Some Thoughts on the New Year

In the book of happy memories, the 2009 section may come up shorter than most. Our economy suffered, unemployment rose and hopes for a quick recovery were dashed. Terms like “jobless recovery” and “double dip recession” became the hot phrases of the year. Most can’t wait to raise their glasses in farewell.

However, we can look at 2009 another way. Its conditions may have been inclement but for those who survived (without government assistance) it can be seen as a great storm weathered; victory through perseverance. As Thomas Paine so eloquently put it, “these are the times that try men’s souls”. Well consider our souls tried, bent and pushed. For those who remain, the hard part is over.

This is something that could be observed earlier this year at the 2009 ICSC conference in Las Vegas. There were half as many participants but the ones who stayed were worth talking to. So indeed let’s raise our glasses high on New Years but instead of blind faith in 2010, lets toast to the grit displayed in 2009 and the opportunities that will be rewarded to those who grinded it out!

The Ghost of Christmas Past

As the holiday season approaches its crescendo, one can’t help taking a trip down memory lane. Just a few years ago televisions were filled with commercials featuring nice middle-class driveways being populated by two Lexus luxury cars, adorned with giant red bows. Those bows should have been a warning, a form of theatrical foreshadowing, representing the massive amount of debt resting so precariously on those essential luxury mobiles. We could afford the Lexus today, but we would have to pay for the bow later. When that time came, we realized our whole lives, from our homes to our banks were wrapped in similarly styled red tape.

So the season is here when red tape is at its highest demand and everyone gears up to wrap some new gadget or non essential item in it. Even Santa shows up wearing a massive red suit, riding a red sleigh, guided by a reindeer with a red nose. For heavens sake the holiday colors are red and green, debt and cash! This particular year seems the perfect time to take a long honest look at our past, present and future.

No longer can we afford to strip ourselves of equity and finance it into oblivion, for it seems that oblivion actually shows up at some point.

Perhaps it is not a good idea to leverage investments with “ZERO money down” or for banks to fill their balance sheets with assets whose debt to equity ratios would send a seesaw shattering into the ground.

And maybe, just maybe, we should invest in assets which are somewhat safe and secure. Like a well positioned grocery store as opposed to manufactured islands (made out of sand) in the middle of the sea which serve as play grounds to the fabulously opulent.

If you want to look at someone who has staying power, look at Walgreens, its 1Q profits just rose 20%! And who does Walgreens cater too? Only any person who needs some sort of medication at some point in their life. In other words, pretty much everyone. Dollar General, a few years ago the most unheralded name imaginable, is experiencing never before seen growth. McDonald’s and Wal-Mart both continue to prosper. The key point in all of this is that the best investments are the ones which will be there when the weather gets rough, the ones that have staying power. So this year, if you’re going to invest, make sure it is in something that’s lasting, not a heap of red tape.

Free Wi-Fi at McDonald’s (hopefully you’ll want fries with that)

McDonald’s (NYSE: MCD) has recently announced plans to start providing free Wi-Fi service, through a partnership with AT&T, at over 11,000 of their 13,000 U.S. locations. AT&T customers may already be familiar with this benefit, as the company already provides free Wi-Fi to AT&T wireless and wired customers at Starbucks, McDonald's and various other locations. For the rest of us, a $2.95 fee for 2 hours of internet access is charged. Thanks to this recent agreement all Wi-Fi seekers, regardless of their service provider, will have free access at McDonald's.

This development seems to be the latest in a trend started a few years ago, when McDonald's began to refocus it image towards a chicer look, this has covered everything from eliminating trans-fats, redesigning the stores to look higher-end, and in the extreme case in over 100 stores in Germany, changing the color scheme from red to green (for environmental affect). Introducing free Wi-Fi seems to be the next logical step in this campaign. If the goal is to make McDonald’s not just a place to “smash and dash” but to stick around for a while, why not allow customers to surf the web and maybe enjoy an invigorating McCafe while their at it?

On a side note, can you imagine sticking around and surfing the web at the McDonald's restaurants of a decade or so ago, the ones with the plastic chairs, bright pastel linoleum cushions and in some cases, large sculptures of those McDonald's monster/mascot things?

With the new image and offerings of McDonald's and their constant pursuit of self improvement, it is easy to see why they enjoy such financial success. As a net lease investment, McDonald's is one of the finest available and adding a service like free Wi-Fi will only enhance its value and drive higher sales. Who knows how many extra coffees or fries may be ordered by the flocks of cheap internet seekers who may congregate their. This development should only encourage interest in McDonald's as a net lease investment.

Are the Golden Arches of McDonald's Still “Golden” to Net Lease Investors?

McDonald’s reputation as a company unassailable by the effects of the recession has come into question with the release of recent sales figures. Specifically, McDonalds saw a 0.6% drop in U.S. sales in November, which follows a 0.1% drop in October. Globally, McDonald’s fared better, posting a 2.5% increase in Europe, which caused the company’s total sales to increase by 0.7%. Though these numbers are not dismal, they are quite different from the numbers McDonald’s was posting last year, increases of 4.5% in the U.S. and 7.7% globally in November 2008. This has many doubting the health of McDonalds and the economy in general.

Traditionally, McDonalds has been the one of the gold standards of net lease investments. It’s been given high investment grade credit ratings by both S&P and Moody’s, maintains low cap rates, and always performs well financially. Demand for McDonald’s properties actually increased recently due to the fallout from high risk investments. Investors are now seeking more stable and safe assets rather than risk fueled ones, for many there is no safer place to invest than beneath those iconic gold arches. This perception was enhanced in 2008 when McDonalds continued to post strong sales figures despite the economic fallout of the recession. With recent numbers looking less promising, should investors be worried?

If history is to be our guide than “no”, these numbers do not represent a trend to be fearful of. Even with the dip in U.S. sales, McDonald’s numbers look better than many of their peers and no indication has been made that their credit ratings will be affected. In reality, McDonalds was most likely suffering from its own success. After the shocking growth of a year ago, it would be natural for a cool down phase to occur, especially in a climate with unemployment over 10% and declining consumer spending.

Despite the recent numbers, McDonald’s remains one of the strongest net lease investments when available and should remain as such for the foreseeable future.

Net Lease Insider Pulse: Jay Bastian of National Retail Properties

Jay Bastian is SVP of Acquisitions for National Retail Properties, Inc., a NYSE traded REIT focused on single tenant, net leased retail and restaurant investments.

(1) Will the commercial real estate market bottom out in 2010?

Our only frame of reference is net lease, so we’ll stick with that. An acquisition we’re evaluating at the moment speaks to the current state of the market, and future implications. It’s a portfolio of drug stores, and we’ll separate out one asset as an example. The seller purchased it for a 9% cap in 2000, put 80% LTV, 25/10 year debt in place at 8%, with a balloon in 2010 at $2.5M. Hope you caught that, a 9% cap for an “A” credit drug store in 2000! Today’s value with 10 years remaining on the lease, may be 9%. In order to refinance, the Seller would have to write a check for $225,000 just to pay off the original lender, and has opted to sell the property instead. While the original mortgage LTV and amortization were a little aggressive, the rent’s only $21 psf, so decent fundamentals.

As far as the industry’s turnaround is concerned, if we have reasonably conservative underwriting on transactions pre-2005 that require additional equity, how does that translate to the scale, valuation, leverage, and lack of amortization in most transactions since? Again this focus is only on performing net lease properties, not the remaining universe of CRE with its pro-forma underwriting based on lease-up and growth in rental income across all property types, with impending debt maturities.


(2) Is commercial real estate’s fate tied to unemployment or any other pertinent economic factors?

Net lease real estate, at least in our retail and restaurant segment, is tied to the health of the consumer and disposable income. There’s been some fallout of various retail and restaurant chains, but for now it seems stabilized, if we’re at the bottom. As far as the balance of CRE, in order to see growth in rent and occupancy, there will need to be workforce expansion, whether existing companies, or new businesses. Obviously, CRE’s health is ultimately tied to the vitality of the real estate capital markets for imminent re-financing requirements and future development.

(3) When recovery does begin, what areas will grow first and fastest?

Our sense is that a recovery in lodging and casual/upscale dining occupancy levels and sales, along with increasing travel center revenues will provide evidence of the start of a recovery. This will hopefully indicate that employees on expense accounts are back on the road building business again, and trucks are delivering new inventory and product.

(4) Are there segments of commercial real estate that you find appealing even in this economy, including the net lease market?

Our bias is net lease, and especially so in this economy. I am sure there will be value-add plays out there, but if you’re investing in real estate, net lease offers stability and growth if well underwritten. Our targets are a 20 year lease, strong tenant, annual rent bumps for growth, conservative rent and valuation fundamentals, on a property that’s profitable for the tenant? With this uncertain economy, can’t imagine investing anywhere else.

(5) Would you prefer to invest: Close to home or in a stronger metro market?

What are your top two choices in your preferred area?
We focus first on unit level performance, strong real estate fundamentals, with a good operator as the tenant. We’re probably shy on some markets in the upper Midwest, but have investments and interest in the entire country.