Here’s a bold but very backable prediction on my part…
Most sit-down restaurant chains are due for disaster in the next 10 years.
Last Wednesday, while writing about the “death” of drugstores, I told you there was “another set of retailers I’m watching” that’s in major trouble.
Chili’s… Applebee’s… Denny’s… IHOP… TGI Friday’s… Outback Steakhouse… Red Robin… Bob Evans… Bubba Gump Shrimp… Johnny Rockets…
They’re all on notice, the way I see it. These once-popular chains lost their luster years ago. And their appeal isn’t done declining yet.
That might sound like a Chicken-Little-style apocalyptic prediction, but I have to call it the way I see it. Don’t for a minute think that Red Lobster’s recent descent into bankruptcy is the end of the industry’s woes.
Trust me when I say there’s a lot more coming.
Back in my commercial real estate developer days, I built for many sit-down restaurant chains like the ones mentioned – some of which are now shut down. I even worked in the food industry myself, operating no less than eight Papa John’s locations at one time.
So, I know what it takes to make or break it in the biz.
But here’s the real reason why I’m convinced the dining branch of the retail world is in for some tough changes going forward…
I have eyes to see. And as I’ll show below, the writing is most definitely on the wall.
Not a Great Century So Far
Way back in the 1990s into the early years of the new century, sit-down restaurant businesses were booming. Diners would wait an hour or more to eat at chains like Red Lobster and Ruby Tuesday on a weekend night.
The food was delicious. The atmosphere was fun. And customers would leave knowing they’d be back for more soon enough.
But as a Restaurant Business Magazine article noted in 2005:
Casual dining’s trailblazers must branch out to compete with a slew of new competitors. Chains featuring American favorites – steaks, chicken, burgers – launched the casual dining phenomenon. T.G.I. Friday’s celebrates its 40th anniversary this year. But those chains are facing stiff competition from newer casual dining formats, steakhouses, Italian, and other ethnic eateries such as P. F. Chang’s.
That crowded picture didn’t get any better with the Great Recession, which led cash-strapped consumers to eat at home much more often. In response, these restaurants began making modifications to their menus. Like so many other food-based companies, they offered smaller portion sizes for the same or even elevated prices.
Shrinkflation was the name of the game.
But unlike grocery-store staples like General Mills – which ended up benefiting from the literal “out of the box” scheme – it only did so much good for casual dining restaurants. As International Council on Hotel, Restaurant, and Institutional Education (ICHRIE) noted in 2017:
Due to increased competition, changing consumer preferences, tougher market conditions, more knowledgeable shareholders, and rising raw product costs, U.S. restaurants are experiencing more economic distress and higher risk of bankruptcy.
And then, of course, we had the shutdowns of 2020, which damaged the industry even more.
It hasn’t been an easy road for these businesses. And there’s still plenty of room to fall by the wayside from here.
I’m Happy I’m Out
Here’s something about the restaurant industry many people don’t know…
It is not an easy place to be profitable.
Not to say that it can’t be. But it isn’t easy. Take a man who has been there and done that.
As I mentioned before, I used to be a Papa John’s franchisee with eight locations all told. I thought, going into it, that it’d be easy money. A breeze.
It was misinformation I was quickly cured of.
For starters, restaurants and eateries work with very thin margins, typically between 3% and 6%. As pricey as your menu choices may seem, management realizes very little of that thanks to two main costs:
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Food
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Employees
Let’s start with the food, which is the direct result of other people’s labor from the start. Every edible asset a restaurant purchases has probably already seen several rounds of markup, from the farmers who grew it to the processors who shaped it to the truckers who shipped it.
By the time it reaches the restaurant, the cost considerations have grown even without the inflationary pressures of the last few years – all while the clock is ticking since food is perishable. It has an expiration. And often an abundantly cautious one at that.
In short, there’s a lot that gets wasted even if a restaurant’s employees are perfect and never make a mistake.
Which, for the record, they do. A lot.
Back when I was running my Papa John’s stores in the ‘90s and 2000s, I was mostly dealing with teenage employees. Who, as a general rule, are not the most intelligent, reliable resources out there.
And while I wasn’t paying them excessively high wages, their collective salaries easily added up. So, imagine what it’s like for such businesses today that are desperate to attract help.
Today’s eateries are advertising $14… $19… or more per hour just to attract enough employees to stay open. And that’s to say nothing about minimum wage raises in states like California, which now mandate no less than $20.
This is not an easy or even sustainable place to be.
These Chains Are Downsizing Across the Country
For all of these reasons, we’ve seen so many stories in just the last six months about chains like Applebee’s, Cracker Barrel, Denny’s, Hooters, MOD Pizza, Outback Steakhouse, and TGI Friday’s that are shutting down locations thanks to “underperformance” issues.
This downsizing might very well save some of these chains from bankruptcy in the years ahead. I’m hardly predicting the death of casual dining nationwide; there will be survivors in the end.
But many individual franchise owners are going to suffer in the process. So will their landlords, which is why you’ll want to be careful about investing in associated real estate investment trusts (REITs).
Most of the REITs we own don’t have a sizable position in these assets. But there are some net-lease and shopping center owners that do.
So, if you’re looking for growth, here’s my advice…
You’ll probably want to look elsewhere for places to put your money. Either that or prepare for a rollercoaster ride.
It’s going to get rougher from here.
Regards,
Brad Thomas
Editor, Intelligent Income Daily