McDonald's is a Large Real Estate Company
buy the rumor; sell the news
Ask most people what they first think of when you say “McDonald’s,” and you will likely hear something like “Quarter Pounder,” “French fries,” or “fast food.” Ask most people what they think McDonald’s business model is, and most people will say “selling hamburgers and fries.”
Neither answer is incorrect but both answers are incidental to McDonald’s main business. McDonald’s business model is real estate. Searching for “McDonalds and real estate” on Google returns a bunch of links:
In other words, I’m not the first to have come up with this argument.
McDonald’s is a real estate company with a franchise operation layered on top of it, which franchise operation sells fast food to millions of customers. To understand what McDonald’s is, you have to ignore the food its franchisees sell and the franchise licenses it sells to franchisees, and focus more on the real estate it acquires and holds on its balance sheet.
A veteran equity research analyst once gave me a great method to quickly understand a company’s business. Say you are looking at a particular bank, and you want to understand how the bank thinks interest rates affect its business prospects. Take the annual report, in PDF form, and search for “interest rate”. All paragraphs that contain “interest rate” are relevant to you. Extract them from the PDF, and you’ve assembled the bank’s narrative about interest rates. This is a very quick way to learn more about a company than most people ever will.
We can do the same with McDonald’s annual report. Following are a few real estate-related excerpts from McDonald’s annual report. Let’s see what information we can glean here about how McDonald’s really makes its money.
Excerpt 1:
Under a conventional franchise agreement, the Company generally owns or secures a long-term lease on the land and building for the restaurant location and the franchisees pays for equipment, signs, seating, and decor. The Company believes that ownership of real estate, combined with the co-investment by franchisees, enables us to achieve restaurant performance levels that are among the highest in the industry.”
Takeaway
McDonald’s owns the real estate, and leases it to people who buy a franchise license. The franchisee takes on the risk of maintaining equipment that can wear out, and which may need to be replaced. McDonald’s, meanwhile, books both the tax-advantaged treatment of real estate depreciation, and the appreciation inherent in owning real estate. McDonald’s has its cake and eats it, too.
Excerpt 2:
Under a developmental license or affiliate agreement, licensees are responsible for operating and managing the business, providing capital (including the real estate interest) and developing and opening new restaurants. The Company generally does not invest any capital under a developmental license or affiliate agreement, and it receives a royalty based on a percent of sales, and generally receives initial fees upon the opening of a new restaurant or grant of a new license.
Takeaway
McDonald’s leverages its brand name to extract up front fees from franchisees who open new restaurants, foists interest costs onto those franchisees, and does not invest any capital in the opening of new restaurants. This means that McDonald’s takes on no risk for new restaurants, and is paid for doing so! If a new restaurant does not work out, McDonald’s still would have been paid fees, and would have no risk at stake.
Excerpt 3:
Cash used for investing activities totaled $3.1 billion in 2019, an increase of $616 compared with 2019. The increase was primarily due to the Company’s strategic acquisitions of a real estate entity, Dynamic Yield and Apprente, partly offset by lower capital expenditures. Cash used for investing activities totaled $2.5 billion in 2018, an increase of $3.0 billion compared with 2017. The increase was primarily due to lower proceeds from the sale of restaurant businesses in 2018 including the comparison to the proceeds received in 2018 associate with the sale of the Company’s businesses in China and Hong Kong, as well as higher capital expenditures.”
Takeaway
This excerpt doesn’t give us a whole lot of insight into McDonald’s real estate operations, other than to vaguely note that it used cash to acquire a “real estate entity.” What we can infer here is that McDonald’s thought that acquiring a real estate entity with its cash was a good use of that cash. This maps to our thesis that McDonald’s is primarily in the business of owning and managing real estate.
Excerpt 4:
New restaurant investments in all years were concentrated in markets with strong returns and/or opportunities for long-term growth. Average develop costs vary widely by market depending on the types of restaurants built and the real estate and construction costs within each market. These costs, which include land, buildings and equipment, are managed through the use of optimally-sized restaurants, construction and design efficiencies, as well as leveraging the Company's global sourcing network and best practices. Although the Company is not responsible for all costs for every restaurant opened, total development costs for new traditional McDonald's restaurants in the U.S. averaged approximately $4.0 million in 2019. The Company owned approximately 55% and 50% of the land for restaurants in its consolidated markets at year-end 2019 and 2018, respectively, and approximately 80% of the buildings for restaurants in its consolidated markets at year-end 2019 and 2018."
Takeaway
There’s a lot to chew on here. This reads very much like a real estate developer looking at potential sites for development, and very much unlike a restaurateur contemplating a new restaurant. Further, McDonald’s is pretty explicit here about the amount of real estate that it carries on its books: a majority of restaurants in its “consolidated markets” sit on land that McDonald’s owns, and fully 80% of the buildings that house its restaurants are owned by McDonald’s.