Rick Ormsby
If you're listening to this, it's going to be season 8, episode 7 of the Restaurant Boiler Room. And thank you for all those who listen. That continues to grow, that platform. And really cool that folks are finding a way to tune in on podcast. And I can't believe it, man. We're almost towards the end of season 8. Admittedly, this isn't trying to be the next Joe Rogan podcast. But one day soon, I'm going to wake up and have done 10 seasons of a podcast. I mean, what the heck? You know what I mean? I don't know. My wife tells me I need to stop talking so much, but I can't.
Chris Lomuto
So, but hopefully you'll know you've made it when you have Terrence Howard on to come talk about how 1 * 1 equals 2.
Rick Ormsby
the crazy thing is, all these podcasts, I mean, it's mostly me just talking. I don't know. I'm thankful to have you. Over the years, I've kind of dialed back the guest speakers just because, I mean, frankly, I've noticed that people that do tune in, tune in for something that's very specific. And I appreciate that. So we try to keep the content really specific and related to valuations and buying and selling franchise restaurant and franchise non-restaurant concepts and real estate's a big portion of it. In other words, a time 10 years ago where maybe 60% of the businesses that you sell had real estate attached to them. It's becoming less and less now, but it's still a big portion of the value that's created when someone goes to monetize their life's work. And certainly there's a major professional market for buying triple net real estate. And that's why we have Chris here. And so Chris, we'll go ahead and start it. Thank you so much for joining and being a part of year three. And let's go ahead and kick it off. I doubt you need another introduction. Everyone knows you, but Chris, has been just a tremendous asset, does a great job, and we've worked with him on many assignments. And so he's highly endorsed by the Unbridled team, and he's got a great demeanor for digging into the technical nature of some of this real estate stuff. And so we'll try to do that today. Let's go ahead and get her started. What do you think? You want to pull up a slide and start talking?
Chris Lomuto
Yeah, and let me just quickly kind of run through the notes that I took to kind of give you the lay of the land in a nutshell. Same thing I was saying to you yesterday offline. In the grand scheme of things, the franchise, specifically QSR restaurant real estate market is pretty much in line with the rest of the triple net real estate market right now in terms of the trends. 2022 was a really strong year. That was kind of the peak for franchise real estate in terms of valuations and cap rates, where cap rates really bottomed out. Low cap rate means high value. Cap rates kind of bottomed out in 2022. Interest rates started going up early in 2022. And that's when things really slowed down in the triple net market, including in franchise real estate. So 23, 24, pretty sleepy years. There was a market, but it was definitely slower. Last summer, 25, we saw things really start to pick up. We came into 2026 looking pretty strong, but a little bit cautiously optimistic. And then since Q1 of this year, with interest rates rising again, the 10-year treasury kind of bumping up against 5% most recently, which is high in historical terms, that 10-year treasury tends to be what most directly pushes cap rates around. So since Q1 of this year, we've seen the triple net market starting to soften. It's not kind of a hard reset like we saw in 2022, but it looks like it's softening. I'm paying really close attention to the indicators. That's I think what we're going to spend some time probably touching on today is things are still pretty good in relative terms, but the indicators are saying we might be getting softer. And I'm getting a little bit I'm thinking more about 2027 and what 2027 is going to look like. So there you have it.
Rick Ormsby
Okay, and I think that's consistent with the comments that we've seen on the business side when people are selling businesses. what operators are dealing with is slightly different. I mean, they're dealing with labor and food costs and things that have, higher spikes and seasonability and all kinds of stuff, seasonality, not seasonability. and we're also dealing with Ozempic, less demand, less immigration, all these things that are kind of affecting top line revenue in the restaurant business and over building, kind of coming to roost after a couple of years. But it's interesting because we'll sing from the same sheet of music for a lot of this discussion. I think kind of the same comment is coming through on the business side. A lot of Uncertainty about 2027. Just not sure what's going to happen. I mean, our deal flows down quite a bit. I think we'll do 2026. We'll have a good year this year on the heels of probably one or two brands that have done well and bigger assignments that we've been working on. But across the spectrum of the QSR business, it's been kind of a bit of a barren landscape. A lot of phone calls of clients who aren't doing as well as they were, whose businesses aren't worth it as much as they used to be. And we're just not sure 2027 will hold. We'll have to see. But I know you're more closely watching interest rates. Now we're gonna geek out a little bit, so just stay with us here on some of these things, because I think they're just like some really meaningful slides that tell us more than just real estate stories along the way, by the way. So keep in mind too, Chris, that a lot of people, probably 3/4 or 90% even of the people who are gonna be listening on podcasts. So we wanna make sure to explain to people who can't see, but essentially what we're looking at here looking graph from 2021 through 2026 year to date. And it shows like 5 different trends. One's gonna be the difference between asking cap rate and closing cap rate. And the other is going to be, we're gonna be showing the S&P earnings yield. We're gonna be showing I don't know if the gray, oh yeah, the 10-year treasury, and then we're gonna be showing the Fed funds rate. So what jumps out at you when you see this? I mean, obviously in 2022, at the end of 2021 and 2022, we started seeing the Fed funds rate increase substantially. At that time, we started seeing, kind of the after effects of cap rates that kind of started to drop quite a bit because of the supply and demand from 2027 having a, or 2021 having a lingering effect, right? And then go ahead and explain what you see here to us.
Chris Lomuto
Yeah, so since not everyone has it in front of them, it's a chart with five lines going across from left to right, tracking several different things, cap rates, being one of them. And then looking at Fed funds rate, treasury rates, and what's going on with the S&P 500 earnings yield, which is sort of like a yield on the S&P 500 stocks or a cap rate on S&P 500 stocks. That's the idea anyway. And so sort of just looking at like, okay, what are these things, how are they behaving relative to each other? To me, the big takeaway is that on the left-hand side of the chart, we start in January of 2021, and the Fed funds rate is almost zero. up until about March of 22. And then that's when you start to see the Fed funds rate climb, climb, climb all the way up to a little over 5%. So the conventional wisdom in commercial real estate has always been when you see interest rates climbing, you're likely to see cap rates climbing too. Rates up means values down, same as with bonds. And so here you do see that happening, but cap rates change much less than the Fed funds rate did.
Rick Ormsby
That's a big one, isn't it? Like, as you could just see it, like you'd expect cap rates to travel almost, I mean, just me, I would have thought like quite a bit more closely to the 10-year treasury, but, or the Fed funds rate, but it doesn't. I mean, it's only tracking like to 20 or 35, 20 to 35% correlation, really, isn't it?
Chris Lomuto
Yeah, the Fed funds rate went up a lot and cap rates went up a little. And there's a couple ways to look at that. But the thing that this chart doesn't tell you is that the cap rates, interest rates went up a lot, cap rates went up a little. But the other thing that happened in the triple net market was the volumes went way down. And I think the takeaway there is that the sellers, The sellers were able to move to a certain extent. they moved as much as they were able to or willing to move on price to kind of meet the market, but they couldn't move all the way or they wouldn't move all the way. And a lot of sellers just sort of took a while. If I can't get the price that I was able to get a year ago, I'll just hold onto it and wait till things get better. And that worked for a lot of sellers, I think, however we define that working. They ran with that strategy and have largely been able to hold onto their real estate. But a lot of would-be sellers just were not able to sell. And we saw a lot of inventory build up on the market, which we can see in future charts here.
Rick Ormsby
One of the other things I just noticed, again, going back to the Fed funds rate, since like August, September of 2024 to now, the Fed funds rates moved down probably, I don't know, the numbers, it looks like maybe 5 1/2 down to like 3.75. Whatever the number is, it's moved about a point and a half, 150 basis points downward. So a lot of the people who are on this call are gonna be saying, oh, when Fed funds rate decreases, interest rates drop, our cap rates should be better. But I mean, because of the supply and demand and the state of the economy and some of the other things you just talked about, look at what's happened to the cap rates, the asking and closing cap rates on these 1031 deals. They've basically stayed the same in terms of the price or the cap rate while the Fed funds rate has moved down pretty substantially. So that's interesting too, isn't it? And I think goes a little bit contrary to what people might think.
Chris Lomuto
I think the real insight here, at least to those of us who are thinking about cap rates all day for a living, is definitely the last few years confirm that interest rates absolutely impact cap rates. What we've seen is that you can't predict one for one. First of all, there's definitely a lag here. I mean, you can see as the Fed funds rate was coming up, cap rates were still coming down, at least on the closed deals. So there's definitely a lag here, maybe six months or thereabouts. And then to the degree that interest rates change, cap rates did not move to that same degree. And then to your point, they started, you can see here, this is like July of late 24. The Fed funds rates started coming down. Meanwhile, cap rates were kind of bumping along averaging around 7% on closing caps. They didn't start coming down until, to me, it was sort of like late last summer. You started to see them kind of drifting down. It's a pretty gentle line, but they started coming down kind of last summer. So there's There's definitely a lag and they don't move one for one. And I think that's something that we're really able to appreciate now more than we were before. We just have a lot more information as to how impactful the relationship is. Okay, enough of that.
Rick Ormsby
It's excellent. It's excellent. Let's move to the next one, but I'll just see if you're listening to the podcast. I think the takeaway from the first slide is twofold. Number one, there seems to be a six to nine month lag between the time there is action at the Federal Reserve, up or down on the rates to the time it affects the 1031 market. So that's a number one point. And #2 point is it's a way more complicated situation than just interest rate moves up and cap rate moves up. It doesn't necessarily work that way because sellers may not sell, buyers may not buy, the environment might be good, the stock market might be going really well. earning yield on the S&P 500 might be great. You know what I mean? And so there's all these things to take it into play. So don't assume, because I get these calls A lot. Hey man, Fed funds rates dropping or going up. We need to do something quickly. And I just would urge people not to think that way because it doesn't move so explainably and so quickly as people think.
Chris Lomuto
It's the right way to be thinking about the market. Directionally it's correct, right? If interest rates are going up, you can safely assume that in the long run, if interest rates are up in the long run, the cap rates are going to go up in the long run. And vice versa. With interest rates falling, if they continue to fall, then in the long run, cap rates will almost certainly follow, at least directionally. It's just not quite the one-to-one perfect correlation, all that stuff. It's a little bit looser than that.
Rick Ormsby
Good deal. Let's jump to #2. I beat that one to death. I'm sorry about that.
Chris Lomuto
I'm gonna count on you to cut me off. I'm not going too long.
Rick Ormsby
Okay, yeah. Well, the next one's a good one for those of you who are listening on the podcast for sure. It's a difference between supply and demand. And all these slides that you can see or can't see are gonna be like the last five years. And so basically you're gonna see like these two lines come together in 2021. Basically, we all knew, and QSR is the same thing. There was like any deal that was on the market had lots of buyers for it, right? For all the reasons we talked about in prior webinars and podcasts. But now there's a gap between, there's like, it looks like what, 250 new deals come on the market, and then there's 150 buyers, deals that sell. We're showing kind of consistently through all of this, aren't we, Chris, that somewhere between half and 60% of these deals Or at least what
Chris Lomuto
we're able to get comps for. So there's probably some slippage where there are deals that are closing that we don't get comps for. And that's what I'm tracking. We're probably, as an industry, we're probably closing. So the red line on the bottom of the chart is what's closed. and the blue line on the top of the chart is how many listings came to market each month. The spacing between the two lines is sort of saying like, okay, well, like if we look at 2022 Q3, the chart is saying there was lots and lots of supply relative to how many deals closed during Q3. So the space in between is sort of like, okay, that implies what didn't close. I wouldn't take that too literally on numbers because we don't capture everything that closed. But that's the idea. So on this, I tend to say it's more looking for trends than we are hard numbers in terms of how many came to market and how many closed. I would say the trend is more the important thing.
Rick Ormsby
Broadly speaking, supply is increasing slightly faster than demand over a five year time period. I mean, right?
Chris Lomuto
That's the implication. Yeah. What I notice is that they're both increasing over time, right? From 1/4 to the next and over several years, the supply, and this is just QSR, new build and sale lease back. I tried to contain the data to just new build and sale lease back QSR. Over five years, I see both lines generally trending upwards, right? We're getting more triple net listings of QSR over time, and we're also selling more triple net listings over time, right? They're both going in the right direction overall, which is good. They're both going in the same direction overall, which is good. We want.
Rick Ormsby
And the difference between supply and demand doesn't seem to be changing a whole lot over the last couple of years, right? I mean, just generally speaking, since late 2023, it looks like it's staying pretty roughly the same.
Chris Lomuto
Yeah, you have some tall peaks in supply, which tend to correlate with kind of end of year, right? Towards the end of the year, you tend to get a big boost in supply where sellers decide like, okay, let's get this done. And in this case, in 2026, right? Like, let's try to get this done in 2026. That tends to be why there's just some seasonality here, right? And then as you go into Q1 every year, supply tends to be a little bit lower.
Rick Ormsby
It's an interesting point, isn't it? What do you think? So all things equal, take all the other extraneous things out of this. If you were a seller of a piece of real estate, would you try not to sell towards the end of the year if your taxes didn't necessitate you doing so? Because it does look like from this chart that there's more supply relative to the demand towards the end of the year. It looks like I'd be a Q1 seller is what it looks like to me if I wanted to have more demand, less supply.
Chris Lomuto
What I see, this is where my head is currently as well for this year. You see a big spike in Q4 almost every year. And that to me is telling you that everyone's trying to meet their mandates.
Rick Ormsby
Oh, there's the buyers. Okay, the buyers. Okay, so buyers are spiking at the end of the year.
Chris Lomuto
Okay, Yeah, so it's almost like the sellers are, I don't know that the sellers are necessarily anticipating the buyers closing in Q4. I don't know that it's that. The seasonality of listings and stuff is not something that I hear about a lot. In fact, I'm the only one who really seems to talk about seasonality of field flow right now. But I think what's happening is that the sellers are looking at, let's get this done by the end of the year. And so they're putting them on the market in Q3 and the buyers are saying, let's get this done by the end of the year instead of closing in Q4.
Rick Ormsby
Okay. Yeah, that makes sense to me. Okay, next on to the next one. Let's go forward.
Chris Lomuto
I'll make it real quick here just for 2026. I made these red and green highlights on here just to look at. I wanted to know for myself, it looks like from Q1 to Q2, the transactions were slowing down a little bit this year. And so I wanted to look at like, okay, is that usual or unusual, like seasonally speaking? And it's about 50-50. Over the last five years from Q1 to Q2, about half the time transactions rose and about half the time they fell. The fact that they fell from Q1 to Q2 is not a strong indicator. It may be telling us something, but it's not a definite indicator. Okay. So sort from trends.
Rick Ormsby
So what does that mean for someone who doesn't see a graph?
Chris Lomuto
We're looking at trends in how many of the deals are closing. So however many listings come to market in any period of time, 1/4, a year, how many of those deals closed, based on what we've been able to find for comps, for deal comps. And so again, we're looking for trends to see if things are changing. And from that perspective, in 2026, we haven't been closing as many relative to number of listings. The absorption of those listings in 2026 was maybe not as strong as it was in 25, but still pretty good relative to the last five years. And part of it too, what this chart isn't telling you is that if there's a lot of supply and the same number of buyers, that will drive the absorption down just because numerator up, denominator stays the same or vice versa. It doesn't necessarily mean there's less buyers, it could just mean there's more sellers. And so if we flip that, then we can see, okay, actually there were a lot of sellers in 2025. The fact that we're not fully absorbing everything in 2026 isn't necessarily telling us that the buyers aren't here. It could just be selling telling us that there's a lot of sellers right now, which that definitely was the case in 2025. There was whole lot of inventory coming to market and buying activity was good. I mean, if we look at buying activity, it was high relative to the last five years. There's just so much inventory coming to market. It wasn't all getting absorbed.
Rick Ormsby
For those of you who are listening, not watching, I guess the point would be basically since the second quarter of 2024 to now, we've been hovering around 50 to 60% of the deals that come to market are closing. Back in 2021, there was a period where it spiked up to 90% almost, 89%. And then it fell in the middle of 2022 down to 38% of the deals closed, which is pretty consistent with kind of the rapid and abrupt change in circumstance in our country between 2021 and 22. But otherwise in the last couple of years, it's been hovering between 50 and 60% of the deals coming to market close. And it looks like it's a little bit lower in the last quarter than it has been. we may, we hope we don't see that trend continue to dip and see more coming to market and less closing in 2027. Let's move to the cap rate trends if we can.
Chris Lomuto
To that, by the way, I would just say again, for me, putting all this data together, it's the trends that I'm more focused on than the raw number. Because again, we don't capture every deal. So your comment was like, yeah, 50 to 60% are closing. It's probably higher than that. I don't know how much higher because it's almost impossible to track every single deal and what happened because deals get done off market. They don't all get reported. So for a franchisee who's saying like, oh, I only have like a 60% chance of actually selling this if I go to sell it. No, that's more pessimistic than reality. What I'm sort of tracking here is like, Are your odds better or worse than they have been in the past? And I would say they are currently better than they have in the last five years, but compared to 2021, we were closing deals as fast as we could listen. That was the really red hot market. Okay.
Rick Ormsby
Cap rate trends. Okay, so what we're gonna talk about now is basically what's happened with the cap rates over the last five years, right? Which for QSR concepts, this is a great slide. And I think this is going to strike to pretty much everyone who's tuning in, which is basically looks like the closing cap rates, back in 2021, 5 1/2 all the way down to mid 2022, they were below 5. And now they've been cruising kind of on a slow upward trajectory that kind of peaked around the third quarter of 2025, around 6 cap. Then we dropped a little bit, but now we're, so now we're kind of in the 5.75 cap range and headed slightly upward. It looks like obviously with the Fed funds rate just increasing and kind of the environment probably not being the best. We'll probably, who knows, but we may be back it to the six cap rate. And to keep in mind, this is a six cap rate for 1031 buyers, right? Not if you're trying to negotiate a deal with your next door neighbor necessarily. This is somebody who's tax motivated and is probably a California high with a boatload of money in his pocket and has to flip it into another piece of real estate in 90 days or less. So just be mindful of how to apply these cap rates. Go ahead, Chris.
Chris Lomuto
These cap rates are sort of biased towards 1031 exchange buyers. We don't have big portfolio transactions in this data. So if a REIT buys 100 deals from another REIT, that cap is not in this data. Or even if a REIT buys a portfolio of 10 or 20 or 30 deals in a sale leaseback or something, most of those transactions are not in this data. This is so to your point, yeah, this is mostly sort of 1031 exchange type deals.
Rick Ormsby
But I want to stop for a second and make sure that everyone understands this point really clearly, because people will take this, they always do, they take this information and they apply it the wrong way. So if you hear that the average cap rate in 1031 in QSR is a six cap right now, It doesn't include, does it, the amount of fees that, so that's like, you should be thinking of it being like a six and a half cap rate if you're gonna be paying fees to sell your real estate. And it doesn't include a 10th, like a REIT buying the properties. And a REIT is a different buyer who usually buys at a 75 basis point higher cap rate than this.
Chris Lomuto
it could be as close as seventy-five basis points for the right deal. It could be 100, 125, 150.
Rick Ormsby
So when someone sees here and reads the six cap rate, because they're liable, most operators are liable to spend one minute on this and see a six cap rate and walk away. It really, the average cap rate, if we blend it with REITs and we add fees to it, this number is around 7. It's not 6. True or false?
Chris Lomuto
I guess my thought would be on average, they're closing at six. Obviously, there's going to be arranged, depending on sort of the specifics of the deal and all that stuff. You're selling fees. If we're talking about one property at a time, typically in triple net to the types of deal size that we're talking about, if we're talking about just one property at a time, you're probably looking at fees of 3 to 4% for brokerage commissions and then maybe like a half percent to 1% in other closing costs, title fees and escrow fees and stuff like that. So I think figure like on average, they're closing at six. It'll range depending on the details. There's still lots of plenty of QSR out there selling in the five cap range. There's even, there's still stuff trading in like the three cap range. That's mostly like the corporate Chick-fil-A Raising Canes. in the preferred geographic markets. But that just shows you there's a pretty wide range of deals. If you figure like the average deal is closing at 6 cap and then figure for round numbers 5% in total selling costs for brokerage commissions and escrow and title fees and all that stuff, then you should be pretty close.
Rick Ormsby
It looks like the closing cap and the asking cap have really kind of come together in the last couple of quarters. What do you make of that?
Chris Lomuto
Yeah, I think that's right. I mean, they were right on top of each other there in kind of late 2022. With the closing cap rate data, you figure it takes a deal from the time the price gets negotiated till the time there's actually a closing cap rate put on the books. That can be 75 to 90 days. So these closing caps are showing us prices that were negotiated like a, half 1/4 before then, which actually kind of tracks, right? When you see the, when the asking cap bottom, roughly, 90 days later, you see it showing up in the closing caps.
Rick Ormsby
Yeah, interesting. Any other takeaway, 30-second takeaway that you make from this?
Chris Lomuto
No, I don't think so. Just as you said, where pad breaks were coming down starting last summer, and then you see them kind of bottoming out again in Q1. And then based on the Q2 data, it looks like they may have started rising a bit, which is what you would expect with rates changing. You would expect to see something like that.
Rick Ormsby
It looks like we may be forecasting a increase in cap rates, both asking and closing cap rates for the next few quarters. Who knows? We'll see what the data tells us. But the point would be that when the cap rates go up, the prices go down.
Chris Lomuto
That's right.
Rick Ormsby
And so, yeah, something to keep watching. But otherwise, it's been pretty consistent over the last, let's call it three years. If we just draw a straight line, you know, the closing cap rates in QSR are gonna be like averaging a little under 6. the asking cap rates are going to be around 5 1/2, right? And there's usually, is that normal that usually someone asks for a half a point better than what they usually accept? I mean, so, which is what, about 8 or 9% on the price, roughly speaking?
Chris Lomuto
decades of deal making and stuff like that. In triple net, we've all been sort of programmed to think about 25 basis points as sort of your typical. And so that the sellers are usually told like, okay, if we think the deal trades at, you know, five and three quarter cap and price it at 5 1/2 cap, we think it closes at 5 1/2 and price it at 5 1/4 cap. The logic there is 25 basis points tends to be what the buyers think is worth spending their time on, like, okay, I think I can get 25 basis points out of the seller. But if a buyer comes into a deal thinking they're going to get 100 basis points out of the seller, usually the buyer decides in the end, like, oh, that was kind of a waste of time. Like, we just couldn't, the seller wasn't willing to move that much. So it's kind of a feedback loop a little bit where it's like, okay, the reality is whatever your expectations are. And so the expectations nowadays for the last 10 years or so has been like, yeah, the sellers are usually asking within 25 basis points of where they think it's going to trade on average. And buyers are sort of expecting that much negotiating room. And then you're kind of starting from there and working within that. And then of course, every deal is different. So any rule that I give you, throw out the window on any given day.
Rick Ormsby
No, that's helpful. It's helpful though. It's helpful. I hope you all listen to that and maybe jot that down. Let's go I always like to talk about cap rates by state because several years ago, I mean all these years ago I guess now, I realize that things don't sell the same in different places of the country, So for those of you who can't see, we're looking at a US map and basically Chris has pulled comps from all these different states. To give you some perspective, I'm just eyeballing this quickly. Michigan's the worst at 6.4 cap. Did I get that right?
Chris Lomuto
Yeah, that's right. Michigan is 6.4.
Rick Ormsby
And then Delaware is the second worst. And then the best cap rate is in California, Maryland, Florida, Texas kind of areas of the country. And the swing can be a 6.4 cap in Michigan to a 5.34 cap in California. And that's over a full 100 basis points. So it can be pretty substantial. Like my homegrown state of Kentucky is a 6.09 cap rate. And my inherited state of Florida here is it what, 5.4 something, right? Or 5., I can't tell, 5.48. So you can't just talk about it globally or nationally without digging into the details. What else do you see?
Chris Lomuto
I think that's right. I kind of highlighted the median is just under 6 cap, which aligns with what we were saying a minute ago in terms of like the average cap. So yeah, you're kind of averaging around half the deals are above 6 cap, half of them are below 6 cap in terms of closing across the country. And yeah, I think intuitively, if you ask most brokers without referencing hard data, I think most triple net brokers would probably tell you like the difference in spread from the most preferred markets according to buyers, what they prefer. If you ask them what that spread is from the most preferred markets to the softest markets in terms of cap rate, they would probably tell you intuitively, yeah, it's probably around 100 basis points. That's what the data says as well.
Rick Ormsby
Yeah, for those of you who are operators who are listening, just be mindful of some of this, because again, you get the emails and you get the cold calls and all this stuff. And if you're sitting, for example, let me give you a state like Illinois or Mississippi, you know what I mean, where the cap rates are not as favorable as they would be in like Texas or Florida or California, Don't be thinking, because the difference between a Louisiana and a Texas cap rate is 75 basis points. 75 basis points is like 15%. So I mean, all things equal, if you own a whatever, a Popeye's restaurant in Texas and a Popeye's restaurant in Louisiana, I mean, this doesn't always work this way, but it might be worth $2,000,000 in Louisiana and it may be worth $2.4 million in Texas. It could be a substantial difference.
Chris Lomuto
Yeah, I would say that's right. The thing I think to bear in mind is within every state in the country, there's going to be a wide range. So we said what, Michigan, right, was 6.4 on average. That was in this data set from the last 12 months, which is what I used. From that last 12 months, the Michigan cap rates on average were the highest. But if we look, I'm sure we will find some very, very attractive very aggressively priced deals that closed in Michigan, right? I have no doubt that maybe not in the last 12 months, but if we go back a year or two or three years, I'm sure we'll find some three and four cap deals in Michigan. So it's not to say that some deals are good, some states are good and some states are bad. It's just that the buyers tend to be more competitive in certain states. than others, right? They'll be more aggressive on price. And you would think that with sort of the tax situation and the controversial politics in California, you would think that buyers would be. sort of less aggressive about going after deals in California. And I think in the long run, really could say that for the whole West Coast. I think in the long run, it may bear out that way. It doesn't seem to be showing up yet in the cap rates just yet. But I think a lot of us are sort of expecting like, at some point, if California keeps getting the negative press that it's been getting, at some point, the buyers may decide to start moving their money elsewhere, or at least not be willing to be as aggressive on prices they have in the past. It is fairly predictable. in terms of what states buyers do get the most aggressive for. It tends to be the Sun Belt and the tax-free states. So like California, Nevada, Arizona, Texas, Florida, tends to be the Sun Belt and the tax-free states.
Rick Ormsby
It's interesting. Yeah, it's good. Yeah, great. Some of this data can be made available anytime. Just reach out on email, I guess, and we can Get it to you if you're interested. Cap rates by tenor, that's the next tab. So we've been geeking out for almost 40 minutes now, Chris. This is great. I appreciate everyone hanging in there. Hopefully there's some good tidbits along the way as we go through this. So tell us a little bit cap rates by tenor. So this is the closing cap rates. And what we're trying to do here is, and I want to spend some time on it, is let's say you've got a Taco Bell with four years left on the franchise agreement. As you think about possibly selling your real estate to someone other than, if you decide to do this, to someone other than the buyer of your business, which isn't always the case, then the buyer of the business is gonna probably be seeking A coterminous lease with the franchise agreement expiration. It's pretty standard across all brands these days. The thing we run into all the time then is then how do you value the real estate when there's only four years left on the franchise agreement and the franchise extension is not guaranteed? That's totally different than what this slide is depicting, but it's directionally similar. So let's talk about it a little bit. Go ahead, Chris.
Chris Lomuto
So I think the takeaway here is, first of all, to your point, as the remaining lease term gets shorter, right? So at the beginning of the lease, a typical triple net lease would be 20 years for the base term, right? A fixed term of 20 years. As the remaining term gets shorter, when you go to market that property for sale, the buyers will be less aggressive in terms of what they're willing to pay as the term gets shorter, right? Buyers love a really long lease term because it means they have rents coming to them by contract for 20 years into the future, they love that. As compared to a property with one year on the lease term, doesn't mean the tenant's going to leave in a year, but it does mean that you don't yet know what's going to happen in a year, right? It could be very uncertain. And so that tends to show up in the price, right? A buyer will pay, put it in the terms of multiples. We say cap rates, but multiples, same thing, just upside down math. What we're saying is a buyer will pay a really, a real estate buyer will pay a very high multiple for something with a lot of lease term left on it. When there's very little term left on it, they'll pay a lower multiple. That should make sense to everybody. The question that sellers tend to ask is like, okay, well, how does that work out per year? If I sell it now versus a year from now, how much of A change, how much does that impact my value? That's a question that comes up a lot. If I sell it a year from now or two years or five years from now, right? People are trying to time everything. When should I sell this? Should I sell it now or should I wait? It's not quite so clear because the line on this chart is jumping up and down a little bit. But what I tend to tell people is like a lease with 20 years, 19, 18, 17 down to like 15 years, right? From 20 down to 15, From one year to the next, the change in value is not that great. It's not making a huge difference in price if you sell it with 18 versus 19. What you see in the chart here, this is why I have this red line here, is you do start to see, especially in this data, you definitely see a meaningful change when you get to year 14, where it's like, okay, each year now is starting to have a consistent impact on price. And this light blue line is kind of like a line of best fit where it's like, okay, on average, what does each year mean starting in year 14 on this chart and this data? What is each year of one year less of lease term? What is each year doing to my cap rate? And on average, it works out to about 13 basis points of cap rate per year.
Rick Ormsby
Per year. So someone who's listening, not looking, you would say like, just directionally speaking, I mean, everything's, dependent on the actual deal, but from year 20 to year 14, my cap rate should be around 5.75, but then it goes from 5.75 to 6. to like over 7 if I don't have any lease term left over the 14 years dropping from year 14 down to year one. And it makes a pretty substantial drop from, let's call it 5.75 to 6.5 cap rate from year 14 to year 10. That seems to be a pretty steady, noticeable increase in cap rate. So buyers get, once they see less than 14 years, they start dropping their price. don't they? And they drop it pretty seriously between year 14 and year 10. Then it seems like we trail around kind of for a while in the 6 1/2 cap rate. And then when we get below 5 years, the cap rate gets really bad, obviously, which is what you'd expect, a buyer only having four or three years left on the lease. They're not going to get a whole lot, are they?
Chris Lomuto
There's some subtle real estate stuff happening under the hood too, which is kind of interesting. I won't dig into it too much, but you see a cap rate suddenly drop at five years and then you see it suddenly drop again at two years. And what that's telling you is at five years, you get lease renewals, right? Where the landlord and the tenant say, hey, let's re-up you for another five years, right? And sellers will go sell the market at that point. And so those deals It does make sense that you see a sudden drop in cap rate at year five because you have a whole bunch of deals on the market that are in this average that have brand new renewals from the tenant where the seller's saying, hey, my tenant just signed up for another five years. They're obviously happy here. This is a great property, right? I see. And then you see that again at two years, which is sort of telling you like, yeah, when they're getting towards the end of the term, the landlords are calling their tenants and saying, hey, your lease is coming up here in 18 months, two years, whatever. Do you want to re-up? and the tenant, they may not have resigned yet, but the seller is telling the buyers like, yeah, we've got them all lined up. They've said by email, they're willing to re-up, they'll do so right before the close or at the close.
Rick Ormsby
Yeah, that's a nice catch. Really good. Okay, we've got a little less than 15 minutes. Let's try to spend like a minute and a half per slide on these and give some good information to folks. So the rent survey, what does this one mean really quickly?
Chris Lomuto
This is telling you what, at least for triple net QSR real estate deals that are on the market, what are buyers seeing for rents? In other words, when they look at these offering memos for these available properties, what are they seeing that the tenants are paying, looking at all the deals that are out there, and the median right? Where half the deals are paying less in rent, half the deals are paying more in rent. The median is just under 130,000 a year. If we looked at 1000 deals, half of them are paying more than 130, half of them are paying less.
Rick Ormsby
Yeah, which is like on a $2 million AUV restaurant business, that's like saying 6 1/2% rent. Most of the businesses that we sell, probably I would say not all, but most of them have less than $2 million in sales. A lot of the clients, a lot of the franchisors will not let rent be above a of sales fixed at closing if they're gonna sell the real estate separately from the business. Some don't hold so close to it, but it's been kind of a industry norm all the way along that anything above like 9% of sales rents are very difficult for operators to be happy with. So when you see these numbers, you know, kind of like layer that against what your sales are, but 23% of the deals are less than $100,000 in rent, 44% are between 100 and 149,000, which is, you know, almost half of them. And then 24% are between 150 and 199,000 in rent. And then just a small percent are above $200,000 in annual rent. So the sweet spot, it looks like, appears to be right around the median, 130,000, 120, 140,000 in rent. That's where buyers tend to be happy, is it?
Chris Lomuto
Yes, they're definitely happy with that. I would imagine there's any number of franchisees that are going, what is Lamuto smoking right now? When was the last time I was able to get a deal done, a development deal or something like that, paying $130,000 a year in rent? And that's definitely true. I'm surprised by this median, especially for kind of new build and sale lease back. I would have guessed that the median, it feels like the median nowadays is more like 150 to 155. Yeah, that feels kind of more normal. I think what we're seeing is that there's a fair number of small deals. We also have things like 7 Brew in here where like it may be a really small parcel or small building where the ranks are fairly low just because of the dynamics of it. That could be kind of skewing the numbers lower. But for like a full drive-through, days, forgetting what this data, I mean, the data's real, but in terms of intuitively, if you asked a broker, what are people paying now? For drive-thru, it's probably closer to 150, 175 is pretty normal, I would say.
Rick Ormsby
Okay, average rents based on lease commencement date.
Chris Lomuto
If you're a franchisee and you're saying, gee, it seems like rents are going up, it's not your imagination. The data says that over the last five years, the leases that have been getting signed are up, the rents on those leases over the last five years, the data says the rents are up by
Rick Ormsby
about 15%. 15%. So the same piece of property I was going to, build, do a build to suit lease on is, 15% higher than it was five years ago, which to me, I'm not surprised. I would have thought it might have even been higher than 15%. You know, frankly, everything seems to be going up, unfortunately. Okay, price points. Let's look at price points.
Chris Lomuto
To me, the takeaway here, so when we say price points, I'm saying what's the value, what, you know, how big are these real estate deals on new build and selling?
Rick Ormsby
Someone selling one Jack in the box and what is it selling for? You know, kind of question. Okay. And so you see a distribution here.
Chris Lomuto
Yeah, look at five years of that kind of transaction data and the median there is just under two and a half million. So half the deals are selling for more than two and a half, half the deals are selling for less than two and a half. I tend to tell people, you know, like especially 1030 one buyers, if they're in kind of the two to three and a half million range, I'm telling them like, yeah, QSR is going to be a great fit for you because that's where a lot of the QSR tends to be is like 2 to 3 million range.
Rick Ormsby
And I suppose it makes sense, doesn't it? Do you start seeing a bit of a degradation of cap rates and interest from buyers. If you have like, this goes counterintuitively, if you have like a Taco Bell that's doing 5 million in sales and the price of the real estate's gonna be six and a half million dollars, you tend to kind of, I mean, I know it depends on the credit and who the tenant's going to be and all these things, but there's probably not as many buyers for something like that as someone who's in the wheelhouse of this two to $3 million, two and a half to three and a half $1,000,000 purchase price, right?
Chris Lomuto
This is a very astute point that you're raising. that comes up a lot, especially in sale leaseback. And so to kind of encapsulate it, I would say the first thing to understand is that buyers of single tenant real estate love cheap rents. The reason they love cheap rents is that in a triple net real estate deal, you know what your income is going to be because you sign a contract with the tenant at the close that says the income is going to be exactly this number for the next 20 to 40 years. So for a triple net buyer, they just want to make sure that they get that income that they've been promised in that lease. And the lower the rents, broadly speaking, the lower the rents, the more a buyer says, yeah, I'm going to get this income. So the lower the rents, the safer the investment from their perspective, broadly speaking. So the buyers love low rents. As far as they're concerned, the lower the better. During sale leaseback, oftentimes the franchisees or the operator, the business owner is saying, well, but gee, I've got room to move these rents up. I could be paying 300,000 a year in rent and still have plenty of coverage here. I have plenty of EBITDAR to cover $300,000 a year in rent. And that is true on paper, but to your point, do buyers penalize those deals in terms of cap rate? At a certain point, Your rents can get, when they get noticeably high, depending on the other surrounding factors, buyers will look at a deal like that. Several years ago, one of the brands was doing really well coming out of the pandemic. The sales were like super high, their AD was super high, and they had lots of rent coverage. But this brand was doing a lot of deals out on very, what we would call tertiary real estate, sort of felt like it was out in the middle of nowhere. You look at it on Google Maps and there's green grass. everywhere around it. And so on paper, from the franchisee perspective, they're saying, well, we're making tons of money to pay this rent, but the buyer's looking at it and they say, yeah, but if I lose you for some reason, I'm never going to be able to get someone to pay this rent again because there's.
Rick Ormsby
We've got the same thing going on in the business side. We've got the same thing going. You've got like a $10 million, a Sonic doing $10 million in revenue, for example. Some crazy example. Someone's probably not going to pay you the current market price on that big of a multiple because Okay, let's keep going though. SLB model. We got a couple more slides. One of these is a really, really good one for people. This one is 1 I want you to see. So when you look, when you want to put your head in the mind of a commercial real estate buyer, if you're a seller of real estate or if you're a buyer, you want to look at rent coverage. which is simply store level EBITDA divided by a rent coverage ratio. And we want that ratio to be at least 2.0 to establish our annual rents. So if you have $325,000 in store level EBITDA, we're targeting A2 rent coverage, then our rent shouldn't exceed $162,500. And this is going to be something that you're going to pound into the heads of buyers and sellers. they're going to know this. REITs are going to know this, right?
Chris Lomuto
Yeah, the sophisticated real estate buyers, the REITs and people like that, they look at rent coverage ratio. The brokers are looking at rent coverage ratio, especially when they're advising the clients, right, in terms of where to set the rents, right? The clients are saying, the operators, the franchisees are saying, where should we set these rents? And the brokers are telling them, think about two to three times rent coverage with two times rent coverage being sort of the benchmark. The REITs have got us all programmed to think about two times as a minimum rent coverage.
Rick Ormsby
I do want to speak all these numbers for people who are listening because this is really valuable. So we're going to use the example of $325,000 of EBITDA, store level EBITDA in a two times rent coverage ratio. You take one divided by the other and you get $162,500 in rent, okay? And then we take that 162.5 and divide it by an asking cap. In this case, we're gonna use an asking cap rate of 5.75%. And you will take one divided by the other and you get a $2,826,000 asking price. So then what Chris did here is he took the 5.75 asking cap rate and threw 1/4 of a point on top of it for the difference between the bid ask, which we talked about earlier. and we've got a closing cap rate of like 6 cap, okay? So that implies that the actual price, the closing price would be $2.708 million. And then we subtract out 5% for closing costs, the brokerage fees, title, escrow, all this stuff, and you get the 2.71 million times 0.95, and you get a $2,572,000 Before tax. And I think that little analysis is the main thing you need to know if, in terms of dollars and cents, as you kind of layer in the assumptions of what you're gonna get for net proceeds. Right, Chris?
Chris Lomuto
Yeah, that's right. And a couple footnotes. As we said earlier, the sophisticated buyers think about rent coverage ratio. The brokers are gonna talk to the clients about rent coverage ratio. The 1031 exchange buyers, they don't live in a world of rent coverage ratios, they tend to think about rent to sales. And they've mostly been programmed over the years to think about like 8% as the benchmark rent to sales. Most brokers will tell their clients like up to 9% rent to sales can be okay when we're getting into double digit rent to sales. If the broker's thoughtful, they're telling the client like it's 10% rent to sales If they're a thoughtful broker, they should be telling the client, it's not a non-starter, but 10% rent to sales is pretty high. We definitely want to dig into it and make sure. That's the kind of feedback that the brokers are giving to the clients. And then the clients are like, oh, well, can I get this down to 7% rent to sales, 6% rent to sales, right? Because again, the lower the rents, the buyer feels about the tenancy.
Rick Ormsby
Excellent. I mean, I think this has been a really good webinar. I'll leave you with this. Chris, last 30 second comment, anything that you wanted to say that we haven't said?
Chris Lomuto
I would say keep the rents low. And I've been telling everybody for the last probably 90 days that if you need to sell, I mean, I'm a broker, I'm supposed to say this, but I usually don't unless I mean it. If you're thinking about selling in the next, I would say 12 to 18 months, I would probably be trying to do it now. And when I say now, I mean like trying to close before year end because the year end buyers are out. All those buyers that are trying to find depreciation for 2026, for calendar year 2026, they're all putting the offers in on their deals now. I've got, I don't know, 10 or 12 deals on the market right now. I don't know, maybe more. And the buyers are definitely active right now. So if you can, if you're thinking about it, I would say do it now.
Rick Ormsby
Okay, I think that's a key point. It's a little more nuanced on the business side, but you've often heard me say stuff like this before too. And I'll just say that Chris is a pretty conservative guy, which is one of the things I like about him. He's not trying to sell people too much. But hear his point, which is things probably are gonna be getting a little bit worse in the commercial real estate market because of the way the Fed funds rate and the interest rates are projected to move in 2027. We may be in an unfavorable supply demand bid ask situation if you're trying to sell something as we push into 2027. And so if you're going to sell something, maybe do it now or do it soon. Don't wait 12 months or 18 months. That's his recommendation, which I think is pretty balanced and pretty fair. On the business side, it's a little more nuanced by brand and by performance in your actual market and what you're doing. But a similar proposition is kind of holding because the market for just operating these assets has been pretty challenging too. And I'm not sure that we're going to see a more favorable supply demand situation present itself in 2027, unfortunately. But we'll leave it at that. Anytime reach out to us. You can reach out through me to Chris if you like and glad to get you in touch. Thank you so much for all those of you who listen. Thank you for listening to the Restaurant Boiler Room. It's a bit of a patchy world out there. Hang in there and hope to see you at RFDC in November. And thank you so much, Chris. You're wonderful. Thanks for joining us today.
Chris Lomuto
Thank you, Rick. Thanks, everybody. Have a great day.
Rick Ormsby
All right, you all too. Take care. Thank you.