By James Mitchell, Cushman & Wakefield
The typical conversation about the purchase or sale of a dealership focuses on determining blue sky, but often overlooks the elephant in the room: the real estate. NADA data for 2017 shows average dealership earnings at $1.4 million and an average multiple of 4x, for an average blue sky of $5.6 million ($1.4 million x 4). The average value for dealership real estate is almost twice as high at $10 million.
Understanding how to reap maximum fair value for the entirety of a dealer’s asset base requires careful attention both to blue sky and to the right positioning of a dealership’s real estate.
How you charge your dealership rent has a huge impact on blue sky. The analysis below shows why:
- Three dealerships report the same net profit after rent;
- Each dealership owns its real estate but charges the operation different amounts of rent;
- The market rent is the cap rate applied to the true value of the real state. In this example, we use a 7.0% cap rate on $10 million for a “Pro forma” rent of $700,000.
Undercharging for rent, as with Dealership B, does not improve blue sky because in almost all cases a purchaser will get an appraisal of the property and adjust rental expense to reflect market conditions. Understating rental expense and therefore overstating net profit, gains nothing, and it may in fact result in the purchaser taking a harder negotiating position, because of the ask to pay $800,000 in phantom blue sky (rent at $200,000 below market x a blue sky multiple of 4).
Conversely, by charging the operation an above-market rent, Dealership C creates a potential increase in blue sky once the rent is adjusted to reflect market rent.
The process of understanding the value and proper positioning of dealership real estate is opaque and difficult. The land has few readily available alternate uses and the buildings must conform to stringent OEM requirements. Relative to other types of commercial real estate, the number of dealership transactions is small and sales comparison data is often not publicly available.
Without in-depth understanding of the real estate, a selling dealer risks leaving money on the table. Also, absent expertise specific to dealership real estate, it can be difficult for both buyer and seller to arrive at a reasonable market rent. Transactions can fail over this issue. In short, you can’t achieve an acceptable blue sky value unless you get smart about your real estate before you go to market.
Knowing the value of your property is only the first step in implementing a successful transaction. Here are some other issues that require consideration:
- Given a proper appraisal of the property, how much rent should be charged to the dealership so earnings are neither over nor under-stated?
- What is the best way to stay current on market trends to ensure rent expense is adjusted accordingly?
- If the real estate is highly valued, will the franchise be able to support market rent?
Over the coming months, we will explore other real estate-related questions in subsequent columns.
Cushman & Wakefield Dealership Capital Services (DCS) specializes in buy/sell transactions, partner buyouts, equity solutions, debt restructuring and sale-leasebacks. James Mitchell has over 20 years of automotive industry experience. He can be reached at james.s.mitchell@cushwake.com or (202) 407-8120.
