What has traditionally been the primary means of making money by McDonald’s corporation? Most of us wouldn’t have to think much before answering that its hamburgers, fries and the fast food items that have been responsible for the genesis of the fast food nation. When I read “Rich Dad, Poor Dad”, it gave a different picture. It said that the primary business was real estate. I couldn’t really understand the logic then, but I have a slightly better picture now.
I am currently reading “Mc Donald’s Behind the Arches”, and am thrilled to know the strategy behind making money by the company. Ray Kroc, a consummate salesman, had total control over the operations, and believed that money will follow. But the $950 franchising fees and the 1.9% of the sales didn’t do much to add value to the corporation. It was the acumen of the behind the scenes Sonneborn who could leverage the successful McDonald’s operations to make money in a way not many can imagine. By leasing out land / real estate to franchisees at 20% and then 40% markup it ensured a constant inflow of cash. While it solved the problem of the smaller franchisees (who were individuals starting off a business with their accumulated life’s savings), it also made sure the corporation made money.
The scheme was simple: the company would take a long term lease over a piece of lucrative land and then sub lease it to the operator. And the company had the rights to terminate the contract should things not go as Kroc wanted. In course of time, Mc Donald’s corporation started buying land and leased them out to the franchisees. This was executed by a separate real estate company, called Franchise Realty Corporation. So while the parent company was virtually a cost center, the realty company was the real profit center.
For such schemes and agreements to come to India would require a considerable amount of maturity in the Indian markets. In the two MNC IT companies I have worked for, the premises have been leased, and so the company only pays a rent on it, without locking in capital. Perhaps it makes sense for them, given that they are in no business of real estate, and would not like to end up like Enron (that had numerous non performing assets taking up space in its balance sheet, before the tweaking started).
Indian companies have traditionally been self sufficient. Particularly in the manufacturing sector, companies have bought land from the government and developed their factories. There wasn’t any one who could lease the land out to them. But now that India is witnessing a real estate boom, a steady growth of over 8%, a lot of direct investment from overseas, it is a signal that markets are maturing. I read about a new avenue of joining the bandwagon. The corporates could use the sale-leaseback to unlock capital and get more funds for their primary business. And this capital put in their core business could translate into high ROI. Sale-leaseback transaction is a technique used by corporations to raise capital, increase shareholder value and remove the real estate assets from their balance sheet. This gives operational control over the assets to the corporations.
Why would an investor put in money? The way Mc Donald’s corporation is making money, investors (realty MFs, FIIs, corporations interested in venturing into realty) could expect steady returns. They could have a right risk return trade off by giving it out to credit worthy tenants.
This transaction, even though currently not too popular, is fast catching up. We might find more companies selling off their land and leasing it back to have more control over their capital.
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