What rising interest rates could mean for restaurants
Sources: U.S. Federal Reserve and Statista
Interest rates are expected to climb this year – and for the first time since 2018. As inflation has reached 40-year highs in recent months, the Fed is sure to use the key tool it has in its toolbox to chip away at it. While we can’t say for certain what interest rate increases are coming in 2022, the prevailing opinion of experts in the financial sector is that the Fed will raise rates at least four times (and perhaps up to seven times, according to newly adjusted predictions from Goldman Sachs).
While those increases are likely to happen gradually to help slow the economy enough to reduce prices without intensifying unemployment, they may still be unsettling. After all, we have been living in an era of nearly-free money for some years now. What’s more, there aren’t many cases of central banks curbing inflation without sending the economy into recession.
But it’s important to put the increases in perspective. For instance, even amid multiple increases, interest rates are likely to remain low when put in historical perspective. The Fed has said it anticipates getting rates back to around 2 percent by 2024 and there are factors keeping downward pressure on rates in the longer term. As a February report from The Economist said, “In the long run the world’s aging population will keep a cap on interest rates. That points to an unpleasant financial squeeze, rather than a return to the 1970s.”
Still, the knowledge that interest rates are likely to rise should prompt some strategic thinking for restaurant operators – both about how they look at potential deals and how they approach financing.
Restaurants with a lot of debt could see declining profits as interest rates rise. Alternatively, those with a lot of cash stand to make more money for the same reasons. A company’s decision to move forward with a merger or acquisition will depend on their balance of debt and cash.
In a January webcast from Restaurant Finance Monitor, Cristin O’Hara, Bank of America’s managing director and group head of restaurant lending, said restaurant operators should be developing some pro forma financial statements – and probably a number of them depending on their view of how many interest rate increases will occur. They should also think about their financial leverage when making deals. “If a franchisee wants to go on the outer edge of their leverage, I think interest rates rising will have more impact on them versus someone who has a lot of cash on hand and doesn’t need to take the last dollar of leverage that they have.” Sometimes that leverage is needed – but having a cushion of cash right now will put operators in a stronger position going into the increases.
While those increases are likely to happen gradually to help slow the economy enough to reduce prices without intensifying unemployment, they may still be unsettling. After all, we have been living in an era of nearly-free money for some years now. What’s more, there aren’t many cases of central banks curbing inflation without sending the economy into recession.
But it’s important to put the increases in perspective. For instance, even amid multiple increases, interest rates are likely to remain low when put in historical perspective. The Fed has said it anticipates getting rates back to around 2 percent by 2024 and there are factors keeping downward pressure on rates in the longer term. As a February report from The Economist said, “In the long run the world’s aging population will keep a cap on interest rates. That points to an unpleasant financial squeeze, rather than a return to the 1970s.”
Still, the knowledge that interest rates are likely to rise should prompt some strategic thinking for restaurant operators – both about how they look at potential deals and how they approach financing.
Restaurants with a lot of debt could see declining profits as interest rates rise. Alternatively, those with a lot of cash stand to make more money for the same reasons. A company’s decision to move forward with a merger or acquisition will depend on their balance of debt and cash.
In a January webcast from Restaurant Finance Monitor, Cristin O’Hara, Bank of America’s managing director and group head of restaurant lending, said restaurant operators should be developing some pro forma financial statements – and probably a number of them depending on their view of how many interest rate increases will occur. They should also think about their financial leverage when making deals. “If a franchisee wants to go on the outer edge of their leverage, I think interest rates rising will have more impact on them versus someone who has a lot of cash on hand and doesn’t need to take the last dollar of leverage that they have.” Sometimes that leverage is needed – but having a cushion of cash right now will put operators in a stronger position going into the increases.