Red sign hanging at the glass door of a shop saying in French “Fermé à cause du coronavirus” meaning… [+]
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Aside from the airlines and hotel operators, restaurants could be one of the biggest victims of the coronavirus pandemic.
In only a matter of days, thousands of eateries – from fast-food chains to fine-dining establishments – have shut down across the country. Eating out at restaurants was one the first things that many people cut back on, as they realized COVID-19 could be spread via human-to-human contact.
And then, one by one, many cities and states across the U.S. began ordering dining establishments to lock their doors, though many are still allowed to offer deliveries and take-out options to customers looking for a quick and easy bite.
Unfortunately, for many restaurant operators, the coronavirus could be the final blow to their businesses – one that puts them out of business.
Profit margins in the industry are already razor-thin to begin with. Turnover has always been high. The mechanics, to run a restaurant, are complicated. The supply chains are complex. As a restaurant operator, you are dealing with fresh food, which is difficult to keep in stock as demand fluctuates.
It will be extremely difficult for many of these restaurant owners to continue to pay staff, when they are not serving customers. Even those still offering deliveries are losing sales. The demand from consumers has dropped off tremendously.
The National Restaurant Association has estimated that between 5 million and 7 million restaurant jobs will be lost in the U.S. over the next three months.
Danny Meyer’s Union Square Hospitality Group, which is based in New York, has already laid off about 2,000 workers, or about 80% of its workforce.
The irony of this all from a real estate perspective is that, for some time now, restaurants have been considered a safer asset to incorporate into a shopping center or mixed-use development. They drive traffic. And then, hopefully, people will visit some of the nearby shops after they grab lunch.
But for the foreseeable future, all of that logic is out the window. We don’t know what restaurants we’ll be left with when this is all over. Some pizza delivery chains like Papa John’s are looking to hire thousands of workers “immediately” to meet a surge in demand. But there are many companies that have never been prepared to handle orders that way.
The parent company of Olive Garden and Longhorn Steakhouse – Darden Restaurants – has withdrawn its fiscal 2020 outlook and also suspended its quarterly dividend because of COVID-19. It fully drew down its $750 million credit facility “out of an abundance of caution.”
We can only expect many more businesses will be following suit.
But Wait, You Can Buy Their Real Estate At Bargain Prices Now
As a REIT analyst, I cover a variety of companies that lease to restaurants and the net lease REIT sector offers some attractive buying opportunities, if you have the appetite for the higher risk.
We recently upgraded shares of Realty Income (O), a net lease REIT with a portfolio of over 6,400 free-standing properties of which around 21 percent is exposed to restaurants. It gives me comfort in knowing that around 49 percent of the revenue in the portfolio is generated from investment grade rated tenants.
Realty Income has done an excellent job of maintaining strict discipline by maintaining a fortress balance sheet (rated A- by S&P) and growing its dividend (increased every year since 1994). Shares are now a tasty $43.34 which translates into a dividend yield of 6.5 percent. We recently upgraded to a Strong Buy.
Another terrific strong buy is Four Corners Property Trust (FCPT), a net lease REIT that invests exclusively in restaurant properties. The company was created a few years ago after Darden (DRI) spun its restaurant and today Darden owns 426 Darden properties and 273 others under additional brands.
Four Corners portfolio is 72 percent investment-grade rated (the highest in the net lease REIT sector) and has the second-strongest tenant earnings before interest, taxes, depreciation, amortization, and restructuring (EBITDAR)-to-rent coverage (of 4.8x) in the net lease REIT sector. Shares now trade at $13.78 with a delicious dividend yield of 8.9 percent.
While there’s little doubt that restaurants will be like zombies for a few days, if not weeks, we believe that these two REITs are well-positioned to continue paying dividends. Eventually life in the U.S. (and the world) will normalize and things will get back to normal.
But for now, we see opportunity in buying shares in some excellent REITs that are trading at a wider margin of safety. Put these two REITs on your menu!
I own shares in O and FCPT.