Finding Opportunities in Today's Puzzling Real Estate Environment

Global economic pressures are putting a crimp on real estate dealmaking. As a result, brick-and-mortar franchise concepts – and many of their franchisees in verticals such as restaurants, entertainment, and retail – face new challenges to their growth plans. With inflation and interest rate hikes, supply chain issues, a labor shortage, and a host of other issues have arisen to dampen the dealmaking spirits of many.

The puzzling aspect of this is that there is a subset of franchise operators with deep pockets who are muscling through many of the challenges and are flush with opportunities to both buy and sell – and are doing just that, tapping into acquisition and fresh development opportunities that stem from evolving consumer trends.

Redesigns and upgrades have enveloped restaurant and retail concepts rapidly, opening opportunities for well-capitalized groups. They have the capital and lending chops to make moves, and many longstanding owners are ready to get out of their businesses. This is partly because they don’t want to make the investment in things like new drive-thrus, interiors, and ordering systems given today’s pressures, and partly because the values of their businesses and real estate are at all-time highs.

Currently, inflation is affecting the real estate world with unpredictable price hikes. I have seen 25% increases in prices several times over, caused by many things, including delays in the supply chain, labor costs, and additional financing requests.

My industry colleague, Eric Wasserman of Acropolis Commercial Advisors, works closely with commercial developers and has his finger on the pulse of how today’s economic pressures are affecting real estate and, in turn, challenging franchise growth. Here’s what he sees:

Many franchisees in the restaurant space who have immediate development requirements per their franchise agreements have chosen to partner with third-party developers. Most franchisees will go this route to preserve capital for operations, whether for operating existing locations or acquiring additional units/networks. These third-party developers are oftentimes running into unforeseen increases in costs. In return, the franchisee ends up paying more in rent in these new locations. While the franchisees are still preserving a chunk of their capital, even with a slight increase in the new rent, the ROI modeling and overall return is affected.

What were once $1.5 million buildouts are now $2 million because of labor, product costs, permitting delays, and slowdowns. This is creating a lot of uncertainty for the vast majority of franchise owners seeking to grow and open new locations, while also causing operators to consider their exit strategy as store performance remains strong and the most well-funded groups have available capital to invest.

One piece of advice is for franchisees in growth mode to frequently communicate with advisors and lenders and ensure a level of understanding that loan amounts may change as variables in pricing continue to cause pricing instability.

Likewise, franchisees must effectively communicate with their franchisors – and vice versa. For existing franchisees looking to capitalize on the market, franchisors should take an interest in supporting their exit strategy and buyer vetting. And, franchisors must find common ground with franchisees that are developing new locations and eager to stick to their development schedules. Finding new suppliers and potentially building more flexibility into opening dates may be required.

Pete DiFilippo is a principal at C Squared Advisors, a leading investment bank and advisory firm that helps multi-unit franchisees in the restaurant and retail industries maximize the value of their businesses by presenting comprehensive solutions and executing complex transactions. With 75 years of experience, C Squared has helped sell, purchase, refranchise, and recapitalize more than 10,000 franchised locations. Services include mergers, acquisitions and divestitures, valuations, private financing and recapitalization, restructuring, and ongoing financial advisory services.