McDonald's REIT Could Be a Sizzler

With Vornado in the picture, things have gotten rather interesting. Vornado CEO Steven Roth is considered one of the most powerful and well-respected real estate executives in the U.S. Last year, Vornado -- which owns about 87 million square feet of office and retail space mostly in New York and Washington, D.C -- disclosed a 5% stake in Sears just weeks before Ed Lampert's Kmart acquired the company and subsequently formed Sears Holdings (SHLD Quote). Vornado also was involved in the private equity buyout of Toys R Us.

But make no mistake, McDonald's represents a tremendously different real estate play for Vornado than Sears did, according to Deutsche Bank analyst Lou Taylor, who recently picked the brains of Vornado's management.

Vornado's plan for Sears was to unlock value by closing underperforming stores and selling or redeveloping the real estate.

With McDonald's, Vornado likes the retail space as it is, but it feels the company's real estate would be valued higher by the marketplace if it were held by a new publicly traded REIT, according to Taylor. Vornado's thesis is that the $30 billion of real estate on McDonalds' books (since the fast-food giant owns many of its locations) isn't being properly valued by the market, Taylor wrote in a recent research report.

How much is McDonald's real estate really worth? A simple way to value a real estate portfolio is to apply a cap rate, or rate of return, to a property (the cap rate equals operating income divided by asset price). In this case, Taylor used a 7% cap rate, which, he explained in a phone interview, is where a retail portfolio like that of McDonald's would trade in the private marketplace.

By applying this 7% cap rate to McDonald's EBITDA, Taylor calculates that McDonald's real estate could be worth about $64 billion. In most instances, in order to convert to a REIT, companies are required to distribute unpaid earnings and profits tied to real estate before conversion, likely in the form of a special dividend. If McDonald's entire real estate portfolio were converted to a REIT, about $20 billion of earnings and profits would be triggered and distributed to shareholders as a special dividend, Taylor says. Shareholders likely would pay a 15% capital gains tax.