American Money Overseas Flowing Back Into The U.S Starbucks Coffee – What Commercial Real Estate Investors Should Know

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Starbucks Coffee – What Commercial Real Estate Investors Should Know

Company summary

Starbucks Coffee, sometimes referred to as Fourbucks Coffee, is the largest coffeehouse chain in the world. He opened the first store in Seattle’s waterfront Pike Place Market in 1971 with three partners: Jerry Baldwin, Zev Siegel and Gordon Bowker to sell high-quality coffee beans and equipment. In 1982, current president and CEO Howard Schultz joined the company as director of marketing. After moving to Milan in 1983, he was impressed by the popularity of espresso bars in Italy. After returning to America, he convinced the founders of Starbucks to sell both coffee beans and espresso drinks. However, the idea was rejected, so he left the company and founded the Il Giornale coffee bar chain in 1985. In 1987 Howard Schultz and Il Giornale bought Starbucks for $3.8M and renamed the Il Giornale coffee bar to Starbucks and became the Starbucks you know today. . The company went public on June 26, 1992 at $17/share with 140 stores under the symbol SBUX. The stock has split 5 times since then. As of May 2008, SBUX was trading at around $16 from a November 2006 high of $39.43.

Starbucks opened its first overseas store in 1996 in Tokyo, Japan. The company currently has about 16,000 stores, employing 172,000 associates, AKA employees, in 44 countries as of September 2007. It has annual sales of over $10B and most recent quarterly revenue of $2.526B. About 85% of Starbucks’ revenue comes from company-operated stores.

Starbucks does not franchise its operations and has no plans to franchise in the near future. In North America, most stores are company-operated. You’ll find some Starbucks stores at Target, major supermarkets, university campuses, hospitals, and airports. These stores are operated under licensing agreements to provide access to real estate that would otherwise be unavailable. Starbucks receives licensing fees and royalties from these licensed locations. At these licensed retail locations, workers are considered employees of that particular retailer, not Starbucks. As of 2008 it has 7,087 company-operated stores and 4,081 licensed stores in the US. Internationally it has 1796 company-operated stores and 2792 joint-venture or licensed stores in 43 foreign countries. Expansion has slowed as the company plans to open 1,020 US stores in 2008, down from 1,800 stores in 2007 to 400 stores in 2009. In addition, it also plans to close 100 stores in 2008.

Threats to real estate investors

The Starbucks Coffee Building is a popular investment for many investors. When you consider investing in a property occupied by Starbucks, you need to understand the following risks to your investment:

  1. Recession-Sensitivity: A hungry man can live with a Big Mac and fries but without a four-penny Frappuccino. This means that Starbucks is very sensitive to downturns in the economy, as seen in 2007 and 2008, compared to Burger King and McDonald’s. This may be the main reason that sales at stores in the U.S. are open for at least a year and are expected to decline by a mid-single-digit percentage, the first decline. This prompts Howard Schultz to return to the CEO position. The company plans to double its marketing spend to $100M in 2008 to boost sales. An aggressive coupon campaign offering free drinks every Wednesday until May 28, 2008 was launched. This can be a sign of frustration. On April 22, 2008, Starbucks lowered its outlook for the year, citing a weak economy.
  2. Calories and sugar: Starbucks drinks are high in sugar and calories, which consumers are increasingly concerned about due to the explosion of America’s obesity and diabetes epidemics. For example, its Strawberry & Creme Frappuccino® Blended Cream – Whip has 120 grams (more than 1/4 pound) of sugar and 750 calories in a venti 24-ounce size. If consumers decide to cut back on sugary drinks or stick to a low-carb diet, that will affect Starbucks’ revenue.

  3. Competition: McDonald’s, Wendy’s and Dunkin’ Donuts now offer low-priced espresso to compete with Starbucks. They will gain some revenue from Starbucks, especially from cost-conscious customers. Current Starbucks prices are already too high; It will be very difficult for Starbucks to raise prices in the near future without affecting its store traffic.

  4. High cost business model: Starbucks’ profit margins are high because it pays an average of $1.42 per pound for unroasted coffee, making its business, like most food businesses, very labor-intensive. It takes 10-20 employees to run a shop. All eligible part-time and full-time partners in the US and Canada receive a benefits package that includes a stock option plan, 401k with company match, medical, dental and vision coverage. Starbucks was voted the 7th best company to work for in the US in 2008 according to a Fortune magazine employee survey. What is good for employees may not be good for employers. These benefits are generally only available to key employees or managers in the restaurant industry. Historically, the cost of these health benefits has risen faster than the rate of inflation. In the long run, they could have a negative impact on Starbucks’ bottom line. If Starbucks doesn’t perform well, it could be under pressure to close more stores as a public company.

  5. Special purpose building: The Starbucks Freestanding Building is a special-purpose building designed specifically for Starbucks. If Starbucks decides not to close or renew the lease, it is difficult to re-lease the property. There are some tenants who are willing to pay higher rents like Starbucks. Its relatively small square footage makes it difficult to use as a fast food restaurant. Besides, there is no commercial kitchen here. Once Starbucks vacates, the property’s value will likely decrease.

Starbucks real estate operation

Starbucks divides the US and Canada into 17 real estate regions, each with its own store development office that develops the market within its territory. Developers built approximately 1800 SF freestanding buildings with drive thrus in high visibility, heavy traffic locations. Once the location is approved by the territory office, Starbucks typically signs a 10-year NNN lease with 2 five-year options in which the landlord is responsible for the roof and structure. All leases typically contain a corporate guarantee that means Starbucks will continue to pay rent if it closes a store. The lease has a 10% increase every 5 years. Rents range from $1.65/SF in stores in Utah to $5.84/SF in New York. This rent survey is based on rents for only 30 Starbucks properties, 18 of which are free standing, on the market for sale outside the US as of April 2008.

At least one Starbucks location is likely to close

In difficult times, e.g. When sales were declining in 2008, Starbucks would try to cut costs and close poorly performing stores. As a real estate investor looking to invest in a Starbucks building, you don’t want to invest in a property that will close in the future.

Location—— 1 mi——3 mi——AHI/yr—–Size (SF)—-Base Rent /yr—Rent/SF /mo –price——cap(%)

Ohio ……………….296……..2609..$88375…1613……… $58,590 ………..$3.03……….$868K………6.75

Florida ………..9186……55270……$68595…..1816………$75,000……. ….$3.44……….$1.2M………6.10

Georgia………5717……57201…..$143936….1750………$74,000……….. $3.52……..$1.091……..6.75

Mississippi….188……..4923……..$77372…..1816………$112,184………$5.15 ……….$1.558M…..7.2

Texas………….5944…..40970…….$75043…..1752………$92,914….. ……$4.42………$1,327M….7.00

Table 1: Rent comparisons for free-standing Starbucks buildings

Location—–SBUX Rent/Year—SBUX Size—SBUX Rent/SF/mo—Other Tenant Size—Rent/SF/mo— Variance

California…….$30096……..1248 SF…..$2.01………………….1245 SF……………….$2.50…………-19%

Kansas ………..$43200……..1600 SF….$2.25…………………. ..1600 SF……………….$1.33………….68%

Utah……………….$38568……..1950 SF…..$1.65…………. …. ……..1200 SF……………..$1.86…………-11%

New Mexico..$92004………2000 SF….$3.83………………………. …..2500 SF.. ……………$1.92…………100%

New York…….$125004……1785 SF….$5.84……………………..2819 SF ……………….$2.75…………112%

Table 2: Rent Variation in Multi-Tenant Starbucks Retail Centers

Since Starbucks doesn’t release sales revenue for a specific location, you’ll just have to make an educated guess. Based on annual revenue and the number of stores operated by Starbucks, the average annual revenue per store is about $1M. Additionally, if the annual rent to revenue ratio is less than 10%, there is a good chance the location is profitable. For example, if the base rent for a Starbucks in Ohio is $58,590, the annual revenue should be more than $585,590. In addition to choosing a store in a good location (see this author’s article titled “What is ‘Location’ in Commercial Real Estate”), and cap rate you should consider the following:

  1. Densely populated area: More people means more customer size and hence more revenue. Starbucks in FL, GA, and TX from Table 1 are more promising. Note: The author tries to be sensitive by not mentioning the exact locations.
  2. Low rent: Starbucks in MS pays $112,184 for base rent. It would need to have $1.12M in annual revenue to be reasonably profitable. However, with only 188 people within 1 mile of the store and 4923 residents within a 3 mile radius, it is unlikely that the store will ever generate that revenue. Additionally Starbucks pays $5.15/SF which is very high compared to only $3.52/SF, GA has 57,201 residents within a 3 mile radius and a median household income (AHI) of over $143K/. It is hard to understand how a Starbucks in MS can be an irreplaceable location in an area with only 188 people within a 1 mile radius of the property! Offering the highest 7.2% cap, this property appears to be a good investment but actually has the highest risk of underperformance and may be closed in the future. Alternatively, Starbucks could try to renegotiate the lease at a lower rent during tough times. Although Starbucks has not yet asked for a rent cut, it would not be surprising if Starbucks does so in the future to improve its bottom line. In either case, the value of the property will decrease.

  3. Rent a premium: Most Starbucks properties are freestanding in that it is 100% occupied, you will find a Starbucks in a small multi-unit strip center with few other tenants. It generally occupies an end unit with a drive through and is therefore expected to pay a premium compared to adjacent units. However, most of the time Starbucks charges higher fares. For example, in Table 2, a tenant in a unit adjacent to a center in New York paid $5.84/SF, or 112% more, compared to just $2.75/SF. Should the rent for the Starbucks-occupied units in this strip center be reduced (due to closing or lease renegotiation), the center’s value would be significantly reduced. You definitely don’t want to invest in this property.

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