Factors considered in appraising an auto dealership facility

NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided.

The appraisal of an auto dealership facility is a critical factor in an auto dealership buy-sell transaction. The purpose of this article is to describe the factors that impact such an appraisal so that buyers and sellers can better understand the meaning of the appraisal.

The appraisal of an auto dealership facility generally involves the real estate only, without any consideration given to the business or any franchise value. This generally means only the land, buildings and site improvements are valued, along with any arms-length leases on the property (typically the business/franchise is sold separately). Though some auto dealership facilities are leased, they are not often purchased based on investment criteria nor are they typically purchased based on cost. Prices for existing facilities are “loosely” based upon the principle of substitution (cost of acquiring a similar property) which primarily involves the Sales Comparison Approach. The inclusion of the Cost and Income Approaches in the valuation adds support to the value conclusion via the Sales Comparison Approach. If the auto dealership facility contains more than one showroom with adjacent service facilities (conducive for rental to more than one tenant), then more weight is generally given the Income Approach (depending upon the terms of the leases).

The valuation process is a systematic analysis of the factors that influence the value and/or utility of the appraised property. Though sales prices of auto dealership facilities may be affected by certain conditions (a seller’s desire to get rid of a property – generally resulting in a lower value; a buyer’s desire to acquire a specific property – may result in a higher value), there is only one “market” value (which is usually the sales price – assuming the existence of a willing buyer and a willing seller, both knowledgeable and acting without undue stimulus). When the appraisal report is to be utilized by a lender, of primary consideration is what that lender could sell the property for (or rent it for) if they had to take the property back. This is another reason that no consideration is given to any business or franchise value.

The “date of value” utilized in an appraisal represents the property’s value as of that specific date, as affected by current economic pressures. This value is a reflection of the most recent historic trends along with buyers/sellers anticipation of future trends for the auto market and for auto dealership facilities. When there is a high demand for a property, values appear to accelerate rapidly. Conversely, in times of over-supply or poor market conditions (low demand), values tend to drop drastically. When highly volatile market conditions are present, it is important to remember that the value estimate contained in an appraisal is as of a specific date and would change based upon changes in the market conditions.

Physical Property Characteristic Considerations -

Rentable Building Area: This includes all enclosed building areas measured from the outside of walls, including covered service areas. Display canopies and service writers’ canopies are not considered rentable building area, although their value contribution to the property is considered.[Both the appraised property and the comparables utilized the same definition of building area.]

Construction Materials: Newer facilities utilize concrete block, concrete tilt-up or wood frame and stucco (all with some steel pole and beam supports) with a good showroom design and longer economic life potential than the older auto dealership facilities. In more remote areas, or areas where the total economic life of the improvements is expected to be shorter, less expensive metal butler-type buildings are still utilized.

Effective Age: The “effective” age of the improvements depends upon the utility of the facility in comparison to other similar facilities in the same area. The effective age may be less – or occasionally greater — than the actual age and may partially reflect the quality of materials utilized in the construction. For older facilities, instead of reconstruction, consideration should be given to the possibility of minor remodeling to conform to a similar functional utility to other auto dealership facilities in the area (new facade, conformance with ADA requirements, etc.).

Personal Property: Personal property (furniture, computers, cars, etc.) or that equipment peculiar to the operation of the business is not considered in the real estate valuation. Built-in hydraulic lifts (hoists) are considered personal property but are typically included in auto dealership facilities. An auto facility seller will not remove the built-in hydraulic lifts (unless leaking) or assign a separate value to those lifts. In most older buildings, the buyer is required to repair or replace the hydraulic lifts.

Underground storage tanks and hydraulic lifts, etc.: Underground storage tanks can present a problem. Depending upon the age of the tanks, there may be less – or more — likelihood of leaking and soil contamination. Hydraulic lifts have been eliminated from the underground storage tank category; however, the operator of the property should be questioned regarding any leaking, etc. Most newer developments and many remodeled facilities are converting to above ground lifts. Further, many lenders will not lend on a property which contains underground storage tanks. It is recommended that the dealer hire an engineer to inspect the property and test the soil as most buyers and lenders will require such information.

VALUATION

There are three valuation methods utilized in appraisal: The Cost Approach, Sales Comparison Approach and Income Approach. Each of these approaches is applicable to the appraisal of an auto dealership facility.

COST APPROACH- Land value, as if vacant, added to depreciated improvement value (includes all costs involved in developing a property, less depreciation for physical, functional and economic factors). The Cost Approach;is seldom given the greatest weight in a valuation. However, it does serve as:

a check against the value indications by the other approaches (the cost “new” plus the land value is typically an indication of the upper limit of value);
an indication as to whether there is any value to the improvements and whether the property is developed to its highest and best use (if the total property value is less than the land value, then there is no value to the improvements); and
an indication of potential market activity (future competition – i.e., if it is not economical to rebuild improvements, then the likelihood of new competition being built in the area is diminished).

Most lenders require the Cost Approach to be included in their appraisals for these reasons.

In applying the Cost Approach, it is best to utilize similarly located land sales which were subsequently developed to auto dealership facilities. However, auto dealership facilities are a “special purpose” property and land sales (for eventual development to auto dealership facilities) are scarce. When land is acquired for an auto dealership facility, it is typically based upon comparably priced commercial land in the area (upon which an auto dealership facility could be constructed). Therefore, other commercially zoned land which permits auto dealership facility development is typically utilized. Land sales for auto dealership development by redevelopment agencies or other governmental agencies are typically not indicative of “market value.” They usually include sales tax guarantees, etc. and penalties if the auto dealer does not meet their quota of sales. Some auto centers restrict the land usage to auto dealership facilities. This restrictive use could demonstrate a lower land value than nearby unrestricted commercially zoned land.

SALES COMPARISON APPROACH– In the valuation of auto dealership facilities, the Sales Comparison Approach is best exemplified by the comparison of sale properties on a price-per-square-foot-of-building basis (floor area divided into sales price). The comparables are also identified on a price-per-square-foot-of-land-area basis (land area divided into sales price) due to the large amount of land area typical to auto dealership facilities (needed for the display/storage of autos). These methods are understood and accepted as they tend to convert prices of different sized buildings with different land-to-building ratios into single units for easier comparison. Consideration should be given to the areas of differences such as date of sale, age, quality, condition, location, land-to-building ratio, etc.

The market for auto dealership facilities is considered to be regional in nature; thus, sales throughout a wider area than that typically used for most commercial properties are utilized. Also, as these facilities do not sell often, the utilization of older sale transactions is typical. Often the older sales have to be adjusted for changes in market conditions.

Adjustments to the comparables are typically made for:

property rights conveyed (fee simple versus leased fee, leasehold, etc.);
financing terms (considers above or below market terms);
conditions of sale (estate, distress, etc.);
market conditions (time);
location;
land-to-building ratio;
physical characteristics (building size, age, quality/layout[including type of construction materials, enclosed service areas, "flow" of facility, etc., which is also reflective of the remaining economic life of the facility], physical condition), and other (parking decks, etc.).

Because of the differences in auto dealership facilities (with regard to location, age, land-to-building ratios, etc.), it is difficult to obtain a sufficient number of recent sales of properties which are truly comparable. Therefore, the appraiser should utilize a larger number of sale properties for comparison in order to bracket the appraised property.

INCOME APPROACH– “Market Rent” (that rent another dealer would pay for use of the property) less typical vacancy and expenses, then capitalized by an appropriate rate produces a value indication by the Income Approach. Auto dealership facilities are seldom purchased for investment value. Most purchases of leased facilities have been by the tenant. The tenant may wish to know how much to pay for the property (and whether to purchase the property based upon their current rental amount). A lender may wish to know what rental they could exact for the property if they took it back in foreclosure. Further, a property owner who is relocating, retiring, etc. may want to know how much rent to charge for the property.

Auto dealership facility rental comparables are difficult to find for comparative purposes because auto dealership properties typically are owner-occupied or are build-to-suit. Therefore, dated comparable auto dealership facility rental properties are typically utilized in the valuation. Only arms-length rentals should be utilized, no intra-company leases.

Vacancy and expenses should be market derived just like any other property type. A vacancy rate is applied even if the facility is currently leased. The vacancy rate is to depict the estimated vacant time period (or the time period when the property owner is not receiving rent) over a typical lease term.[For instance, a total 6-month vacancy on a 10-year lease term would represent a 5% vacancy rate.]The vacancy rate utilized would depend upon the overall market, i.e., if there are no current vacant facilities, the vacancy rate will be low and if there are numerous available vacant facilities, the vacancy rate will be high. Typically, expenses are limited to management and reserves though expense information on most auto dealership facility sales tends to lump these expenses together.[The expenses to be considered are what the landlord would have to pay annually if leasing the property.]

The overall capitalization rate is generally market derived. That means it is extracted from sales of leased auto dealership facilities. Additional support may be given by utilization of an “investor’s survey” derived rate. Generally, the overall rates derived from sales of auto dealership facilities occur within a fairly consistent range. This is due to the fact that the majority of leased sale purchasers are the tenants of those facilities. The extreme (high and low) rates are primarily due to high or low leases at the time of sale or other conditions affecting the sales price (REO, etc.). The overall rate sales utilized by this appraiser (approximately 17 over the past 14 years) are fairly consistent which indicates a stable requirement for overall rates on auto dealership facilities (typical average of 10%).

The Income Approach is considered to be a viable method of valuing an auto dealership facility. The Income Approach is more pertinent when there are several different auto dealership facility tenants on the same site . Rented auto dealership facilities are sold based upon their income producing capabilities (if not purchased by the tenant) as that is the only source of income from the property that a purchaser would receive. The knowledge of what a “market” rental value would be is highly important in those instances to determine whether the sales price was reflective of above/below market rents. As long as a property (of any type) has the capability of being rented in sufficient numbers to permit the estimation of a market rental rate for a property and as long as such rented properties sell, then the Income Approach is valid.

This article was written in 1998.