McDonalds owns their real estate. Why doesn’t Starbucks? (YouTube Video Transcript)

(00:00:00) Your YouTube transcript will appear here (00:00:00) In the mid1 1950s, Ray Croc discovered (00:00:03) the secret that would make him a (00:00:05) billionaire. McDonald's wasn't a (00:00:07) restaurant business. It was a real (00:00:09) estate business that just happened to (00:00:11) sell hamburgers. By owning the land (00:00:14) under every restaurant and leasing it (00:00:16) back to the franchises, Croc unlocked (00:00:18) steady cash flow, control over (00:00:21) expansion, and predictable returns. (00:00:23) [music] Today, McDonald's owns 57% of (00:00:26) the land under its 43,000 restaurants. (00:00:29) Their property [music] portfolio is (00:00:31) worth $42 billion. This motto was taught (00:00:34) in every business school as the gold (00:00:36) standard for franchise expansion. (00:00:37) [music] So, here's the puzzle. Howard (00:00:39) Schultz knew all of this when he started (00:00:42) expanding Starbucks in the late 1980s. (00:00:44) He had the same goal [music] as Croc, (00:00:46) rapid expansion across America. He had (00:00:49) investors ready to fund all of their (00:00:51) property purchases. [music] And yet, he (00:00:53) did the exact opposite. Starbucks has (00:00:56) 41,000 stores worldwide and leases (00:00:59) almost every single one. Why would (00:01:01) Schultz deliberately ignore a proven (00:01:05) billion dollar playbook? The answer lies (00:01:07) in understanding what McDonald's (00:01:09) strategy is actually optimized for. (00:01:19) >> Tell me about the land. (00:01:20) >> The land. and the land, the buildings, (00:01:22) how that whole aspect of it works. (00:01:25) >> Wow, pretty simple really. Franchisee (00:01:27) finds a piece of land he likes, gets a (00:01:30) lease, usually 20 years, takes out a (00:01:32) construction loan, (00:01:34) throws up a building, and off he goes. (00:01:36) >> So, the operator selects the site. (00:01:39) >> Yeah. He picks the property, (00:01:41) >> right? (00:01:41) >> You provide the training, the system, (00:01:43) the operational knowhow, and he's (00:01:46) responsible for the rest. (00:01:48) >> Is there a problem? (00:01:49) >> A big one. You don't seem to realize (00:01:52) what business you're in. You're not in (00:01:54) the burger business. (00:01:56) You're in the real estate business. (00:01:58) >> With the help from his CFO, Harry J. (00:02:01) Sonorn, Croc discovered that he could (00:02:03) make more money by changing his business (00:02:05) model, owning the real estate and (00:02:07) leasing it back to the franchisee. This (00:02:09) shift is what led to Croc becoming a (00:02:11) billionaire and McDonald's becoming one (00:02:13) of the biggest brands on the planet. Up (00:02:16) to this point, Croc was struggling to (00:02:18) turn a profit on the 1.9% of sales he (00:02:21) received from all of his franchises. In (00:02:23) his autobiography, the film is based on, (00:02:25) Croc elaborates on what Harry told him. (00:02:28) You don't build an empire off of a 1.4% (00:02:30) cut of a 15 cent hamburger. You build it (00:02:34) by owning the land upon which that (00:02:36) burger is cooked. What you ought to be (00:02:38) doing is buying up plots of land, then (00:02:41) turning around and leasing those lots to (00:02:43) franchises who, as a condition of their (00:02:45) deal, are permitted to lease from you (00:02:47) and you alone. Prior to this shift, (00:02:49) growth was stunning. But as David Synra (00:02:51) says in the founders podcast, the move (00:02:54) provided two things that Croc did not (00:02:56) have. Number one, a steady upfront (00:02:59) revenue stream. Money flows in before (00:03:01) the first stake is in the ground. And (00:03:03) number [music] two, greater capital for (00:03:05) expansion, which in turn fuels further (00:03:08) land acquisition, which in turn fuels (00:03:11) further expansion. That that right there (00:03:14) is how they go. At this point, they have (00:03:15) maybe a few dozen McDonald's to by the (00:03:18) time the book ends in 1977 to 4,000 to (00:03:21) today 40,000. Today, McDonald's owns the (00:03:25) land under most of its restaurants. rent (00:03:28) payments from the franchises create the (00:03:29) steady, predictable cash flow that made (00:03:31) this model so powerful and gave (00:03:33) McDonald's access to capital that (00:03:35) accelerated their expansion. All in the (00:03:37) back of a strategy of buying and then (00:03:40) leasing real estate to franchises. So (00:03:42) then why on earth did Starbucks go in a (00:03:44) completely different direction? Howard (00:03:46) Schultz pursued the same rapid expansion (00:03:49) that Ray Croc did. The difference being (00:03:51) the lever for growth was the complete (00:03:53) opposite. Instead of buying the land, (00:03:55) Schultz would lease it. Let me explain. (00:03:57) Schultz opened his first espresso bar in (00:04:00) 1986, which was actually called Ill (00:04:03) Jordan, which I'm sure I butchered. But (00:04:05) by 1987, he'd expanded to 17 stores (00:04:08) across Seattle after buying the retail (00:04:10) side of a local coffee roaster and his (00:04:13) previous employer, Starbucks. He merged (00:04:15) the brands and kept the Starbucks name. (00:04:18) This new way of drinking coffee, (00:04:19) inspired by Italian espresso bars with (00:04:22) an American twist, it's catching on. (00:04:24) Schultz had attracted more than $3 (00:04:26) million in investment to fund these (00:04:28) expansions. Convenient speed and (00:04:30) cappuccinos which were new to most (00:04:32) Americans were proving to be a hit. But (00:04:34) Schultz wanted to continue expansion and (00:04:37) he required [music] further rounds of (00:04:38) investment to fund it. The question from (00:04:40) investors was always the same. How can (00:04:43) Starbucks defend its concept? Coffee is (00:04:45) a commodity and you might have been the (00:04:47) first to bring cappuccino and lattes (00:04:49) over to the US with any degree of (00:04:51) success. But what's to stop industry (00:04:53) giants like Maxwellhouse from just (00:04:55) copying you? Time was of the essence. (00:04:58) Starbucks provided an affordable luxury (00:05:01) and experience unlike anyone else. Once (00:05:03) they'd proven the concept, the goal was (00:05:05) to be first to market in every market. (00:05:08) It didn't matter whether they were the (00:05:10) first Italian style coffee shop in the (00:05:12) US. What mattered was that they [music] (00:05:14) were the first that their customer knew (00:05:16) and liked. If they could get to market (00:05:18) first and maintain that quality and (00:05:20) consistency in each location, they'd (00:05:22) become the number one brand and market (00:05:24) leader. They were not going to do that (00:05:26) at pace by tying up their capital into (00:05:28) property ownership. All cash was (00:05:30) required to fuel the pace of expansion (00:05:33) at the best locations in each market (00:05:35) whilst maintaining that quality and (00:05:37) consistency of each location. Chicago (00:05:40) proved why this mattered. In October of (00:05:43) 1987, Starbucks made a bold move, (00:05:46) opening their first store outside the (00:05:48) Pacific Northwest in Chicago. They were (00:05:51) entering a market with no existing (00:05:53) specialty coffee culture, no brand (00:05:54) awareness, and higher operating costs (00:05:56) than Seattle. For the first 2 years, (00:05:58) those Chicago stores struggled, barely (00:06:01) sustainable. Customers love the coffee (00:06:03) when they tried it, but there just (00:06:04) weren't enough of them yet. The market (00:06:06) had to be built from scratch. But here's (00:06:08) the thing. Because Starbucks was (00:06:10) leasing, not owning, they could afford (00:06:12) to wait it out. They weren't servicing (00:06:14) property debt on top of operating (00:06:16) losses. They could keep pouring capital (00:06:17) into staff training, quality control, (00:06:19) and slowly building that customer base. (00:06:22) By 1990, the stores turned a corner. The (00:06:25) concept worked. It just needed time and (00:06:28) sustained investment to build awareness (00:06:30) in a cold market. If they had been (00:06:31) locked into property ownership in (00:06:33) Chicago while bleeding cash for 2 years, (00:06:36) they wouldn't have had the flexibility (00:06:38) or the capital to stay in the game. Then (00:06:40) came Los Angeles in 1991. Before (00:06:43) Starbucks even opened their first LA (00:06:45) store, the Los Angeles Times named them (00:06:49) the best coffee in America. They opened (00:06:52) in the right neighborhoods, attracted (00:06:54) the Hollywood crowd, and suddenly the (00:06:56) opening of a new Starbucks became an (00:06:58) event. photos, publicity, lines out the (00:07:02) door. This is what the leasing enabled. (00:07:04) The ability to cherrypick the absolute (00:07:07) best locations in high-v value markets (00:07:09) without tying up all of your capital in (00:07:11) property acquisition. Get in, prove the (00:07:13) concept, build the brand, and move to (00:07:15) the next market while the iron was hot. (00:07:17) By the early '90s, Starbucks had cracked (00:07:19) the code. Target cities where they (00:07:21) already had mail order customers, (00:07:23) built-in advocates who would spread the (00:07:25) work. open in the best locations those (00:07:27) cities offered and let the brand do the (00:07:29) heavy lifting. This was only possible (00:07:31) because every dollar that could have (00:07:32) gone into buying real estate in Chicago (00:07:34) or LA instead went into opening the next (00:07:37) market. Completely the opposite of (00:07:39) McDonald's. So what's the real estate (00:07:41) principle to take away here? Trade-offs. (00:07:44) McDonald's is arguably better built for (00:07:46) the long haul because they control their (00:07:48) destiny. But Starbucks, because of their (00:07:51) strategy, were able to expand at two (00:07:54) times the rate that McDonald's were. (00:07:56) Both brands have a similar number of (00:07:58) stores. Now, let's break this down. (00:08:00) [music] Imagine each company invests $2 (00:08:03) million. For Starbucks, that money (00:08:05) builds stores. It buys equipment and (00:08:07) fuels coffee sales, producing an (00:08:09) operating return near 18%. McDonald's (00:08:13) puts the same $2 million into real (00:08:15) estate, generating a steady but lower 8% (00:08:19) property return. The McDonald's strategy (00:08:21) to own or control its real estate works (00:08:24) because it enables the company to secure (00:08:26) long-term predictable cash flows from (00:08:28) their franchises through rent and (00:08:30) royalties. Returns that are lower (00:08:32) percentage- wise, but higher in (00:08:33) stability and duration. Owning its (00:08:35) properties allows McDonald's to generate (00:08:37) steady inflationprotected rental income (00:08:40) and build long-term asset value rather (00:08:43) than depending solely on restaurant (00:08:45) operations. The Starbucks strategy on (00:08:47) the other hand to stay asset light in (00:08:49) retail real estate works because it (00:08:50) enables them to fund store buildouts, (00:08:52) equipment, tech, product innovation, (00:08:55) buybacks, areas that management views as (00:08:57) higher return than owning property. (00:09:00) Leasing gives Starbucks faster openings (00:09:02) and easier exits or relocations across (00:09:04) malls, high streets, airports, and other (00:09:07) landlord controlled venues that coffee (00:09:08) shops commonly inhabit. Now, I'm a (00:09:10) commercial real estate investor. This (00:09:12) channel is all about commercial real (00:09:14) estate. So, what does this mean for (00:09:16) investors? For many, Starbucks (00:09:18) represents the ideal tenant. They're (00:09:21) blue chip like Chase Bank or Chick-fil-A (00:09:23) or 7-Eleven. Perfect for investors who (00:09:25) want secure cash flow without the (00:09:28) headaches of tenant management. Now, I (00:09:30) personally don't have any Starbucks in (00:09:32) my portfolio. So, why is that? Well, (00:09:35) because I'm an active investor, I am (00:09:37) willing and eager to work on investments (00:09:39) on a day-to-day basis. I'm willing to (00:09:42) put in the time, the energy, the effort (00:09:44) into creating value on my deals. But (00:09:47) when I'm older and ready to retire or (00:09:50) just spend more time with my family or (00:09:52) travel the world for years at a time, (00:09:54) that's when I'll invest in something (00:09:55) like a Starbucks. If that's the stage of (00:09:57) life that you're in, one where you're (00:09:59) looking for passive investments, owning (00:10:01) a Starbucks might be something for you (00:10:04) to consider. So, how do these types of (00:10:06) deals work? Well, here's your 30,000 ft (00:10:09) overview. A developer who has already (00:10:11) been pre-selected by Starbucks and (00:10:13) understands their needs goes out, finds (00:10:16) a site, packages it up, pitches it to (00:10:18) Starbucks, Starbucks says yes. Then that (00:10:21) developer goes and builds it with a (00:10:22) 15-year lease typically in hand from (00:10:25) Starbucks, which allows them to get (00:10:26) their financing. Then, as soon as it's (00:10:28) completed and Starbucks is open and (00:10:30) operating, the developer puts the (00:10:32) property on the market to sell it as a (00:10:34) single tenant net lease investment based (00:10:36) on a cap rate. Then you as the investor (00:10:38) come in and essentially buy a brand new (00:10:40) 15-year lease with a brand new building. (00:10:43) Now, not every deal is like this. Of (00:10:45) course, you could go buy one that's also (00:10:47) been there for 5 years already. So, (00:10:49) there are different ways of doing it, (00:10:51) but in all cases, you as the investor (00:10:53) buy it. You notify Starbucks that you're (00:10:55) the new landlord and they send you rent (00:10:57) every month. Starbucks pays you. Now, (00:10:59) let's get into the finer details. To (00:11:02) understand what makes a Starbucks lease (00:11:03) so valuable, I spoke with Evan Pilaski, (00:11:06) director at Blackgate Partners, a real (00:11:08) estate investment firm focused on the (00:11:10) acquisition and operation of (00:11:11) neighborhood strip centers nationwide. (00:11:14) Evan knows retail inside and out, and (00:11:16) he's been analyzing these deals for (00:11:18) years. Starbucks loves the anywhere from (00:11:20) the ground lease to the double net (00:11:22) lease. So, they very rarely, if ever, (00:11:25) own their their actual real estate. So, (00:11:28) from an investor standpoint, love it (00:11:30) because you're getting great brand (00:11:32) recognition, credit behind the store, (00:11:35) the understanding that they have a (00:11:38) corporate real estate team running all (00:11:40) the demographics, traffic counts, (00:11:42) traffic patterns, access points to even (00:11:45) put a store in that location. So, you're (00:11:48) as an investor, you can leverage their (00:11:50) expertise and their business to maximize (00:11:53) your investment in the real estate side. (00:11:55) In other words, you're not just buying a (00:11:57) property. You're buying Starbucks site (00:12:00) selection experience. Their corporate (00:12:02) real estate team has already done all (00:12:04) the work for you. The traffic counts, (00:12:06) the demographics, access analysis, all (00:12:08) baked into the location that you're (00:12:10) acquiring. And unlike franchise chains (00:12:12) where you're betting on an individual (00:12:14) operator, with Starbucks, you're getting (00:12:16) a full corporate guarantee. That credit (00:12:19) strength translates directly into value. (00:12:22) Evan makes the point on paper, a local (00:12:24) tenant might offer $25 per square foot (00:12:27) while Starbucks only offers $20 face (00:12:30) value. That $25 per square foot might (00:12:33) seem like a better deal. But Starbucks (00:12:36) arguably creates more value because of (00:12:38) their credit, the renewals, and the (00:12:40) predictability of income. That local (00:12:42) tenant, there's a bit of risk that they (00:12:44) go out of business and default before (00:12:46) the lease is up. With Starbucks, that (00:12:48) risk is pretty negligible. Genuinely (00:12:51) though, is this the kind of deal that (00:12:53) you buy for cash flow or appreciation or (00:12:56) is it kind of just bragging rights? (00:12:59) >> I'm sure there's a bragging rights (00:13:00) person out there. I would buy for cash (00:13:03) flow. It is, in my opinion, the the cash (00:13:06) flow first and foremost and your (00:13:08) residual value. You can only really rely (00:13:10) on the land side of [music] the (00:13:12) building. (00:13:12) >> So, why did Schultz ignore Ray Croc's (00:13:15) billion-dollar blueprint? Because (00:13:17) [music] great strategies aren't (00:13:19) universal. Though they had similar (00:13:21) ambitions, they were selling a different (00:13:23) product at a different time. McDonald's (00:13:25) traded higher returns for control and (00:13:28) stability. Starbucks traded control for (00:13:30) speed and flexibility. Both won, just (00:13:33) differently. And for investors, (00:13:35) Starbucks's choice created an (00:13:37) opportunity. A Fortune 500 tenant paying (00:13:40) you rent on properties that they will (00:13:43) never buy. steady, safe, predictable. (00:13:46) Perfect for when you're done chasing (00:13:48) returns and ready to just collect (00:13:51) checks. Your neighbor might own a (00:13:53) Starbucks. Why don't you? Before you (00:13:55) leave, if you're thinking, "All of that (00:13:57) sounds great. I'd love to invest in a (00:13:59) Starbucks, but I still don't know where (00:14:00) to start." That's why I started the CR (00:14:03) Accelerator Mastermind. It's a (00:14:05) step-by-step system that I wish I had (00:14:07) had when I was first getting started in (00:14:09) commercial real estate. And it's already (00:14:10) helped people just like you close their (00:14:12) first deal way faster than they ever (00:14:15) thought possible. But if you're not (00:14:17) ready for that, if you want to know more (00:14:18) about how all of this triple net real (00:14:20) estate investing stuff works, check out (00:14:22) this video next on TripleNet 101.