Economic crisis is a disaster for industries like aviation and tourism. However, with fast food chains, the recession does not seem to affect much when people look for cheap food like them instead of upscale restaurants.
During the period 2008-2010 when the global financial crisis took place, a series of restaurants and businesses closed, while fast food chains like Subway expanded to 6,000 more branches. The KFC chain has opened more than 300, and McDonald’s has opened more than 600 new locations.
Take McDonald’s as an example, the fast food chain’s return on equity reached 29% in the same period, making it one of the most successful business chains during the crisis season.
However, few people know that McDonald’s secret doesn’t lie in the sale of burgers or the gimmicks of advertising. The success and rapid expansion of fast food chains like McDonald’s are located in locations. In simple terms, the factor that guarantees the great success and sustainability of this empire is the real estate business.
“I’m not in Hamburger. I’m in real estate.”
During a lecture at the University of Texas-America, McDonald’s Founder Ray Kroc asked the students below, “What do I do in business?”. Most of the students laughed because they thought Ray was joking. No one answered. Ray asked again: “What do you think I do in business?”
The students laughed again and at the end someone shouted: “Ray, who doesn’t know you run Hamburger.” Ray said delightedly: “I think you would say the same.” He paused for a moment and said quickly, “Guys, I’m not in Hamburger. I’m in real estate!”
In fact, McDonald’s is a company that specializes in real estate rather than in the restaurant segment. McDonald’s 2019 financial statements show that the total value of assets including equipment, real estate … before deduction reached 39 billion USD. This makes McDonald’s become the 5th largest real estate company in the world by total asset value.
So why do people think that McDonald’s is a food service company, not a real estate company? This story concerns the franchise of this famous brand.
Similar to other fast food chains like Subway or Burger King, McDonald’s has expanded rapidly thanks to a strategy of franchising instead of opening branches. About 85% of McDonald’s restaurants are owned by franchise owners, renting a brand name to the fast food chain.
Hearing this, many people will mistakenly think that McDonald’s relies mainly on royalty and franchise fees. But the strategy of this fast food chain is much more sophisticated.
With a long experience in the real estate industry, McDonald’s stores all have prime locations like the corner of two facades or on busy large streets. The company is not merely renting a premises for business, but they will negotiate to hire or buy or ask a financial partner to support to buy the entire premises.
With its credibility, McDonald’s can easily get loans from banks. So they only need to spend 1/3 of the money to buy that real estate. 2/3 of the rest, the bank or financial partners will lend.
The amount of interest plus monthly profits will be paid by McDonald’s own operating cash flow. Interestingly, after a few years, McDonald’s gradually pays off all its debts and owns these properties. Given the nature of real estate price increases over time, McDonald’s total value has also increased.
For franchise owners, they will be required to enter into a standard McDonald’s business contract, thereby paying the franchise fee and the land rental under the contract. Any boss who wants to give up the game will be eliminated by McDonald’s and looking for a new partner.
Of course, the company must also maintain the standards, image and revenue for these partners to indirectly benefit real estate business loans.
As McDonald’s reputation and total assets go up, it will receive increasingly concessional loans from banks and like a snowball, the company continues to expand. This model is often referred to as the dual cash flow real estate business.
In 2019, about 64% of McDonald’s $ 11.6 billion in franchises came from land rentals. As a reminder, McDonald’s franchise owners have to pay a price that isn’t cheap. In the US, they have to pay a deposit of 1-2 million USD, franchise fee of about 45,000 USD and many other payments.
A study once showed that the average US franchises restaurants pay 6-10% of their sales on land rent, and for McDonald’s, this number goes up to 8.5-15%.
Apparently, McDonald’s is a real estate company that borrows from banks to buy land and then lease it for a fixed price because they are pre-set under the reputation of franchising. It is entirely possible for the company to find a new owner after the franchise expires or simply sell the land.
Even during a crisis, McDonald’s has an opportunity to buy cheaper land for business and growth. This is one of the factors that made this brand continue to expand despite the 2008 economic downturn.
The grandfather of real estate with dual cash flow
Have you ever wondered why Ray Kroc is considered the founder of McDonald’s when the brand name has nothing to do with him. In fact, McDonald’s business idea came from two brothers Richard and Maurice McDonald.
At that time, Ray Kroc was just a little blender. Kroc’s business collapsed after World War II, and all his projects fell to a dead end. Kroc’s start-up path seemed to be over at the time, but suddenly he realized that the Richard brothers’ fast food restaurant bought more blender than any other restaurant.
Kroc immediately drove to California to visit the restaurant and saw McDonald’s potential with a fast, compact business process. Kroc then proposed a partnership, responsible for developing McDonald’s model with the Richard brothers. At this point, Kroc is just the guy who works for McDonald’s true founders.
McDonald’s founder Ray Kroc
However, the McDonald’s growth has been so successful that the Richard brothers feared. They just want to open regular restaurants and intend to stop the expansion. So Kroc decided to borrow $ 2.7 million to buy the entire McDonald’s chain in 1961, at a record price at that time.
Initially the Richard brothers did not want to cede their chain of business to Kroc. However, with a broad view, Kroc has quietly negotiated, borrowed to buy back the properties that McDonald’s chain has rented.
As a landowner, Kroc has forced the Richard brothers to sell the brand in the danger of being kicked out of the branches. This is the beginning of the dual cash flow real estate business model of today’s fast food chains. Ray Kroc himself is also considered the ancestor of this model.