What does the future hold for casual dining vs “fast” food net lease properties?

Goodbye Fuddruckers, California Pizza Kitchen and Chuck E. Cheese! The casual dining industry, has felt the full impact of e-commerce as traditional brick-and-mortar retail. Full-service or casual dining restaurants are revising their business models to adapt to pandemic and post-pandemic trends.  COVID-19 has definitely exacerbated the problems that the weaker brands possess. The pandemic lockdown drives the softening in the casual dining sector which is currently priced at a discount, 50 b.p. discount to the overall NNN net lease market.  In 2020, national cap rates in the casual dining sector increased to 6.60%. This is a 30-basis point increase year over year, from 2019.  The growth in days-on-market, and cap rates have definitely turned bearish for future pricing. In Dec. 2019, 102 NNN triple net casual dining properties were leased to a basket of full-service tenants, average cap rate of 6.59% and 170 days-on-market. As of Dec. 20, 2020 there were 87 properties for sale leased to the comparable tenants with an average list cap rate of 6.72% and 197 days-on-market.

According to industry reports, when the coronavirus pandemic began, casual dining restaurants saw 62 percent less traffic compared to just a 29 percent decrease for fast food or QSR. As the pandemic continues, sales continue to fall for casual dining brands, even as dining rooms open.  As a result, many casual dining brands have set out to rapidly alter their brand to suit the pandemic era and millennials.

At casual dining restaurants, slim margins on food led companies to focus instead on selling more high-margin alcohol. Meanwhile, tech advances in mobile ordering, delivery, or customer loyalty programs drew millennial customers to fast-casual and fast food, QSR restaurants. Delivery services have made eating at home a breeze, and these e-commerce driven sales tend to favor QSR fast casual restaurants.

With a declining customer base, this eroding restaurant sector is poised for further decline. Industry reports note that in a bear case, the best-capitalized restauranteurs can exist for 3-7 months, tops. Some of the largest U.S. casual dining operators, have seen liquidity problems together with troubling performance. Locations without $5 to $7 million in sales do not have the margins to induce lenders or restaurant operators in the current market.  Further, the top 15 largest U.S. casual dining restaurant lenders have reduced their exposure by as much as 20%. Lenders still considering new deals now they seek deals with, more equity, and more stringent covenants.

Casual dining restaurants need to update their value offerings to address food that should be novel, healthy, and delivered fast. Casual dining investors need to distinguish the safe harbor concepts, typically those located in profitable markets, in great locations, and tenants working towards revamping their brand.  Casual dining brands with ongoing business models must take advantage of increased curbside services, speed of service and convenience.  Corporately guarantee leases or large franchisees will remain in strong demand among NNN investment property investors.

In 2021-25, casual dining restaurants should closely mimic that of fast food QSR, as many companies continue to incorporate delivery and novelty menu offerings. NNN triple net lease investors in casual dining will buy brands that address the pandemic’s restrictions well and provide customers with a state of the art, delivery and dining experience.