Appraisal Matters

The income approach can be the most perplexing and difficult approach to value when appraising automobile dealerships.  Prior blogs in this series have cited the large dollar amount and percentage of total business enterprise value that the business value encompasses.  It is impossible to ignore, yet separating business from real estate value is an ongoing delimma for appraisers.  Partitioning incomes and expenses between the two, deriving a capitalization rate for just the land and improvements and making it credible are the three largest hurdles to overcome.

So let’s simplify it!  We’ll also hit the easy button too.  We have two end-arounds to help us.

• Dealership rental analysis
• Income statement models

The latter will be addressed in Part 7 and it requires thinking well outside of the three traditional appraisal “box” that we appraisers so conveniently live within.  Let’s explore the former.

Problems with Dealership Rental Analysis

The first step in the income approach, as advocated by standard appraisal practice, is to locate other similar automobile dealership rentals so that a rental analysis can be performed.  This can be difficult because lease information is treated as confidential.  Even publicly traded companies, which make financial information much more freely available than privately held firms, provide few financial details of their lease agreements.

Although the above is important, the primary reason for the struggle to obtain rental data is emphasized in the quotation below:

Auto dealership facility rental comparables are difficult to find because they are typically owner-occupied or are build-to-suits… Most auto dealership facilities are owner-occupied or contain inner company leases.  Even though these inner company leases may be written at a market rate, they cannot be used in the valuation since they could be canceled at any time (Hale, Carole, MAI, “The peculiarities of Appraising Auto Dealership Facilities”, The Appraisal Journal (Chicago, Illinios, Appraisal Institute, October 1998), pages 355 to 365.)

Simply put, autombole dealers have more than enough financing sources and wealth to purchase a dealership (this is even more evident in the large trend for multiple dealer groups and publicly traded companies to acquire dealers, not lease them).  Even if leases are present and they are truly arm’s-length, many times the date of the lease is usually too old to be reflective of market conditions.

Dealership Rental Rates

OK, so leases are tough to get.  So when they are available, how are they calculated?

Typically, rental rates on newer auto dealership facilities are based on a percentage amount of the current value of the land and cost of improvements.  Typical returns are 10% on the land and 12% on the improvements (new).

In addition to direct comparison, another method of estimating the rental value of the subject property can serve as a check.  This method is based on a certain percentage return on the land (typically 10% in this area [Southern California]) and a certain percentage return on the improvements (typically 12%-15% on the depreciated improvement value, depending on the age of the improvements). (Same source as cited in the prior quotation)

From leases I have reviewed, the above is accurate.  It seems that dealers like to hit the easy button too!

Lease Terms

What are the terms of a typical dealership lease?  Yes, I have more quotes for you.

The rents are nearly always on a triple-net basis with the tenant paying all expenses to operate the property, including real estate, insurance and maintenance.  Typically lease terms are for 10-20 years and seldom less than five years with annual increases (usually CPI), or increases at least every three to five years.

Some auto dealership facility leases have been structured to include a lower minimum monthly rent that is 10%-20% lower than market value versus a percentage or dollar amount per vehicle sold (from the prior source quoted above).

Finding Rental Data

I suppose it’s easy to see where I am going with this.  Rental data is hard to get… but it’s out there.  Much of the willingness to do so has to do with deferral of capital gains and minimizing taxes.

Where do we get it?  Listings in CoStar, Loopnet or other major commercial broker listing sites are a great place to start.  When a listing has been taken off the system, that’s a possibility for a lease.  Automobile industry magazines are another source.  A dealer looking to sell may also be willing to lease.  Another source is contacting publically traded companies and trying to obtain data from the appropriate department (difficult, but possible with enough salesmanship).

Hitting the Easy Button

Valuing a triple-net lease is easy.  Trying to extract real estate from business from an income statement is not.  I’ll trade a more time intensive lease data search for a real estate/business separation theory that is only conceptually possible any day.  The end result is a credible appraisal.

John Simpson, MAI