Fast Food Restaurant Appraisals - Cap Rates

by Administrator on May 14, 2017

Even considering the capitalization rate to be applied to the cash flow derived from a fast food restaurant is complex.  This short article discusses some of the considerations made by appraisers when they analyzed lease terms that relate to a fast food restaurant.  The article is not meant to provide a complete analytic picture but it does give those who going down this road some idea of what factors are considered.

Establishing a capitalization rate for a fast food restaurant is an important appraisal element, and one of several consideration when analyzing value

The location of the subject and its comparable rentals is important since, as appraisers know, fast food restaurants located a short distance away may be far enough away from the traffic and visibility that a subject property has to not even be considered comparable.  It's important that similar location is actually similar with regard to auto and / or pedestrian traffic.

The type of the lease established is a primary consideration for the appraiser.  Most leases on properties of this type are triple-net (NNN) leases and appraisers are generally familiar with what is paid and what is not paid under their terms.  Usually they exclude management and they exclude reserves for replacement.   It is important that an appraiser compare leases of the same type when establishing a market rental rate.

One of the most important considerations is the credit quality of the tenant.  If for example you are analyzing the leased-fee estate interest in a property and the tenant's credit is not in the top tier an adjustment of 1% or more to the cap rate may be reasonable.

Lease details are also  extremely importants.  What are its terms?  What are the option periods and how much of an adjustment is there and how often are they applied.  Typically adjustments are made once every 5-years, but I have seen some leases that call for annual or 10-year adjustments.  The standard adjustments are based on a specified consumer price index (CPI) often the CPI estimated for the metropolitan area in which a restaurant is located.  CPI adjustments are usually easy to calculate, they are often based on the year in which a lease was established

It is easy for a lease that is not tied to a periodic appraisal of a property to lose touch with reality.  Market rents may become much higher or much lower than the rent established by a lease that has not considered what is happening in the market.  The CPI can for example continue an upward march while a real estate and market rents can languish.  Without adjustment this can put a tenant in a place where they are paying excessive rent that they must continue to pay until their next opportunity to renegotiate the lease terms.

Leases with relatively short terms remaining on them present more risk than leases with longer terms so buyers would expect a discount if the lease does not provide a long term guarantee.  It's like any other investment, if the term is up in 5 years or less that's considered risky for most investors whie 10 years or more is less risky.  A ten to twenty year remaining term is what most investors are looking for.  So an adjustment to the capitalization rate for a short-term lease is often made by an appraiser.

Leases with remaining options (usually 5 years each) are usually deemed less risky than leases that do not have remaining option terms.  There is no guarantee that options will be excercized but if an tenant hasn't even negotiated options that may be an indication that they do not intend to stay.  Adjustments to the leased-fee estate capitalization rate for this factor are generally small.

For more appraisal information contact Glenn J. Rigdon MA, MRICS, ASA is a Las Vegas / Henderson Nevada based appraiser who can be contacted via email or via his business website known as Appraiser Las Vegas  (http://www.appraiserlasvegas.com), or you can also click on “Contact Us” on the home page of this website or visit my public profile at LinkedIn at http://www.linkedin.com/pub/glenn-rigdon-ma-mrics-asa/1a/30b/879/

Article source: http://www.valuationarticles.com/Valuation-Appraisal-Process/26-Fast-Food-Restaurant-Appraisals-Cap-Rates.html

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