McDonald’s $42B real estate empire, explained
Breaking down the burger chain's financials.
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Today, let’s break down the corporate cliche: “McDonald’s is a real estate company” (and do so by looking at the company’s financials).
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In the fallout from Russia’s brutal invasion of Ukraine, McDonald’s officially exited the Russian market in May.
Per CNN, the burger chain sold 850 restaurants — which employs 62k people — to the local franchisee, a Siberian oil tycoon (McDonald’s says it’ll take a $1.4B charge against its earnings for the deal).
The English translation of the company's new name is straight to the point: “Tasty and That’s It” (the new logo is still in the shape of an “M” and apparently is supposed to look like a burger and two fries).
McDonald’s arrival in Moscow on January 31st, 1990 was one of the most iconic moments in fast-food history. It happened near the end of the Cold War and signified an opening of Russia to the West (the restaurant had 30k+ visited on the first day).
The Moscow location has two general lessons for the McDonald’s business:
Control of franchisees: When McDonald’s entered Russia, the Communist country did not have “private businesses to supply the 300 or so distinct ingredients needed by a McDonald’s outlet” per NYT. So, McDonald’s built a $50m factory outside of Moscow (appropriately called The McComplex) to supply the buns, lettuce, frozen fries, beef etc. McDonald’s wouldn’t completely outsource its Russia supply chain until 2010 (the existence of this in-country supply chain is actually one reason that the current franchisee was able to easily take over the brand).
Real estate deals: In the late 1980s, Russia was so keen to get McDonald’s into the country that it agreed to a wild deal. It took 14 years to negotiate, but McDonald’s was able to secure the first Moscow location for 1 ruble per square meter a year. Here’s the kicker: the lease was for 49 years! And -- over the years -- attempts to renegotiate it repeatedly failed.
McDonald’s Russia business was not lucrative in the early years, as the country was quite poor. While prices for a meal were 50% less that in the United States, it still amounted to a half day’s wage.
The deal was still worth it for McDonald’s. Why? Because of the real estate perks. In 1993, McDonald’s opened a $15m downtown office (appropriately called McDonald’s Tower) that it co-owned with the Moscow City Council.
The fast food chain leased the space to other Western corporations (Coca-Cola, Amex, Toyota) trying to break into the Russian market.
The cliche "McDonald's is a real estate company" was quite literal in the early Moscow days.
Today, McDonald's real estate holding is worth $42B and 36% of its $23B in revenue is from franchisees paying rents.
Let's break down the business.
There are currently 40k+ McDonald's restaurants in 110+ countries (based on crude estimates, I've eaten at 15,876 of them).
Among these stores, McDonald's owns:
55% of LAND under the locations (+ long-term leases for the rest)
80% of buildings
McDonald's $42B real estate holdings are ~80% of total assets and can be thought of like apartment buildings that collect rent.
The McDonald's story is most associated with Ray Croc, who had a contentious relationship with the founding McDonald's brothers (TLDR: Croc partnered with them on the chain but ended up booting them out in a sketchy manner).
However, it was Harry J. Sonneborn -- McDonald's President from 1955-1967 -- who created the lucrative real estate model for the fast food chain.
Croc's initial model extracted money from franchisees by:
Charging an initial franchise fee
Escalating royalty payments
Selling them marked-up supplies
Unhappy franchisees could balk at the demands. So Sonneborn pitched a way for more control: become a landlord.
To build the real estate business, Croc and Sonneborn -- played by Michael Keaton and BJ Novak in the pretty damn good 2016 biopic The Founder -- launched McDonald's Franchise Realty Corp in 1956.
Soon, they started buying real estate and leasing it to franchisees at a 40% markup.
Here was the control catch: if franchisees ignored McDonald's guidance, they were breaking the lease and could be evicted.
This is how Sonneborn explained the arrangement to Wall Street investors:
"We are not...in the food business. We are in the real estate business. The only reason we sell $0.15 burgers is because they are the greatest producer of revenue from which our tenants can pay us rent."
While Kroc disliked Sonneborn's blunt framing, the model remains true to this day.
In 2021, McDonald's made $13.1B in revenue from franchisees. Rent was 64% ($8.4B) and Royalties was 36% ($4.6B) of that figure.
At the individual level, 8-15% of franchisee sales go to rent.
Overall, McDonald's made $23B in 2021 split between:
Franchisee-run stores (57% of sales)
Company-run stores (43% of sales)
Add it all up and rent accounts for 35% of McDonald's TOTAL revenue.
The Franchise model is much more profitable for McDonald's, with 82% operating margins (vs. 18% for company-owned stores, which the chain has to run itself).
Unsurprisingly, McDonald's weights its stores towards high-margin franchisees, which account for 93% of its 40k+ locations.
McDonald's uses company-owned locations to test new ideas/products before rolling them out to franchisees, which typically sign 20-year lease agreements.
To identify good real estate locations, McDonald's uses traffic analysis, walking patterns and census data.
An ideal location has:
Corner or corner wrap with signage on two major streets.
Build height of 23ft
Parking lot potential
Here is the model's secret sauce: McDonald's typically finances the property at a fixed rate but -- because royalties are 4% of sales (+ a fee for ads) -- its take from franchisees are variable.
As sales and prices rise (*cough* inflation *cough*), McDonald's captures sales upside while its largest financial outlay is fixed.
In the early-2010s, investors were clamouring for McDonald's to spin off its real estate biz into a REIT (real estate investment trust).
In 2015, McDonald’s decided against the REIT in part because the deal was too complicated (including changes to the tax code that made such a spin-off less advantageous).
But the real reason is probably that Sonnebon’s model is just too good of a business…as elegantly explained by this Wall Street Bets post:
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Links + Memes
A viral fast food thread: On a related note, here's a former Wendy's pricing manager breaks (what a baller job) breaking down the economics of a single fast food store. Some hi-lights from the Twitter thread:
30/30/30 rule: Successful stores aim for a cost breakdown of 30% wages / 30% site costs (utilities, rent, maintenance) / 30% food costs. The remaining 10% is for profits and franchise fees.
The most profitable items: ...are drinks and fries. Sandwiches have the most food cost and you'd quickly go out of business only selling those.
Ground beef: Major fast-food chains do not get ground beef at a lower cost than regular shoppers (even with high volumes). Why? Ground beef is usually a loss-leader for supermarkets, so prices are already low across the board.
Advertising hacks: A wild YouTube video on how fast-food chains make their product look "good" for TV. Example: motor oil is drizzled on top of pancakes instead of syrup (Why? the pancakes don't absorb the syrup and look fluffier).
Dr. Seuss: I've read my son Dr. Seuss books for years. For some reason, the "That Sam I Am" character from Green Eggs & Ham puts my kid into stitches. Anyways, I recently discovered the wild origin story behind the book (and it's confirmed by Snopes):
Green Eggs and Ham was born out of a $50 wager between Dr. Seuss and his publisher, Bennett Cerf, who bet he couldn’t write an articulate, entertaining book using only fifty different words. The result was a 62-page volume composed of 49 monosyllabic words and a fiftieth three-syllable word “anywhere.”
THE POWER OF CONSTRAINTS! (Side note: While Googling this story, I came by some highly inappropriate -- but hilarious -- fake Dr. Seuss book covers).
And here are some more memes: