Key Takeaways
- Underwriting methodologies differ for auto dealerships and car washes
- Car washes mostly rely on unit-level rent coverage and price per unit
- Auto dealerships involve more complex underwriting methodology including a host of occupancy cost and coverage ratios
As for all asset classes, we look for strong unit-level economics to make sure the subject property rents are supportable with a healthy margin. But as I’ll touch on in a minute, there are some nuances for each of these sub-types that you should be aware of. Let’s take them one at a time:
1. Car washes
For car washes, bonus depreciation has been the buzz term for the last number of years since the 2017 Tax Cuts and Jobs Act established this tax benefit for owners of this real estate asset class. Cap rates have stayed relatively lower in this subsector of the automotive services space given this added benefit, propped up by interest from the 1031 exchange buyer universe. Even with bonus depreciation tapering to 80% this year, demand remains strong.
In terms of methodology, we’re typically looking for anywhere between 2x to3x EBITDAR/Rent coverage at the unit level and a price point of no greater than $5 million per site. Cap rates can range anywhere from high 5s to low 8s today depending on a variety of factors including credit, coverage, and location. Overall, the average credit of a car wash operator nationally seems to be improving as private equity and the large platforms continue consolidating the industry as both the private equity backed platforms and the large public companies acquire more and more local operators into their larger umbrella.
Sale leasebacks and build to suit financing of car washes have been fueling a good component of footprint expansions and greenfield developments as operators have been adding new locations. Financing structures like these allow an operator to grow without taking on dilutive capital, and typically at cheaper rates than other financing alternatives.
2. Auto dealerships
For auto dealership assets, SLB investors pay attention to more metrics than traditional occupancy costs and health ratios. One of the most important drivers is car volume. Particularly new car volume as this tends to trickle down into all aspects of a car dealership’s operations.
Think about it like this – when you buy a new car, you typically purchase it from your local dealership, instead of driving a bit further for a used car where pricing isn’t as consistent. When you buy a new car from a dealership, you are typically interacting with that dealership again – whether it’s for service contracts, financing arrangements, warranty work, etc. This recurring interaction brings additional revenue streams to the dealership that used car sales typically do not. Therefore new car sale volumes have a bigger impact on a dealership versus used car sales.
Even if the manufacturers don’t explicitly say it – store volume is also an implied indicator of how important the factory thinks the specific location is. Said another way – the manufacturers can pick and choose which stores they are going to support. This is another indicator of whether a location is preferred or not. This factors into the “mission-criticality” of a specific dealership location.
For SLBs, this means investors pay attention to more nuanced occupancy cost and coverage metrics instead of simple rent/sales and EBITDAR/rent. Many investors will look at how rents tie in to new car volumes and new car revenues specifically, versus overall revenues, and how rents compare to gross profits, in addition to EBITDAR/rent figures.
Astute SLB investors will also evaluate EBITDA addbacks with a fine-tooth comb, scrutinize management fees, bonus structures, and other expenses. Other underwriting considerations include the strength of the brand, taking into account whether the dealership is associated with a higher-end brand versus a lower-end brand, since this can also affect required coverage and rent metrics.
Dealers are currently paying high rates on money borrowed from banks and captive lenders, much of which was taken out as part of buy/sell transactions over the past two years. This high cost of capital is a drain on dealer profitability and an inhibitor to future growth. While the Fed has slowed the pace of its aggressive rate hikes, there’s no sign of rates coming down in the near term.
This strains working capital loans, blue sky loans and even floor plan lines. SLBs, however, are serving as attractive forms of financing for dealerships, replacing expensive debt capital and helping fuel M&A transactions.
Now is an excellent time for auto dealers to consider a SLB. Why not extract the capital tied up in your real estate to pay down this expensive debt or use it to fuel future growth? According to Legacy Automotive Capital, a SLB investor focused on the auto dealership industry, dealers make 5% – 7% return on their real estate, but an 18% – 30% return on their business. If returns are two to three times higher on your business than on your real estate, it makes a ton of sense to unlock the capital in your property and redeploy it back into your operations.
Growth capital
Another reason for dealers to unlock capital is that sky-high multiples we saw in 2021-2022 are returning to more historical levels and there will soon be ample buying opportunities for dealers looking to make strategic acquisitions. Now could be an ideal time to unlock the capital within your real estate and use the proceeds to fund M&A deals. Don’t let today’s expensive debt stand in the way of your next Buy/Sell opportunity!
Why Ascension
While the upside potential for automotive services is substantial, deals can be complex to structure and execute properly. When automotive services businesses are not viewed through the right lens, significant value can be left on the table. Don’t go at it alone.
Conclusion
If you’re an owner-operator or private equity owner of automotive dealerships or car washes, let’s discuss how we can help you monetize your real estate through a SLB transaction.
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