Subscribe to Entrepreneur for $5

Real Estate Holdings More Than Side Dish for Fast Food Giant

Opinions expressed by Entrepreneur contributors are their own.

Oak Brook, Illinois-McDonald's Corp. leads a double life. In addition to selling fast food, it's one of the country's largest real estate companies.

The fast-food giant owns most of the land under its 12,800 U.S. restaurants-a strategic advantage that gives the company more control over its store base and franchisees than its competitors have. And property and equipment constitute the largest share of McDonald's assets, valued at about $17 billion after accumulated depreciation and amortization.

About three years ago, McDonald's created a stir on Wall Street when it confirmed that it had flirted with the idea of spinning off its property holdings into a real estate investment trust (REIT) and using the proceeds to fund a huge stock buyback program.

Though McDonald's executives never followed through on the REIT idea, they did decide that sinking a lot of money into real estate wasn't the best use of the company's cash. So McDonald's began leasing restaurant sites and letting franchisees own the buildings. "It's a program we expect will increase the company's returns on new restaurants," says a company spokesperson.

Here's how, according to an analysis by John S. Glass, an analyst with New York City-based Deutsche Banc. Alex Brown Inc.:

A hypothetical McDonald's restaurant with $1.5 million in annual sales generates about $169,000 in pretax franchise profit for the company, which, under the old system, makes money by collecting royalties and rent. By contrast, under the new system, McDonald's-leasing the land and having the franchisee own the building-gives up some rental income, and its pretax profit falls to $121,000.

The upside is that the company doesn't incur about $450,000 in capital expenditures, enabling it to boost its return on investment to 24 percent, vs. about 18 percent under the old system, according to Glass. By forgoing ownership of new franchised restaurants, McDonald's freed up about $285 million in capital last year and $230 million in 1999.

The program is available only in the United States, limiting the company's impact, because the U.S. market is essentially saturated and the company is building most of its restaurants overseas. Only 175 of the 1,606 restaurants added last year were in the United States. -Crain's Chicago Business

Entrepreneur Editors' Picks