One of the most overlooked — and costly — mistakes net lease investors make is ignoring the warning signs of franchisee default risk. Just because a tenant is operating under a major brand like Dunkin’, Arby’s, or Burger King doesn’t mean they’re financially stable. Many of these stores are run by independent operators, and their creditworthiness can make or break your investment.
Whether you’re trading into a NNN deal via 1031 or buying cash for income, here are five key red flags that signal elevated default risk — and what to watch out for before you close.
1. Small Unit Count (1–3 Stores)
Lenders and experienced buyers agree: smaller franchisees are inherently riskier.
If your tenant operates only a handful of locations, they likely have limited economies of scale, thin financial reserves, and little room to absorb store-level losses. If one location underperforms, the entire business can collapse.
What to do: Ask for the franchisee’s full store count and geographic spread. Anything under 5 units should raise questions — and demand stronger lease guarantees or financial disclosures.
2. Short Operating History or Recent Brand Conversion
Is the tenant new to the brand or market? Have they only been operating for a year or two?
Franchisees with short operating histories — or those who recently took over a store — often lack brand familiarity, operational consistency, or proven revenue performance.
Why it matters: Early-stage franchisees are still climbing the learning curve and are more vulnerable to cash flow issues or operational missteps that could lead to default.
3. Weak or Nonexistent Financial Disclosures
If you’re investing real capital into a deal, you deserve transparency.
Be cautious if the seller or broker can’t provide franchisee-level financials, especially if there’s no corporate guarantee in place. Key documents you should expect to review include:
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Year-to-date and trailing 12-month P&Ls
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Balance sheets
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Rent coverage ratios (ideally 1.4x or better)
If financials are unavailable or vague, it’s a signal that something is being hidden — or that the operator isn’t strong enough to disclose.
4. Aggressive Rent Relative to Sales
Net lease buyers often focus on cap rate and lease term — but overlook store-level economics.
If the rent is disproportionately high relative to store sales, the operator may already be struggling to stay afloat. For many QSR and retail tenants, rent should not exceed 8–10% of gross sales.
What to watch for: Deals with high cap rates can be masking an unsustainable lease structure. If the operator is paying too much rent, default risk spikes — especially in down cycles.
5. Personal Guarantees That Are Light or Missing
In smaller franchisee deals, the lease is often backed by a holding entity — not the individual.
If the principal doesn’t personally guarantee the lease, and the operating entity has little in assets, you have limited recourse in a default. This is particularly dangerous with newer or undercapitalized operators.
Protect yourself: Strong franchisee-backed leases often include full or partial personal guarantees, giving the landlord more leverage if the tenant walks.
Final Thoughts: Buy the Operator, Not Just the Brand
In today’s market, brand-name signage is not a substitute for strong financial backing. A Burger King run by a 2-store franchisee in a secondary market is not the same investment as a 30-unit operator with institutional financing and decades of experience.
Before you write the LOI or wire your 1031 funds, dig into the credit, performance, and history of the franchisee — because once the ink is dry, your rent check depends on them.
Need help screening franchisee-backed deals with real lender-quality underwriting?
We specialize in sourcing NNN deals with creditworthy tenants, clean financials, and sustainable lease structures — so you’re not left holding the bag.
Let’s help you close smart.
FAQ
Q1: How can I tell if a franchisee’s rent is too high relative to their store performance?
A1: Ask for store-level sales data or a rent-to-sales ratio if available. As a rule of thumb, rent should typically not exceed 8–10% of gross sales for QSR and retail concepts. If that ratio is higher, the store may be overburdened — a red flag for potential default.
Q2: What financial documents should I ask for before buying a franchisee-backed NNN property?
A2: You should request year-to-date and trailing 12-month profit & loss statements, a balance sheet, and a rent coverage ratio (NOI divided by rent). These documents help you evaluate the franchisee’s ability to meet their lease obligations. If these aren’t available, consider that a warning sign.
Q3: Are personal guarantees always necessary when leasing to franchisees?
A3: Not always — but they are strongly preferred, especially for small or mid-size operators. Without a corporate or personal guarantee, your recourse in a default may be limited. A full or partial personal guarantee adds a layer of protection if the operating entity fails.