Recently there has been a proliferation of smaller prototype and drive-thru only format tenants in retail real estate. There are a wide range of retailers involved in this heightened trend including oil change companies, quick service restaurants (QSRs), and multiple coffee concepts, among others. Some specific brands include Starbucks, Take 5 Oil Change, 7 Brew, Wawa, Caribou Coffee, Scooter’s, Salad and Go, Smalls Sliders, Jimmy John’s, Checkers, Elliano’s, Greenlane, Tim Hortons, and The Human Bean. Other QSRs like Chick-Fil-A, McDonald’s, Chipotle, Taco Bell, and Portillo’s have also recently experimented with drive-thru only models and buildings. Typically, the building size for this format is about 1,500 square feet (sf) or less.
Drive-thru only buildings enable retailers to maximize operational efficiencies by reducing facilities management expenses and labor costs. They also allow for increased customer convenience and accommodate shifting consumer preferences by streamlining digital and mobile ordering. Building construction is less capital intensive for both landlords and tenants with a lot of these users starting to incorporate prefabricated buildings in their designs. The smaller building footprints allow operators to establish a presence in denser, infill markets which otherwise have high barriers to entry.
In addition to the above efficiencies, smaller building footprints help landowners maximize value of smaller parcels. For example, most traditional QSRs typically require 1.25 to 1.5 acres while, a majority of the newer drive-thru only concepts can utilize three-fourths of an acre or less. This allows developers or landowners to optimize smaller parcels and, in some cases, they can accommodate an additional tenant. Landowners aren’t sacrificing much on annual rents since retailers are willing to pay higher rents for smaller buildings in order to be in prime locations that might have otherwise been unattainable. These tenants are typically creditworthy and willing to sign long-term absolute net leases or ground leases. If the property owner intends to sell the property, this helps them to attain attractive cap rates when selling the stabilized properties to investors seeking passive income.
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From a capital markets perspective, most of these tenants are well received by net lease property buyers. The main concern for investors is the ability to backfill the asset at an equal or higher rent should a tenant vacate. To overcome this objection, we encourage buyers to evaluate the property’s potential rent-to-sales ratio versus the rent per building square foot. For example, let’s assume a Dutch Bros pays $100,000 in annual rent at one of its new locations. With its typical building footprint of 950 sf, this would be $130-plus rent/sf (a higher than market rent/sf in most markets). However, if you consider Dutch Bros’ average unit volume (AUV) of roughly $2 million per location, they would be operating at a healthy 5% rent-to-sales ratio. The earnings before interest, taxes, depreciation, and amortization (EBITDA) rent coverage would be even more appealing due to the operational efficiencies outlined above. This would be a highly profitable location by any measure and increases the likelihood that the tenant will have long-term commitment to the location.
Additionally, with the escalating number of small building footprints, the long-term viability of backfilling the building if needed, is improved. As mentioned, most of these smaller format buildings are allowing retailers to establish locations in attractive submarkets where real estate is at a premium. This usually means that the surrounding corridor retailers are high quality and the demographics are attractive for a multitude of other potential tenants. We would not be surprised to see more QSRs and other retailers implementing drive-thru only prototypes over the coming years.
Will Wamble is Executive Vice President & Principal – Capital Markets, SRS Real Estate Partners
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