Automotive Real Estate Revs its Engines in a Recovering Economy

With spirited optimists speculating that the vaccine will jump-start this century’s version of the “Roaring Twenties,” modern-day tycoons and the average internet investor alike are lining up to place their bets. Automotive real estate assets, in this regard, are revving up to be great opportunities.

Not only have repair shops, used car dealerships and gas stations mostly resisted the recession, they’re cruising into low-supply, high-demand territory as the market recovers. Personal vehicles have remained need-based transportation through the downturn, and with consumers turning again to the pent-up pursuit of wants as well, cars will keep pulling automotive real estate properties in tow.

Gas stations, for example, were reported by LoopNet’s parent company, CoStar Group, to be one type of retail property investors were pumping capital into during the pandemic. That’s partly because fuel falls into the essential category, but it’s also because convenience stores anchoring gas stations have been bringing in more cash since consumers have shifted their preferences from sit-down dining to grab-and-go options.

Investors also put pedal to the metal on the purchase of dealerships despite the stalling economy, according to Abby Corbett, a CoStar managing director and senior economist. Dealership were attractive because their vacancies remained low and the probability of landlords being able to retain triple-net leases for them — or at least arrange terms in which the tenant pays most expenses — remained high.

“Of the 1,500 auto dealership trades that occurred throughout 2020, all were effectively fully leased,” “I think this illuminates the broader appeal of fully-leased, single-tenant, triple-net leases among investors during times of uncertainty.”

Auto dealerships, repair shops and other types of assets that aren’t quite industrial but aren’t fully retail either, typically adhere to the type of net leases more common in industrial, in which the tenant pays all expenses. It’s usually that, or gross-modified leases in which the tenant sometimes pays everything except taxes and insurance.

Investors favor net leases contracts with “essential-oriented” businesses such as auto dealerships, Corbett said, because it means cash flows are more predictable and net operating income is relatively more protected from other variables.

Automotive-related properties fit in this category, making them solid investments for entrepreneurs, and a “common target among smaller 1031 [tax exchange] investors as well,” she added, “as they offer a bond-like investment profile for investors looking to place capital.” CoStar has certainly seen auto dealership deals in the $30 million to $50 million range over the last year, she noted, “but the largest volume of deals fell below $10 million, with an average deal [value] of around $3 million and a 6.6% cap rate.”

Under the hood, a boom in used car sales is continuing to drive all fundamentals in the automotive real estate niche. Since public transportation ground to a halt and shutdowns initially bottlenecked manufacturers’ production of new stock, more drivers have bought and maintained used cars.

And nothing is more essential for used cars than automotive repair shops.

To discuss the race to snap up automotive real estate assets, LoopNet spoke with a broker facilitating the trade of an autobody garage in Long Beach, California, through an auction on Ten-X, a partner site of LoopNet.

Alex Bikov is the CEO of Osher B, a commercial real estate advisory, brokerage and financing firm based in Seal Beach, California. Below are the questions presented to Bikov, followed by his observations.

The short version of it, Bikov explained, is that there’s an increased demand for used cars.

Lockdown restrictions initially caused vehicle production delays and diminished people’s daily driving habits, but as a result, people increasingly held on to their existing cars rather than buying new ones. When they started driving again, they realized their used cars were fine, as long as they maintained them.

“With the value of used cars increasing,” he said, “there’s increased demand for maintenance and upkeep.”

"The yield for these properties is often good simply because demand is high; there are not enough of them on the market."

Alex Bikov, Osher B.

Mechanic shops didn’t close during the pandemic, he continued. Cars became essential for families to get to work, banks, pharmacies and to carry out other necessity-based activities. Automotive repair shops are essentially recession-proof, because they’re a need versus a want, meaning that from an investor’s standpoint, they’re “more consistent, more predictable and more reliable as an opportunity.” Risk in owning a repair shop is a lot lower than it would be for a retail shop that sells clothes, for example, which is driven by discretionary income.

“Any investor is buying a future cash flow. They are analyzing the risk of that cash flow and the underlying investment and forecasting what that cash flow will look like a year or two, or five, or even 10 years down the road,” Bikov continued. “So obviously, [net operating income] is one way to determine what the current income will ultimately yield. The yield for these properties is often good simply because demand is high; there are not enough of them on the market.”

Repair garages also offer a lower cost of entry than other asset types, he said. Most available properties do not require a heavy capital outlay for equipment, as they often have the heavy lifts and other necessary equipment installed, and the mechanics can bring their own array of toolboxes and “be open the next day.”

Even if the landlord does need to undertake some improvements to attract tenants, Bikov said, it requires a lot less capital than, say, an office. “If you’re trying to bring in a tenant to a doctor’s office, for example, you need to make sure there are water faucets in every room and bathrooms and reception areas, and a lot of other higher-end tenant improvements need to be integrated in. With autobody shops, you have an office and some roll up doors, and off you go.”

The leasing structure is often favorable for landlords as well, he pointed out. Although a landlord would often prefer a triple-net lease, they can often arrange something close: a gross-modified lease. “Landlords will usually pay taxes and insurance, and they are going to push all the other ongoing expenses like water, gas, electricity and security to the tenant.” This means that investors can often position these assets to bring in passive income. Passive income is beneficial in the sense that it requires less ongoing, active involvement in the management of the asset, but it’s also favorable when it comes time to file taxes.

“There are two very clearly distinguished categories of buyers for this particular property,” Bikov continued, speaking of the Long Beach Auto Garage auctioned on Ten-X.

The first category is comprised of business operators. These are owners of individual mechanic shops or chains that are looking to relocate or, more often, expand.

“These are people who specialize in this type of property because they understand the business,” he said. “That’s very common.” More than 50% of inquiries, he said, are from established mechanics looking to expand their operations. They typically obtain financing through U.S. Small Business Administration loans to own the land and operate the business, he noted.

Then there are the yield chasers. “These are investors who want to make passive income and will buy anything as long as the yield makes sense,” he said. “They typically understand the industry as well, so they sometimes try to add value by bringing in multiple tenants or adding some additional things.”

As Corbett mentioned, Bikov also sees a trend in investors using the 1031 tax deferral exchange being attracted to these properties. Because the program is time-constrained, investors seldom have the luxury of waiting and shopping for the perfect investment.

As investors shy away from office and other types of retail, they turn to mechanic shops and the like because they’ve been very predictable and stable, he said. They see there’s a lack of inventory and the cap rates are either at or above market.

Investors and operators alike often ask about equipment already installed at the site of an automotive repair shop, and the number of bays, as these are the most important physical attributes of the property beyond location, according to Bikov. The property condition report and environmental report also become focal points.

People want to know more about the building’s offices as well, he added. “The good thing is,” he said, it’s a mechanic shop — not a high-end office. Potential buyers aren’t expecting a white glove environment, they understand that there’s going to be dirt and a low amount of required upkeep, which is typical of a mechanic shop. Are they expecting some kind of beautification? Yes, but it could just be repainting and branding to the operator’s colors, or some cosmetic stuff and minor repairs that might cost, say, $5,000. People are usually okay with that.”

Some buyers want to think about value-add opportunities, he continued. “There are many different ways to add value to your property,” he said. “You just have to kind of look at it with clear eyes and say, ‘hey, what do I have and how can I add more?’” That could come in the form of subdividing the property and adding a second or third tenant to charge a higher rate, for instance, but that also changes the business model. Or you could increase signage and wayfinding, say, near the freeway. “There’s always something you can do to add value.”

With online actions, he said, all due diligence research is done for the client before he or she even registers to bid. Everything from a phase 1 environmental report, which is extremely important for these types of semi-industrial properties, to the final purchase agreement, is made transparent to buyers from day one. “All that’s missing is a dollar amount and a name,” Bikov concluded. “By the time I am having conversations with potential bidders, it’s much more efficient and to the point. People ask good questions because they already have done their homework.”

It’s also rare for investors to buy a shop without first lining up a tenant, but Bikov said his firm can also assist in pairing potential businesses with landlords.

“When you're buying an asset, you’re analyzing the tenants’ creditworthiness, their financial capacity, their ability to operate the business and generate enough income to cover expenses, so tenant strength is critical for any landlord, and especially for the mechanic industry, because they're typically smaller,” Bikov said.

But it’s a double-edged sword, he continued. “Most landlords want a credit tenant — the big boys — but that comes with a lot of conditions that a landlord doesn’t like. The tenant might want a 10-year, flat lease with no bumps along the way, or [they] could want a discounted rate, additional tenant improvement allowances or holiday rent.”

Landlords in this business often are amenable to smaller operators with proven success at one or two other previous locations, who are willing to sign a three- or five-year lease. “The landlord can reprice them at market at that time,” he said, “so they aren’t stuck in that stock for 10 or 15 years at the mercy of the tenant.”

Investors should also look at automotive shops as a long-term hold. “For the most part, this is not a ‘let me get in and get my money in two years and then get out’ type of business,” he cautioned. “I've seen people who buy gas stations and other automotive-related properties, and it’s a cash cow for many of them. And the typical term is long — such as 10 years or more, especially if they operate the business and they control the underlying assets.”

Like any other real estate, location is paramount, he continued. In the case of the Long Beach Auto Garage, he said, “it’s one block off the freeway. So probably a good 20% of the business comes from drivers exiting the freeway, with say, a flat tire.” Those customers then become open to additional services and even repeat visits.

Signage is critical, Bikov said, as is surrounding competition. “But in today's world, your digital reviews and feedback online is critical.” More so than in any other type of convenience-based enterprise, he said, auto shops get repeat business by being honest and efficient. “Your online reputation precedes you.”

The shop in Long Beach, he said, has been a mechanic shop since 1952, with the current owner, who is retiring, having operated at the site for nearly two decades. “Regional clients will come back to the same location, so the value-add to the new owner comes in the form of the continuation of a profitable location for this type of business.”

Gas stations are related, but are essentially a whole different ballgame, he explained.

“Gas stations are high in demand and have historically been a very profitable business,” he said, “depending on how you run it. The gas itself is small margins. It’s volume-driven. But if you have a good convenience store that drives people in, you can make it very profitable.”

Buying gas station real estate is challenging, he said, because you really don’t want to have the pumps without the store or vice-versa, and everything that is underground brings an additional environmental risk. Petroleum, gas, diesel and all of the other chemicals under the surface can make the property a very expensive proposition. Although stringent inspections, regulations and technology work to reduce exposure, he said, a leak would fundamentally change the real estate investment potential.