Restaurants have taken a huge hit in the locked-down coronavirus economy, especially those owned by individual operators or small groups.
Those kinds of operations have long faced the challenge of "you know what you're getting" consumer preference that's the natural advantage of chain eateries, but the pandemic has made their survival even more tenuous while boosting the investor appeal of the big guys.
According to a Dec. 28 article by MarketWatch: "Large, publicly traded restaurant chains stand to make gains in the coming months as the economy begins to recover and independent restaurants shutter due to the pressures of the COVID-19 pandemic, analysts say."
Shuddering for their future as shuttering soars
The National Restaurant Association says in a Dec. 7 press release that 17% of the nation's restaurants -- more than 110,000 of them -- have closed "permanently or long term" over the course of 2020.
Sadly, the trade group says: "The vast majority of permanently closed restaurants were well-established businesses, and fixtures in their communities. On average, these restaurants had been in business for 16 years, and 16% had been open for at least 30 years."
The press release was a call for Congress to provide more relief to restaurants, and it says chains and independent stores alike are being hit hard. It also contains this somber note: "Only 48% of these former restaurant owners say it's likely they will remain in the industry in any form in the months or years ahead. Our nation is losing a generation of industry talent, knowledge, and entrepreneurial spirit."
CRE takes a hit: Time to invest in the tenants?
Those restaurants also occupy a lot of commercial real estate (CRE), spreading the pain from loss of jobs at those shops and loss of income to their landlords. That's not good for investors in those properties, but it also points to an investment opportunity: publicly traded restaurant chains.
"[W]e believe that industry closure activity, shouldered mostly by independent restaurants, creates an opportunity for Texas Roadhouse (NASDAQ: TXRH) to expand its footprint into smaller markets," analysts from BTIG said in the MarketWatch article. BTIG considers the stock a solid buy.
The BTIG analysts said: "We believe these smaller markets are less attractive to large chain competitors and mostly served by independent restaurant operators. As we expect industry closures to be largely shouldered by independent operators this year, the current disruption could disproportionately impact smaller markets and create unit potential for well-capitalized operators."
It's not just Texas Roadhouse, of course. The article points out that JPMorgan (NYSE: JPM) thinks 15% of independent restaurants will shutter and has highly rated stocks of such competitors as Bloomin' Brands (NASDAQ: BLMN), owner of Outback Steakhouse, and Darden Restaurants (NYSE: DRI), whose brands include Olive Garden and Longhorn Steakhouse.
This is where REITs come in
This solidity for those major brands may also bode well for retail-focused real estate investment trusts (REITs), whose holdings tend to concentrate on larger shopping centers and malls with rental rates that lend themselves to chains.
Corporate restaurant operations just seem more likely to have the wherewithal and cash flow to handle long-term, net leases, which hold tenants responsible for most of the operating costs of their building or space. These are investment-grade leases, and they require investment-grade tenants who also can take advantage of their corporate brand's marketing, digital ordering, and delivery prowess at a scale hard for independent operators to match.
Indeed, there's significant REIT participation in this segment. For instance, that lead dog among retail REITs, Realty Income (NYSE: O), attributed 9.3% of its 2019 revenue to casual dining and fast-food restaurants. And one of its most worthy competitors, STORE Capital (NYSE: STOR), has 511 tenants at 2,587 properties, or about five properties per tenant, according to its third-quarter 2020 investor presentation. Those aren't all restaurants, but 777 of them are, and they accounted for 13.5% of its base rent and interest in the third quarter.
The Millionacres bottom line
Even in the darkness, there is light. The independent restaurant business may well be the beneficiary of CRE bargains as we emerge from the pandemic. The JPMorgan note quoted in the MarketWatch article says its analysts don't expect "the contraction to be permanent," adding: "Supply lags demand, and we believe a pick-up in demand in deeply affected areas (center cities, for example) will see follow-on supply within six months as entrepreneurs take previous restaurant spaces at favorable build-out costs and potentially lower rents."
If and when that happens -- and it stands to reason it will -- investors who locked down the right spot at the right time and offer the right restaurant product for their market may serve themselves up some nice profits.