The strategy that made McDonald's a global landlord

You know the tried and tested way to grow a fast-food chain?

Yes, simply franchise. That means instead of opening a new location, just award a franchise to a third party. The franchisee buys food from the fast-food chain, pays royalties (as a percentage of sales) to the fast-food chain, pays rent for the location, and pays other operating expenses, such as salaries to the location's staff. Sales for the location minus these payments and expenses is the profit for the franchisee.

Typically, this is how things work. The idea (from the fast-food chain's point of view) is to scale fast without investing a lot of money upfront and reduce the operational burden.

But McDonald’s, the world’s largest fast-food chain (revenue-wise), is different. Their revenue strategy, since the 1950s, has been to own the real estate locations and lease them to franchisees.

Step 1: Property purchase

• McDonald’s buys a prime location and builds the restaurant
• Cost of land + building: say $2 million

Step 2: Franchise agreement

• A franchisee pays McDonald’s an initial franchise fee (say, around $45,000).
• Then, they pay ongoing royalties (about 4% of sales)
• But the big piece is the rent

Step 3: McDonald’s typically charges rent as a fixed base + percentage of sales

• Let’s say the fixed base rent is $200,000 a year
• Let’s assume the variable rent is 2.5% of annual sales of $4 million. That’s $100,000.
• Total rent = $200,000 + $100,000 = $300,000
• Now you must be wondering why rent includes a percentage of sales when royalty already includes the same. That’s because the percentage paid in royalty is like a fee paid for the use of McDonald’s brand, systems, and recipes. Whereas, the percentage paid in rent is aligned with the store’s performance. If the store’s location is great with high footfall, the franchisee benefits with more sales that normal. This abnormal sales come at a cost (percentage of sales).

Step 4: McDonald’s returns

• Rent income = $300,000 a year
• Royalty income = 4% of $4 million = $160,000 a year
• Total annual income (excluding profit from food sold to the franchisee) = $460,000 ($300,000 + $160,000)
• Relative to the $2 million investment, that’s a 23% annual return before operating costs like food costs, corporate salaries, etc.
• Plus (most importantly), McDonald’s still owns the real estate whose value will, most likely, always go up.

Step 5: Franchisee’s return

• Franchisee pays rent ($300,000) + royalties ($160,000) + operating costs (food, salaries, electricity)
• They keep the remaining profit margin (often around 5% to 10% of the sales)

The most fascinating thing about this system is that McDonald’s real estate market value keeps growing each year. That’s where the real money is.

How? Let me explain.

Land is recorded at purchase price. And buildings are recorded in financial statements at cost price (minus depreciation). Right now, McDonald’s financial statement shows land and buildings at roughly $40 or $50 billion. As I said earlier, McDonald’s has been owning real estate since the 1950s. Assuming a commercial real estate annual price appreciation of around 3 to 4%, I won’t be surprised if McDonald’s real estate market value today is around $100 billion.

Now, $100 billion in real estate is a big deal. In fact, so big that McDonald’s today is one of the world’s biggest landlords.

Also, when I say the commercial real estate market price appreciates 3 to 4% a year, I also mean that McDonald’s adds $3 to $4 billion (3 or 4% of $100 billion) each year to its wealth doing nothing. To give you an idea, that’s more than most businesses will ever make in their lifetime.

Continuing with the aforesaid example, let’s run a comparison of McDonald’s owning the real estate versus a “traditional” franchise model where the third party owns the property.

Scenario A: McDonald’s owns the real estate

• Property cost: $2 million (McDonald’s invests upfront)
• Annual sales: $4 million
• Rent charged to franchise: $300,000
• Royalties: 4% of sales = $160,000
• Total annual income for McDonald’s: $460,000
• Return on property investment: $460,000/$2 million = 23% per year
• Bonus: McDonald’s keeps the appreciating real estate asset.

Scenario B: Traditional model (third party owns property)

• Annual sales: $4 million
• Royalties to McDonald’s: 4% of sales = $160,000
• Total annual income for McDonald’s: $160,000
• Return on property investment: N/A
• Downside: McDonald’s has less control over location, design, and long-term stability.

So, by owning the real estate, McDonald’s almost triples its annual income per location (in this example, $460,000 vs. $160,000. The traditional model would leave McDonald’s dependent only on royalties and business ups and downs. By owning real estate, McDonald’s is assured of rent and control over location (which is the biggest deciding factor when it comes to restaurant success).

Rightly so, McDonald’s is often described as a real estate empire with a burger business attached to it.

Now you must be wondering: if this revenue strategy is so good, why don’t other restaurant chains follow it? Well, that’s because real estate requires a huge upfront investment, and with restaurants already a thin-margin business (thanks to rising rent), it's not feasible for most chains to go out there and start buying prime locations.

McDonald’s was early in this game. Today, their biggest competitive advantage isn’t their burgers but their real estate. It’s easy for a competitor to prepare a better burger or fries. But what about the locations?

No chance.

The compounding effect has also rolled in. Last year, globally, McDonald’s made a net profit of around $8 billion and had an operating cash flow of around $10 billion. Now, imagine how much they can reinvest each year to buy new locations. So, that means the bigger McDonald’s gets, the bigger purchasing power it gets. The greater the purchasing power, the stronger their competitive advantage (owning real estate) becomes.

What are your thoughts? Comment below.