Starbucks Coffee - Can the Professional Real Estate Investor...

Starbucks Coffee – Can the Professional Real Estate Investor…

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company summary

Starbucks Coffee, sometimes referred to as Forbes Coffee, is the world’s largest coffeehouse chain. It opened its first store in 1971 in Seattle’s waterfront Pike Place Market to sell high-quality coffee beans and equipment by three partners: Jerry Baldwin, Zev Siegel, and Gordon Bowker. In 1982, Howard Schultz, the current chairman and chief executive officer, joined the company as director of marketing. After a visit to Milan in 1983, he was impressed by the popularity of espresso bars in Italy. Coming back 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 with $3.8M and renamed the Il Giornale coffee bar Starbucks and turned it into the Starbucks you know today. , The company went public with the symbol SBUX on June 26, 1992 at $17/share with 140 stores. The stock has split 5 times since then. By May 2008, SBUX was trading at around $16, down from a November 2006 high of $39.43.

Starbucks opened its first overseas store in 1996 in Tokyo, Japan. The company currently has approximately 16,000 stores, in 44 countries employing 172,000 partners, AKA employees, 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 can find some Starbucks stores inside Target, major supermarkets, university campuses, hospitals, and airports. These stores operate under licensing agreements to provide access to real estate that would otherwise be unavailable. Starbucks receives licensee fees and royalties from these licensed locations. At these licensed retail locations, employees are considered employees of that specific 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. The pace of expansion is slowing as the company plans to open 1,020 US stores in 2008, down from 1,800 stores in 2007 to less than 400 in 2009. In addition, it also plans to close 100 stores in 2008.

Risks to Real Estate Investors

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

  1. recession-sensitivity: A hungry man can survive with a Big Mac and fries but can also survive without a four-buck Frappuccino. This means that Starbucks is very sensitive to the downturn in the economy as seen in 2007 and 2008, compared to Burger Kings and McDonald’s. This may be the main reason why sales at stores in the US are expected to decline by a mid-single digit percentage in at least a year, the first decline ever. This prompts Howard Schultz to return to the CEO position. The company plans to double its marketing spending to $100M in 2008 to increase sales. It launched an aggressive coupon campaign offering free drinks every Wednesday starting May 28, 2008. This may be a sign of desperation. On April 22, 2008, Starbucks lowered its outlook for the year, citing a weak economy.

  2. calories and sugarStarbucks drinks are high in sugar and calories, which consumers are more and more concerned about due to the exploding obesity and diabetes epidemic in the US. For example, its Strawberrys & Crème Frappuccino® Blended Crème – Whip contains 120 g (over 1/4 lb) of sugar, and its Venti 24 oz size has 750 calories. If it becomes a trend that consumers decide to cut down on sugary drinks, or stick to a low-carb diet, it will have an impact on Starbucks revenue.

  3. CompetitionMcDonald’s, Wendy’s and Dunkin’ Donuts also now offer espresso at lower prices to compete with Starbucks. They’ll take some revenue away from Starbucks, especially from cost-conscious customers. Current Starbucks prices are already high enough; It’s going to be very difficult for Starbucks to increase prices in the near future without affecting traffic to its stores.

  4. high expense business modelStarbucks: While Starbucks’ profit margin is high because it pays an average of $1.42 per pound for unroasted coffee, its business is very labor intensive, just like any other food businesses. It takes 10 to 20 employees to run a shop. All eligible part-time and full-time partners in the US and Canada receive a benefits package consisting of a stock option plan, 401k with company matching, medical, dental and vision coverage. Starbucks was voted the 7th Best Company to Work for in America in 2008 by 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’ profits. Should Starbucks not perform well, there could be pressure to close more stores as a public company.

  5. special purpose buildingThe Starbucks Freestanding Building is a special-purpose building specifically designed for Starbucks. Should Starbucks decide to close the lease or not, re-leasing the property is difficult. There are few tenants out there willing to pay high rents like Starbucks. Due to the relatively small square footage, it is difficult to use it as a fast food restaurant. Also, it doesn’t have any commercial kitchen. Once vacated by Starbucks, the property will most likely lose value.

Starbucks Real Estate Operation

Starbucks divides the US and Canada into 17 real estate regions, each with its own store development office to develop the market in its area. The developers constructed approximately 1800 sf of freestanding buildings on a drive through location with high visibility, heavy traffic. Once the location is approved by the area 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 have a corporate guarantee, which means Starbucks will continue to pay rent in the event it closes the store. Leases often have a 10% rent increase every 5 years. Rents range from $1.65/sf in a store in Utah to $5.84/sf in New York. This rent survey is based on rents from only 30 Starbucks properties, 18 of them free on the market for sale throughout the United States as of April 2008.

Starbucks locations with minimal store closing prospects

During tough times, for example in 2008 when sales were falling, Starbucks would attempt to cut costs and close underperforming stores. As a real estate investor considering investing in the Starbucks building, you don’t want to invest in a property that will be closed in the future.

Location—— 1mile——3mile——AHI/yr——Size (SF)—–Base Rent/yr—-Rent/sf/month – -price range(%)

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………..$1,327 million….7.00

Table 1: Rent Comparison for Free-Standing Starbucks Buildings

Location——SBUX Rent/Year—SBUX Size—SBUX Rent/SF/Month—Other Tenant Size—Rent/SF/Month—Difference

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 any particular location, all you need to do is make an educated guess. Based on annual revenue and the number of stores Starbucks operates, the average annual revenue per store is approximately $1M. Also, if the annual rent to revenue ratio is less than 10% then the location has a good chance of being profitable. For example, if the base rent for a Starbucks in Ohio is $58,590, the annual revenue must exceed $585,590. In addition to choosing a store in a good location (see article titled “What ‘Location’ Means in Commercial Real Estate” by this author), and cap rate you should consider the following:

  1. densely populated area: More people means more customer size and thus more revenue. More promising are the Starbucks in FL, GA and TX on Table 1. Note: The author tries to be sensitive by not disclosing exact locations.

  2. low rent: Starbucks in MS pays $112,184 for base rent. It needs to generate annual revenue of $1.12M to be reasonably profitable. However, since there are only 188 people and 4923 residents within 1 mile of a 3-mile radius from the store, it is unlikely that the store will ever generate that much revenue. Also Starbucks pays $5.15/sf which is much higher than $3.52/sf in fast growing, high income, densely populated GA where there are 57,201 residents within a 3 mile radius and over $143K/sf has an average household income (AHI) of . Year. It’s hard to understand how an area with just 188 people within a 1 mile radius from a Starbucks property in MS can have an irreplaceable location! Offering the highest cap of 7.2%, this asset appears to be a good investment but it actually carries the highest risk of poor performance and could be locked in the future. Alternatively, Starbucks could attempt to renegotiate the lease with lower rents during tough times. While Starbucks hasn’t yet asked for a rent cut, it’s not surprising that Starbucks will do so in the future to improve its bottom line. In either case, the value of the property will decrease.

  3. rental premium: While most Starbucks properties are freestanding in which it is 100%, you may see a Starbucks in a smaller multi-unit strip center with a few other tenants. It usually occupies the end unit with a drive through and thus is expected to pay a premium in comparison to the adjacent unit. However, most of the time Starbucks pays much higher rents. For example, in Table 2 it pays $5.84/sf, compared to only $2.75/sf paid by a tenant in the unit next door in a center in New York, or 112% more. If the rent on the unit occupied by Starbucks in this strip center is reduced (due to closure or lease renegotiation), the value of the center will drop significantly. You definitely do not want to invest in this property.

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