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For months now, executives at McDonald’s (NYSE: MCD) have said they are looking at all options to boost shareholder value.
McDonald’s new CEO Steve Easterbrook is already polishing up the once-tarnished golden arches. He initiated $300 million in cost-cutting measures and is introducing technology, such as self-ordering kiosks.
And of course, there are the much-ballyhooed menu changes, including all-day breakfast. U.S. sales in the third quarter rose 0.9%. It was the first sales increase in two years.
Nevertheless, activist investors including Larry Robbins of Glenview Capital Management are pushing for a spinoff of the company’s vast U.S. real estate holdings into a real estate investment trust. A “McREIT,” if you will.
Earlier this year, Robbins said that if McDonald’s went the REIT route, it could unlock some $20 billion in shareholder value.
Some restaurant companies are already going down the REIT path. In June, Darden Restaurants (NYSE: DRI) announced it would spin off its real estate holdings into a REIT. The first-of-its-kind proposal for the industry has been approved by its board of directors.
Kroc’s Successful Menu
There are strong doubts among many that McDonald’s will pursue the idea of a REIT.
That’s because McDonald’s is basically a real estate company that sells burgers on the side. Its first CEO Harry Sonneborn once said, “The only reason we sell 15 cent hamburgers is because they are the greatest provider of revenue from which our tenants can pay us rent.”
A large and still growing part of McDonald’s revenue comes from real estate. You see, it franchises out many of its restaurants. But it owns the land where the franchises sit. The franchisees are given no choice in the matter. And they are also responsible for the taxes and insurance on the properties.
In some cases, McDonald’s rents the real estate from another landlord who gives the corporation 5% of that particular restaurant’s sales. But it charges the franchisees 10%. And there’s a monthly franchise fee on top of that. A true real estate happy meal.
That control over franchisees allowed founder Ray Kroc to build his empire. It’s the menu that Kroc believed would be most profitable for his company over the long term.
In the recent lean years, it’s lucky that McDonald’s had the real estate core. Rent payments from these franchisees jumped 26% over the past five years to $6.1 billion in 2014. That was over a fifth of the company’s $27.4 billion in total revenues. Operating margins in real estate are above 75%.
Doubts About a McDonald’s REIT
If McDonald’s went the REIT route, it would be walking away from a cash cow. Down the road, it could negatively impact its credit rating.
McDonald’s would also have to hire a management team to run the real estate operations. That may distract the company from its current turnaround.
Another negative is that real estate operations with a one-tenant concept generally struggle. Ameek Ponda, an attorney at Sullivan & Worcester who has worked on a number of conversions to REITs, has his doubts. He told the Financial Times, “If you’re selling burgers, that’s not going to be in a REIT.”
There’s also a possibility McDonald’s would have to pay higher rents to the REIT on the 1,500 restaurants it owns outright. And the REIT, instead of McDonald’s, would be responsible for site maintenance. Again, that would likely mean higher rents. That likely would lead to franchisees getting squeezed. Franchisees ready to revolt is not what McDonald’s needs right now.
So will McDonald’s go with a McREIT? Anything is possible is this age of the activist investor.
But call me old-fashioned. I like Ray Kroc’s model of having real estate holdings that just happen to sell burgers and now all-day breakfast on the side.
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