Skyrocket your IELTS band score by 1-2 points in under a month with our premium plan!
↔
Thanks to Skillshare for sponsoring this video.
The first 1000 people to use the link in the
description can watch my course and thousands
of others with a free trial of Skillshare
Premium.
During recessions, consumer behavior tends
to change in fairly predictable ways.
The hardest-hit businesses are, of course,
the most unnecessary.
Travel and tourism, leisure and hospitality,
and manufacturing.
Other companies actually stand to benefit.
Like, fast food.
Stomachs don’t respond to economic downturns,
but smaller bank accounts do opt for cheaper
alternatives, which is why chains like Burger
King and Wendy’s often perform better than
average during recessions.
From 2008 to 2010, for example, while other
businesses closed or downsized, Subway, added
nearly 6,000 new locations.
KFC added around 300 in roughly the same period.
One company, however, stands out as the clear
fast food winner of 2008: McDonald’s.
That year, it continued its 55-month long
streak of same-store sales increases with
even better performance than before the recession,
while opening 600 new locations, and with
an impressive 29% return on equity.
Some of this is for obvious reasons: During
that time, consumers were simply eating cheaper
food.
But there’s also another reason McDonald’s
is what some analysts call “recession-proof”:
McDonald’s is, first and foremost, a real
estate company.
Glancing at its 2019 balance sheet, one number,
in particular, should grab your attention:
$39 billion.
That’s the current value of all its property
and equipment before it reports depreciation.
That would technically make it the fifth-largest
real estate holder in the world, measured
by total assets.
Cover the name ‘McDonald’s’, and this
might look like the financial statement of
any other boring big-name real estate developer.
Like Burger King and Subway, the company was
able to grow so fast and reach so many countries
around the world through franchising.
85% of its restaurants are owned by someone
who essentially ‘leases’ the McDonald’s
name and brand, in exchange for a considerable
fee.
What makes the company so unique is that,
unlike other similar fast-food giants, McDonald’s
makes the majority of those franchise revenue
from rents, not burgers.
To be more precise, in 2019, 7.5, or 64%,
of its 11.6 billion dollars in franchise fees
came in the form of rent.
Here’s how it works:
Because McDonald’s has decades of experience
buying and selling properties, it knows the
precise ingredients of a successful location.
It shops around usually for intersections
between two high-traffic roads and buys space
in whichever corner has the most parking.
The ideal space is around 50,000 square feet,
4 and a half thousand for building space.
The intersection should also have traffic
lights.
It then buys the property with long-term fixed
interest rates.
Its huge existing property holdings provide
it with the most favorable deals.
Then, when someone applies to operate their
own McDonald’s location, they sign with
the company a Franchise Agreement — stipulating
nearly every detail of how the business will
operate — from how the burgers are cooked,
to the hours of operation.
For example, they can only purchase from an
approved supplier, who may or may not be the
best or cheapest option.
The franchisee — that is, the local owner
— generally makes a total upfront investment
of $1-2 million for a single location, including
an initial down payment paid in cash, one-time
franchise fee of $45,000, and a percent royalty
of every month’s revenues.
These, usually 20-year contracts, also have
the unusual but highly consequential stipulation
that the restaurant be located at that specific
address — the one McDonald’s, the corporation,
just bought.
In other words, McDonald’s instantly has
a tenant, and one who will always pay above-market
rates.
Depending on the value you attribute to good
location scouting, you might characterize
this as a valuable service, or, a ruthless
business tactic.
Indeed, one franchise union found that the
average franchise tends to pay an average
of 6-10% of its sales in rent, while McDonald’s
franchisees pay 8.5-15%.
And if a location fails to perform as expected,
McDonald’s can simply find a new franchisee
for that location after the contract has expired,
or sell the land to someone else entirely,
likely at a significant profit.
So, why do franchisees agree to these stringent
requirements?
Simply put: because it’s seen as an incredibly
safe investment.
The advantage of this model is that while
the absolute numbers are abnormally large
— the fees, the initial startup costs, and
even the annual revenues — the odds of success
are relatively high.
For example, the average location makes $2.7
million in sales every year, with a respectable
but not incredible, all-things-considered,
$154,000 in final take-home profit.
But precisely because McDonald’s is so demanding,
can it be such a solid investment.
Sure, applicants have to meet high standards
to become franchisees and once they do, they
have little control over their own business,
but all these factors also reduce their risk.
While other franchises may have fewer requirements,
they also come with greater risk.
The owner of a McDonald’s can be pretty
sure they’re qualified for the job, have
a good location, and are meeting customer’s
standards, because otherwise, they wouldn’t
be allowed in the first place.
McDonald’s trains its franchisees in what
it calls “Hamburger University” — the
company’s internal system of teaching business
owners all the skills and knowledge they need.
For McDonald’s, the benefits of owning property
are far greater than just an additional source
of revenue.
It’s no exaggeration to call it an entirely
different business model: It understands that
real estate is a far better business than
hamburgers.
The first reason is just a function of American
tax law — which offers heavy tax breaks
for depreciation, even while that same property
may increase in value over time.
The biggest advantage is the long-term stability
of property prices.
Along with Walmart, McDonald’s was one of
the only two stocks in the Dow Jones Industrial
Average to increase in value in 2008.
It’s also one of the 60 or so members of
the so-called “Dividend Aristocrats” — stocks
that have increased their dividends annually
for 25 consecutive years.
Recessions are only a welcome opportunity
to buy up discounted properties.
When things are truly catastrophic — like
during a pandemic — the real estate model
outsources risk to franchisees — who are
contractually obligated to pay a minimum amount
of rent regardless of sales.
All of this is reflected in the upward trend
of franchised McDonald’s locations and downward
trend of the few remaining company-operated
locations.
If anything, McDonald’s is actively trying
to remove itself from the fast food industry.
But this naturally raises a question: If McDonald’s
makes a huge portion of its profits in the
form of rent, and managing real estate is
a fairly separate skill from creating new
McThings, why not split-off the real estate
holdings into a new company?
Do that, and you have a very stable, active,
and profitable real estate investment trust
— one immune from the variability of fast
food and/ changing consumer appetites.
A group of investors suggested this very idea
in 2015.
The company, however, decided not to, believing
that its property model is what makes it unique,
and that its remarkable efficiency is a function
of doing both.
Now that you know the secrets of how one of
the world’s great companies truly makes
its money, you might be interested in putting
this new information to use with great Skillshare
courses like “Investing 101”, which teaches
you the basics of how stocks, ETFs, and index
funds, work.
Or learn how to build a business on YouTube,
starting with my new course where I explain,
step-by-step how I make my thumbnails and
market my videos.
I also give you a complete walkthrough of
how I created this thumbnail.
When you’re done, learn how to design a
logo with this great course on logo design
— just look at the amazing things other
students have already made.
Skillshare is an online learning community
where you can learn all kinds of new skills
like graphic design, programming, photography,
and much much more, usually in under an hour.
Start learning today with the link in the
description, and the first 1000 people will
get a free trial of Skillshare Premium, where
you can watch my entire course right now.
Please play the YouTube video first