Great Real Estate...the Gift That Keeps on Giving By Dan Rowe As real estate costs continue to skyrocket, it has never been more critical to pick the right locations in order to build a sustainable chain. If your franchise system wants happy franchisees, then make sure they are successful. Start by focusing on their real estate because great real estate maximizes the sales of franchisees’ businesses. Investing in your real estate process is the best strategy for ensuring a company’s success. The more successful the franchisees are, the more additional units they will build and the more new franchisees will be driven to your company. All of this drives the volume and profit of the royalty stream, and better yet, the liquidity or exit value of the franchise system. Great real estate drives enthusiasm, creates credibility and generates “buzz” for the concept. Great real estate is the gift that keeps on giving. Franchisees’ real estate is really just as much of an asset to the organization as a company-owned location. By virtue of the franchise agreement and an executed lease, a franchisee is locked into a given location for the use of the franchise so there should be plenty of motivation to invest properly in the real estate process. “Five years from now you are going to look over your portfolio of stores and there will be 25 percent that are minting money, 50 percent that are paying the bills and 25 percent that you wish you never did,” says Gary Graham, former head of real estate for such chains as In-N-Out Burgers, Red Robin and Taco Bell. “The key is to understand the demographics and site attributes that are responsible for the difference and avoid the last group.” Perhaps the single most important hire to any expanding chain is an in-house real estate professional. Hire this key individual before hiring people for marketing or operations. Great sites don’t need as much marketing attention and enjoy volumes that attract and maintain higher quality employees, making operations easier. Start with the end in mind What should the chain look like over the next five to 10 years? What sort of locations are desired? What sort of market penetration is preferred? How will real estate help shape the brand? As soon as possible, hire the best possible in-house professional with a tremendous amount of experience with the type of real estate and the process and network for securing those types of sites. This individual understands the real estate process, can help shape the vision for the company and has the networks of key third parties to outsource to keep costs down. Establish a national real estate network Every major market in the United States has strong, local retail real estate professionals and the best tend to work with the best retailers such as Starbucks, Kinko’s, Blockbuster and Panera Bread. Take the time to make a list of these professionals. Work from the top down to get the brand associated with the best possible retailers and to get the benefit from the broker’s relationship with the best landlords. The top local brokers know the market better, have the right relationships and the franchise system will be more likely to have “first pick” of new opportunities. Locating Local Brokers: To find the right local brokers, start with the Internet: Affiliated Realty & Management Company http://www.affiliatedrealty.com Council of International Restaurant Real Estate Brokers www.cirb.com International Council of Shopping Centers www.icsc.org Chain Links Retail Advisors http://www.chainlinks.com DJM Asset Management, LLC http://www.djmasset.com CB Richard Ellis http://www.cbre.com New America Network www.naidirect.com NorthStar Advisory Services, LLC http://www.northstaradvisory.com How brokers get paid While some tenant representative brokers work on retainers, most work on straight commission (rule of thumb is that a landlord pays 6 percent of the gross rent during the term in commissions. If the rent averages $100,000 per year for 10 years for $1 million in total gross rent, the landlord is paying $60,000 in commissions—half to the listing representative and half to the tenant representative) and are only paid by the landlord upon the execution of the lease. This can be a double-edged sword because the process is essentially free for the franchisee, but because brokers are only paid for getting deals done they tend to constantly scrutinize their clients. Sometimes brokers are quick to “go cold” on clients they feel are not aggressive enough in signing leases and have even been known to drop one brand for a competing brand taking all the hard-earned momentum to the new client. One trick of the trade is to include a “miscellaneous real estate” fee of maybe $5,000 to $10,000 in the start-up section of the UFOC so that franchisees are prepared for this expense. Then, encourage franchisees to use that money as an incentive for their brokers. Remember, franchisees don’t have to sign a lease or pay the “bonus” unless they really like the space. But if they get a “home run” location that money will seem trivial. Market analysis Ever wonder why there isn’t a competitive Number Two player to Starbucks? It’s because Starbucks is notorious for going into a new market and getting all the attention of the best tenant representatives and landlords, not to mention the best locations. Why? They aggressively sign leases which make brokers and landlords very happy. They pay bonuses to brokers for meeting their development plans. They pay the necessary rent to secure premium and special locations. Landlords feel Starbucks will be an asset to their property. It never hurts to have Starbucks’ credit on a lease. When Starbucks expands into new markets they have the entire market broken down to identify every potential target location—urban downtown, suburban downtown, malls, mass gatherings, strip centers and freestanding locations and then they analyze the potential trade areas and rank them according to their ideal site criteria. Starbucks is as good as it gets in the retail real estate game, which is why they acquire higher profile sites while their competitors are located in much less interesting spaces. They know how to secure a highly-successful site because they have a real estate plan, they can identify their ideal site criteria and they know their customer’s habits. Zpizza, a rapidly-expanding gourmet pizza chain from Newport Beach, Calif., uses a combination of research and data from Brandstand and Restaurant Trends for its nationwide expansion. Zpizza worked with Brandstand to develop an “ideal customer model” for understanding who their customers are, why and when they use Zpizza, and the types of locations their customers would respond best to. Every potential location that a Zpizza franchisee submits for approval goes through a screening process and is measured against the ideal customer model Brandstand created. Restaurant Trends provides Zpizza with competitive sales numbers for every pizza concept in a given market illustrating where competing pizza chains have their strongest units. As a result of Zpizza’s real estate investment, their restaurants average higher sales outside their legacy markets. Third-party Vendors: There are several third-party vendors that can provide market analysis: Brandstand www.brandstandgroup.com Buxton www.buxtonco.com Claritas http://www.claritas.com ESRI www.esri.com geoVue, Inc. www.geovue.com IntelleVue www.intellevue.com Javelin Solutions www.javelinsolutions.net MapInfo www.mapinfo.com Market Research http://www.marketresearch.com Prediction Analytics www.predictioncompany.com ProxixSolutions, Inc. www.proxix.com Restaurant Trends http://www.restauranttrends.com Site Analytics http://www.siteanalytics.com or www.sitemining.com Urban Science International www.urbanscience.com Ideal location model Build a model of an ideal location for greater predictability and to remove the subjectivity of any real estate decision. Establish standards for the concept’s “ideal” location and educate everyone in the organization, as well as local brokers on what these standards are. The model should describe the type of look and feel wanted in a location and should help sell the brand. The model should also include ideal demographics, sociographics, access, visibility, ingress-egress, co-tenancy and other modeling criteria for the identification of high-quality real estate. Turn all this into a site survey or a test that literally self-qualifies prospective locations. Numbers don’t lie—don’t settle for anything less than great sites and never succumb to pressure to make a quick real estate decision because of a sense of urgency to close a deal before it is lost to another developer. Outback Steakhouse had a disciplined approach when it first expanded. The company looked for only “B” sites in “A” trade areas so they could still compete for their target customers, but with a lower-cost structure. Since at the time it was a dinner-only concept, Outback was happy finding sites in neighborhoods or suburban retail areas with much more reasonable cost structures. Outback Steakhouse knew their customer model and communicated that model clearly in new markets and enjoyed an extremely successful expansion. Graham says, “The most successful chains invest in the real estate process and are, consequentially, able to predict costs and sales of new units within a few percentage points even in new markets.” Site approval process Set up a real estate committee to ensure the real estate process is followed and that the decisions are communicated to all parties. The approval committee should be a well-balanced group of people that must be compelled to approve a site they have never seen and have no bias toward. Make total project costs part of the approval process—liquor licenses, impact fees, any and all fees, union labor requirements, venting through a building, how long will the site take to open. Time is money. Tips From a Pro: Gary Graham, former head of real estate for such chains as In-N-Out Burgers, Red Robin, and Taco Bell says: “A good deal on a bad site is a bad deal.” “When it comes to entering a market with a new restaurant concept, failing to plan is planning to fail. ” “You never have a second chance to open your first location in a new market.” “Profit is a function of sales, not rent.” Landlord presentation Put your very best foot forward and never skimp with the landlord package. Make it easy on franchisees and brokers in new markets to get landlords excited about the concept–pictures, press and anything else that illustrates why the concept will be a successful edition to their site. Rental rates still too high? Do more volume in less space Companies like WD Partners help chains engineer their unit model to do more volume from smaller footprints. This is especially critical in the face of increasing real estate and construction costs. The most profitable franchisees are high-producing, multi-unit franchisees. When a franchisee is successful, he is happy and is looking to build more units. The faster the units open the faster the franchise system gets the royalties. Over time, this royalty stream becomes sustainable and builds on itself, compounding as a result of your investment—thus the initial idea of real estate as a gift that keeps on giving.