By Willie Beck, SVP and Director of Acquisitions, Capital Automotive
Should I own or lease my dealership real estate? For most car dealers, the answer is “it depends”.
At Capital Automotive, we provide real estate capital to dealers by funding 100% of the fair market value (“FMV”) of their dealership land and buildings, and lease the property back to dealers under long-term lease agreements (which is known as a sale / leaseback transaction).
While dealers no longer own the property, they retain control of the real estate for 20, 30 or even 40 or more years through the lease agreement. During our visits with dealers, we are frequently asked “should I own or lease?” Determining the answer for a specific dealer to this seemingly simple question depends on a number of unique factors, including:
- Personal intention (expand the business, maintain the status quo or consider exit strategies)
- Real estate equity / Available refinancing options
- Alternative uses for the equity (within or outside of the auto industry)
- Desire to diversify (perhaps for estate planning)
Let’s review each of these factors:
Dealers that are satisfied with the status quo and don’t have an opportunity to invest additional capital, or are considering near-term exit strategies, should probably retain ownership of their real estate, as to maintain maximum flexibility. For example, unless there’s a liquidity or mortgage refinancing need, there probably isn’t a practical business case to explore a sale / leaseback transaction.
Likewise, if a dealer is considering a near-term exit strategy like the sale of the business, it is probably best to retain ownership of the real estate. That way, once a buyer is determined the buyer has the option to acquire or lease the property, thereby maintaining financing flexibility. However, once a property is leased and a sale of the business occurs the lease can be assigned to the buyer subject to customary conditions, such as factory approval and credit approval of the buyer.
Amount of Equity / Available Refinancing Options
When dealership real estate is owned by the dealer (typically through a related real estate company), the property is generally financed utilizing a mortgage loan from a bank or captive finance company. Typical down-payment requirements are 20% – 25%, and typical loan terms are 5 – 10 years. The property’s equity is calculated by the difference between the property’s FMV and the loan’s payoff amount.
Unlike during the recent Great Recession, banks are currently offering attractive refinancing rates and terms for loans that are maturing. Unless there’s a need to redeploy the real estate equity for another purpose (as described below), there probably isn’t a significant business case to complete a sale / leaseback transaction, but it may be smart to consider this option before interest rates increase.
Alternative Uses for the Real Estate Equity
Today, many dealers are looking to expand their businesses by acquiring additional franchises. Besides available investable cash, some of these dealers consider the equity in their existing real estate to be a good source of additional funds for acquisitions. By completing a sale / leaseback transaction, that equity (on an after-tax basis) can be redeployed into the new acquisition, thereby reducing the need for additional investment and / or debt financing.
Additionally, some of these dealers also consider a sale / leaseback transaction on the new dealership real estate, thereby eliminating the need for the additional 20% – 25% equity investment for the new property, thereby effectively lowering their funding requirement and improving their return on investment. Thus, the sale / leaseback can be utilized on existing real estate, the to-be-acquired real estate or both.
The funds generated through a sale / leaseback transaction could be invested elsewhere (even as part of a “1031 exchange” transaction), while the dealer retained control of the property and ownership of the dealership franchise. Many of our clients have successfully utilized us for these estate planning or diversification strategies.
As outlined, a sale / leaseback transaction could be an appropriate real estate strategy, depending upon a dealer’s needs. As with any strategic transaction, dealers should consult with their advisors to fully understand the tax, legal and other potential implications
When Capital Automotive was first formed in 1997, the founders recognized that our sale / leaseback product would also be a good tool for dealers as part of their comprehensive estate planning, or who wanted to diversify some of their investments away from the auto industry, into other real estate types, stocks or bonds, or even other businesses. Capital Automotive currently has invested over $3.4 billion in 300 properties, and does business with over 65 dealership groups in 35 states.