During the Q3 2010 earnings call, McDonald's informed listeners they were substantially behind targets in their plan to rebrand restaurants. Since then I have interviewed hundreds of domestic franchisees on this topic. I find deliberate "foot-dragging" by franchisees and lenders because of increasing demands for capital spending on the franchisee's side of the equation.

Am I saying McDonald's franchise business model is broken? Not quite, but it certainly needs modernization.

Analysis

How many tenants would spend a million dollars or more on a remodel or a complete rebuild of their landlord's building and still have no real property interest? The return would have to be pretty substantial to make that work. Well, in the 1960s and 1970s the return for McDonald's franchisees doing so was terrific. Remodeling an old McDonald's from the red & white tile drive-in building into a brick building with seating often brought sales increases of 50% or more. Turning around a few years later and adding a drive-thru brought similar results.

I was one of the young McDonald's field reps who traveled the Southwest pitching such projects to franchisees. It was an easy sale. McDonald's was a smaller company then and did not have the cash to improve the properties they controlled.

Chances are McDonald's would not dominate the industry today if franchisees had not funded these projects. But the situation is now reversed. To keep up with the rapidly changing QSR scene, McDonald's franchisees are expected to constantly invest in new technologies, new equipment,  and new products. They are still expected to remodel and rebuild their landlord's buildings. While a fresh look is always good today's remodeling yields only a modest return. A few projects see a double digit sales increase but it's also possible to get no sales bump whatsoever.

Within a 55 year old system aren't there old, dilapidated McDonald's buildings out there?

In a word, no.

There was a time in the late 1990s, after McDonald's wasted corporate and franchisee resources building a mass of new locations, the domestic store base was in sad shape. But today I don't think we could find a McDonald's anywhere in the U.S.A. that hasn't been nicely updated in the past ten years. In fact, I'd wager the typical location has been refreshed and upgraded multiple times since the 1990s.

In my opinion it's time to modernize the McDonald's remodel program to one identical to the opening of a new franchised location. McDonald's Corporation provides the building and charges an appropriate percentage rent. The franchisee provides the equipment, fixtures, and other non-leasehold investments.

If Oak Brook thinks a building should be redone they take care of the bricks and mortar, the franchisee buys new equipment and fixtures and signs a new franchise term. Otherwise the remodeling, rebuilding, and rebranding effort will fall further and further behind plan. Since they have no real estate interest McDonald's franchisees are asking - are we borrowing these millions just to improve the assets of the REIT that owns so many McDonald's locations?