. Vital Capital Advisors LLC give legal, financial, or tax advice. These podcasts represent opinions that have been prepared for informational purposes only. We expressly disclaim any and all liabilities that may be based on such information. Errors therein, or emissions therefrom.