Owning vs Leasing Real Estate: Pros & Cons

Hi, everyone. Welcome back to another episode of Franchising Unboxed. I'm here with Dustin Thompson. We've got, my name is Mike Wootton. We've got Dustin Thompson with us, and, we have Esty Chang back for another episode. We're gonna talk a little bit more about real estate today and digging in a little bit deeper into the pros and cons of owning versus leasing real estate. That's always a hot button question with our franchise candidates. You know, which way should I go? What are the pros and the cons? So when you consider a franchise, one of the significant decisions a franchisee faces is whether to own or lease the real estate for their business. Both options have distinct pros and cons that can significantly impact the financial health and operational flexibility of your franchise. Today, we have Esty. She's gonna give us a little bit of details on what she sees out in the real world, on some of these decisions that are real, real tough decisions that a lot of our franchisee candidates make once they are in the Jack in the Box system. So stay tuned, and we'll get started. Alright. So we're gonna start now with talking a little bit about some of the pros of owning real estate, and I'm gonna turn it over to Esty and let her kinda give you some of the things that she sees, that are causing folks to make decisions on making a transaction that would be to purchase dirt where their restaurant would be, operating. So I'll turn it over to Esty and let her give us a little bit of information about what it's like for our folks that are looking to buy. Thank you, Mike. There are definitely both pros and cons to owning your real estate as you're looking to develop your franchise development agreement. And I think franchisees always like to look to own first. A lot of that is because of the pros of ownership. Right? Equity and long term wealth, the long term ownership of your site, as well as the tax benefits and depreciation benefits of owning that land underneath your building. You also tend to have a little bit more control and customization to your site as opposed to being restricted to a shopping center design requirement or maybe some restrictive parcel sizes. You can control your destiny in that regard, if you're going out and searching for land to purchase to develop your store. There's also a lot of operational stability. Right? If you own your land, you are not worried about your lease term coming up in twenty, forty, you know, sixty years and or your rents increasing, at an astronomical rate due to a fair market value increase just through the course of time and how the market shifts over time with rental costs rising. And then you have freedom of landlord issues. Right? You are not reliant on the landlord to possibly complete common area maintenance, roof repairs if that's in your lease, or any other type of property maintenance or improvements that are going to impact the overall aesthetic of your site. But along with that, there are some cons to be considered, and that is going to be the high upfront cost. Right? Land costs are rising across the nation. That is not a surprise to anybody. So that is going to be a consideration for franchisees as they look to secure whether or not financing, or some capital constraints as we look to, you know, the development process for construction. It also lowers their liquidity because their assets are gonna be tied up into that real estate. So really making sure that the franchisees evaluate that flexibility of their portfolio to make sure that they're keeping their assets fluid to be able to continue their development pipeline and as well as, you know, addressing the earlier pro. Right? You have that that flexibility and that control over your maintenance, but those maintenance costs and those improvement costs are now going to be at the determination of the franchisee and the responsibility of the franchisee, so making sure that you account for those costs and those expectations as the lifeline of your asset rolls forward, and making sure you prepare for it. It limits your flexibility as well. Right? You may not be able to resell that asset in the future if the trade area shifts, and you may not want to immediately relocate to newer growing areas because you hold that asset. So making sure you evaluate that perspective, as you look to whether or not lease or own, all of that's going to be a part of the consideration process that our real estate team will help with and investigate as we support you through the decision making process and how you identify your sites. Yeah. That's all really, really great information. You know, when Dustin and I are talking to candidates, you know, we typically advise people to keep their mind open about the type of real estate transaction. Everybody thinks buy first, but leasing. Let's talk a little bit about leasing. What are some of the great pros and cons on leasing? I tell people, you know, as you build out a company, you might be building three, four, five restaurants. You're gonna have typically some combination of owning and leasing because you have to kinda see where the real estate leads you. Let's talk a little bit about leasing. What are some of the pros on leasing? So definitely some of the pros on leasing are gonna be lower upfront cost because you're not having to put forward the capital to buy that real estate. You're gonna be able to find a little bit more opportunity in growth trade areas since that's where some of the new lease opportunities come and or some very mature trade areas as landlords look to improve their properties, redevelop, and, you know, reinvest in their properties, they create carve out parcels. So more often than not, a developer or a landlord is not looking to divest that asset, so it would be limited to a ground lease or a building lease opportunity. So it just opens up the potential of opportunities you're gonna see as we go out there and look for the trade areas we wanna be in. You also have the flexibility that we talked about earlier. Right? You may not want to relocate in twenty years if a trade area has shifted, but as your lease comes up, you're given that opportunity to reevaluate your market, your consumer base, and identify any of those shifts that may need to be addressed in the event that you wanna continue to, you know, fuel your company and organization success to follow your customer. That obviously gives you the opportunity as you come up on your lease terms. And then, you know, just the predictability of cost. Right? You know what your lease rates are gonna be. You know what your CAM cost or triple net costs are gonna be. There are no surprises to major improvements or repairs that are gonna come against you unless, you know, it's your building asset, but, hopefully, those don't come up for some time. But, you know, obviously, there's more flexibility with what you're able to do with your capital in that instance because your occupancy costs are just going to be lower without the burden of a mortgage on that land. You also have more tax benefits with some depreciate opportunities on the building and equipment. So, really, again, similar to what we talked about with purchasing, It's about evaluating the totality of your assets and how it meets your financial and capital needs to grow your business. Let's go to some of the negatives. I know, that some people were gonna say there's some negatives to leasing, but, let's hear a little bit about what you would say would be some of the cons. Obviously, when you're leasing, I think it's important to understand you can grow quicker, which you know, if you've got a large number of restaurants that you wanna build out and you wanna grow aggressively, leasing is obviously a viable way to do that. What are some of the cons? Upfront, some of the cons are the lack of equity. Right? You have no primary ownership in the land underneath your real estate, which is very attractive to new franchisees, and limited control. You may be subject to certain design requirements by the shopping center, but that could be a function of the jurisdiction itself if you own. So really understanding the markets and the requirements that you're growing in are gonna be a part of the consideration as you look to lease or own. And then, you know, obviously, as we mentioned earlier, fair market value increases as you come to the end term of your lease. Really making sure you manage those expectations and how you negotiate leases and increases in the option terms and beyond. And, again, just that landlord dependency. Right? You're gonna be dependent on the landlord to maintain and improve the shopping center. If the landlord does not keep a grade A quality center, Are you gonna be impacted by that? And those are conversations you're gonna have to have with your landlord along the way. Should you see, you know, a decline in the surrounding center that you're in, you know, you wanna be able to make sure your ownership matches your asset and the pride in your asset that each of our franchisee holds in their beautiful prototype building. So what type I have a question. What type of leases exist? Right? You mentioned, ground lease earlier or building lease. Kind of walk us through. For someone who's never worked in franchising or is looking at franchising for the first time, what are those options for leases? The most common lease option you'll see today is going to be your ground lease, and that is you rent the dirt, and we'll construct your building upon that. As we talked in our earlier podcast, second generation spaces or conversion spaces are are gonna be land and building leases because you are now leasing the building asset from the landlord, and those are gonna have different cost considerations from the landlord or developer's side because of the asset improvement value that they deem. And then there is a less preferable option these days, but we do have a few franchisees that actually engage in this option because of the capital requirement for development, and that's gonna be a build to suit lease where you might find a landlord or a developer that is willing to do a turnkey development and build the prototype for you. That is going to come with a higher occupancy cost for the cost of development. But given the sales potential that a franchisee sees, that may be within a reasonable scope of occupancy cost given the fact that there is no capital constraint to enter into that lease and walk into a turnkey building to receive the keys and start operating a business and hit the ground running producing sales. So when you're choosing a lease or a purchase, either one you choose, what is most important? Obviously, it sounds like it's the location from what you shared before, and it's better to go with maybe the location if they have a prime location, and that's a lease. It sounds like it may be a better option to lease versus purchase. Does that does that make sense? Yes. And, ultimately, the decision to own or lease for every franchisee is gonna depend on several factors. One is going to be their financial position and how much capital they can look to extend without overleveraging themselves and really make sure they're capitalized to fulfill the long term operational development of their stores. We never wanna put franchisees in a bind from a financial perspective just to get a store, as well as their long term goals and their risk appetite. We wanna make sure the franchisees understand the decisions they're making as it pertains to their overall asset portfolio and the specific needs of their franchise development agreement as well as availability of trade areas. Right? Like you mentioned, there may be a tier one trade area, a grade chariot area depending on your terminology where only leases are available. Managing that diversification of the asset portfolio to make sure whether or not it's a lease or buy, you are strategically placing the restaurants in the best position possible for your store and operational success. Lending both owned and leased properties will build a stronger, more resilient asset portfolio, and this is gonna help the franchisees balance their risk as they learn to grow out and develop out their pipeline of stores, to build out the market. So with the real estate, everyone has seen the cost of real estate basically increase in most, if not every market across the country. So owning real estate, obviously, is gonna be a little more expensive than it was before. Do you see that escalation in leases as well as these or as the amount that a lease is going for, is that going up with real estate, or is it stayed relatively flat? How how does how do those correlate? Generally, they will correlate. Where land costs go up, lease costs will go up because, ultimately, every property owner, every landlord is a developer, and they're just looking to make their return on the investment as well. But as with all things real estate, it is a very cyclical market. And while when you will see land cost rise, lease cost rise, we're also seeing a very similar effect in the construction world, which is improving the negotiation power that franchisees and tenants have on the market. So whether or not it's a lease or own, it's really gonna be a function of where the current real estate market is at, the availability of real estate, and the appetite of both either the property owners and or the tenant. I would say I do feel like we're working through a shift right now. As developers who are sitting on holding costs, they are becoming a little bit more flexible in their negotiations. So, you know, really, it's, again, the real estate support team to provide that information as well as the franchisee's local knowledge to know where they should really push the boundaries of their negotiations whether or not it's a lease or a buy. Wow. This has been this time's gone by super quick. Thanks, Dustin, and, obviously, thanks, Esty. You have blessed us with quite a bit of information about purchasing real estate versus, leases and what some of the pros and cons are. And I think, hopefully, we touched, you know, we really just scratched the surface today on this video. But I hope it's given you a better understanding of the pros and cons of owning and leasing real estate for your potential franchise. And, again, if you're ready to begin your franchise journey with Jack in the Box, please fill out any form on our website, and a member of our team, most likely Dustin or myself, will be in touch. Thanks for watching, and we hope everybody has a great day. Thanks again.