Why Investing in Franchises Could Be Smarter Than Average Real Estate Investments
By: Robert A. Needham, JD, Ph.D. — Director of Franchise Development for Repicci’s Italian Ice & Gelato and Founder/CEO of Collaborative Franchise Systems, LLC
As a business and franchise advisor for over 35 years, I have guided over 1,000 businesses and franchise owners, helping them discover and develop their ideal ventures. One question people ask when seeking the prudent investment avenue is, “Which is better, real estate or a franchise?”
The debate over which investment opportunities are advantageous has raged among investors and entrepreneurs for generations. Regarding real estate versus franchise opportunities, both offer unique options for wealth-building, creating a legacy, and financial freedom. However, both can come with specific challenges as well. Here, we will dive into the pros and cons of real estate versus franchises. I will share my insights on this crucial investment decision in hopes of creating a clear picture of how franchises could become the smarter decision overall.
Risk and Return
Several key factors may be considered when weighing the risks of real estate versus franchising or considering the rewards of both options.
Real estate investments can offer stable returns, which have stayed steady at 10% to 12% in the past two decades when considering residential and commercial properties. Many consider real estate to be the less volatile option when comparing it to franchising. According to Bankrate, there are several ways that potential investors can calculate their return on investment (ROI), including cost method, out-of-pocket-method, cash-on-cash method, and capitalization rate formula (“cap rate”).
Using the cap-rate example, we could multiply the net operating income (NOI) divided by the property value by 100% to calculate the ROI. Consider an investor who is looking to buy a property as a rental that’s valued at $300,000. After subtracting operating expenses (cost of maintenance, management, etc.) from total gross revenue, the net operating income (NOI) for said property is $30,000. Therefore, the cap rate is ($30,000 / $300,000) x 100% = 10% ROI. Many would find this a safe investment.
However, real estate can also come with some risks. Market fluctuations can significantly impact real estate values. There can also be unexpected maintenance and upkeep costs. When you own the building, those fall to you. There can also be issues with problematic tenants or longer-than-expected vacancies on your properties. Lastly, if you need money fast, liquidating your real estate asset can take time you may not have.
Franchising, on the other hand, provides an opportunity to own a business with a tested model for success and established brand recognition. According to Franchise Times – The Franchise 400, the vast majority of franchise opportunities are in the food industry — approximately 70%. The International Franchise Association (IFA) predicts that the franchise industry will grow by more than 15,000 units in 2024. Franchising is having a moment, and it is for good reason.
The ROI for franchises can be surprisingly high, between 30-50% for some well-known franchise opportunities. Franchisees often see a faster investment recovery than they would experience with real estate. To properly assess a franchise opportunity’s investment quality, I typically review several metrics — gross sales, cost of goods, gross margin, overhead, and profit estimate. By using these metrics and plugging them into an equation that considers them all, we can suggest that a franchise is a good investment if it looks like the franchisee could recover their initial investment within two years.
More minor, mobile professional services may be a better investment option than larger, leading franchises such as McDonald’s. The size of some franchises makes them better options for large-scale investors and developers. However, franchises with lower cost-of-entry in the $60,000 to $250,000 range may allow some people to purchase multiple franchises, and many of these opportunities may allow for investment return in two years or less.
As the franchisor requires, risks associated with franchise opportunities include ongoing fees or royalties. Dependence on the franchise brand and systems could be viewed negatively by some entrepreneurs who want to make a unique mark on the business world. In addition, there is a risk of market saturation with some franchises.
Where Franchises Shine
When comparing and contrasting real estate with franchise investments, it can be easy to get bogged down in the details. However, franchises offer convincing pros that investors may want to consider.
As a franchise and business expert, I always ask investors to consider Rule 72. This well-known rule of thumb determines how long a given investment will take to double. If you take the number 72 and divide it by the ROI of an investment, you will get the time it will take for that investment to double. For example, if you take the average real estate ROI of 10% and use the Rule of 72, you get 7.2 years. If we use a service franchise ROI average of 54%, we get 1.33 years to see a doubling of your investment. The Rule of 72 illustrates how franchising may potentially be better if you seek faster returns, higher scalability, and better overall growth.
While real estate may be predictable, franchises have the potential for exponential wealth building. Because examples abound for most established franchises, people seeking to invest in a franchise can do deep-diving research before choosing that investment route. They will likely see that if a franchise offers robust support to its franchisees, the sky can be the limit regarding how much money investors can make. While franchises require a deeper active involvement by investors in most cases, especially at the beginning, it can be an exciting project that sometimes the whole family can become involved in.
Ultimately, one must weigh one’s financial goals, the time one has to give to a new business venture, and one’s risk tolerance to determine the ideal options for oneself. While real estate and franchising can offer particular rewards, franchising can provide an opportunity to establish a business using a recognized brand and an ideal model.
Disclaimer: This article is for informational purposes only and does not constitute financial or investment advice. Readers should consult a professional before making investment decisions, as all investments carry risks, and past performance does not guarantee future results.
Published by Tom W.