Appraisal Matters

So why talk about dealership operations in a blog series about appraising automobile dealerships?  Isn’t that a business value topic?  Well, yes and no.  Here’s why:

• Dealerships don’t just get appraised when they have gone “dark”.  Most of the time, an operating business sells with the real estate; in fact, the business and the franchise agreement can be worth more than the real estate itself.
• When performing the sales comparison approach, many, if not most, of the sales include business value and it needs to be separated from the real estate per USPAP.  Certainly an understanding of what the business is and does is necessary to determine the value of it and how much of a sale price included is comprised of the business value..
• Dealerships are special purpose properties and to conclude that the highest and best use of a dealership is this same use, appraisers need to have some understanding of how the business works.  How else can they make this conclusion?
• When real estate has a going-concern component, most of the time the real estate is the primary component of the total enterprise value (i.e. real estate plus business value).  In operating dealerships, the percentage that is business value is greater than most other forms of going-concern real estate, both in terms of a dollar value and a percentage of total sale price.

Fixed Ops

The automotive industry refers to the service and parts operations by the term “fixed ops”, which is short for fixed operations.  Service and parts revenue comes from two sources:  warranty work and customer-pay.  During a recession like this one, customer-pay work declines on both a dollar amount and percentage basis compared to warranty work.  The main culprit is the customer’s more conservative attitude and desire to put off large-dollar repairs and mileage break point service, such as occurs at 60,000 and 120,000 miles for most vehicles.

Ironically, defects in cars that require the manufacturer to issue recalls are a boon to dealerships.  The factory pays for parts and the standard labor rate.  Another financial benefit occurs when Government increases regulation requirements for factories, thereby increasing repair opportunities when customers bring their cars in.

Parts and Service Departments

The parts and service departments have become a more integral part of the entire dealership.  It is one of the few areas that has shown consistent growth and increasing profitability over the past three decades.  Unfortunately, many dealers still consider the sales department to be the most important component, to the detriment of the used vehicle and parts/service departments.

Having worked in the leasing departmetn of an automobile dealership mega-chain as my first job, I can say that the perception that the sales departments come first is very real.  Examples of this way of thinking include the following:

• Sales are referred to as the front end of the business, fixed ops (parts, service and body shop) as the back end.
• Showrooms are the most visible part of the dealership, the fixed ops departments the least.
• Most industry periodicals I have read have relatively few articles on fixed ops and an overabundance of sales articles.

Ironically, all dealers realize that fixed ops provide the opportunity for repeat sales.  The ability of a dealer to service a vehicle has a bearing on the repeat purchase.  Dealers pay attention to Customer Satisfaction Indexes and Service Satisfaction Indexes.  That’s why consumers get so many calls from their dealers about service.

Used Car Sales

Factors that affect used car sales volumes and prices include the quantity of trade-ins for new car purchases, rental car fleet inventories, the general level of interest rates, automobile manufacturer finance rates and credit terms and the amount of factory incentives offered to dealers.

Many people believe that used car sales are the opposite side of the coin from new car sales.  If consumers have little discretionary income (as is now the case), the theory goes that the used car sales business will boom and new car sales will hurt.  Traditionally, that has been the case, but this recession is breaking all the old rules.  Just yesterday I heard a story first hand that illustrates this.  A man who earlier this year had had a nice position at Bear Stearns lost his job and he had all of his money in Fannie Mae, Freddie Mac and Wachovia stocks.  In less than two months, he went from employed and wealthy to a negative net worth.  The house was being foreclosed upon next week, so he sold his paid Mercedes for whatever he could get to buy a month or two before foreclosure.  What happens when there is hardly any demand for new and used cars with an oversupply of both?  You guessed it… the profit for the entire sales enterprise disappears.

F & I

We all know that financing has a pivotal role in dealership operations.  Although the actual numbers may have changed since the days when I was an assistant leasing manager, typically finance and insurance generates more profit than the sale of cars or trucks.  That’s because the profit can be so easily built into the payments.  Another reason is that consumers are better shoppers and they come into a dealership knowing the invoice price of a vehicle, so they are only willing to pay a certain amount over that or they take a walk.  The prevalence of internet pricing and no-haggle CarMax also make this possible.  To counteract this, financing is where a dealer can make their profit.

Finance and insurance fit have two components:  leasing and buying.  Of the two, leasing is more prevalent and has more profit - that’s why the F&I manager mentions leasing first.  Since only part of the car is financed in a lease (the value of car at the end of the lease, referred to as the residual, is not included), there’s more wiggle room for profit.

The next part of this blog series will discuss unique aspects of automobile dealership appraisals followed by future installments delving into problems associated with the three approaches to value and the always controversial business value topic.

John Simpson, MAI