Article Summary
Collision repair shop owners who own their real estate can significantly increase business value at exit through cap rate compression, diversify their wealth by retaining property while selling the business, and access capital for growth by borrowing against their property equity.
- Cap rate compression can increase property value by up to 77% when leasing to credit-worthy consolidators versus local operators, turning a $2.17 million property into $3.85 million.
- Triple-net (NNN) leases typically charge 5-6% of annual sales as rent and run for 10 years, providing steady income streams for owners who retain their property after selling the business.
- Real estate ownership enables three wealth drivers: increased exit value through cap rate compression, diversification by retaining the property while selling the business, and access to capital for growth through borrowing against equity.
- Consolidators rarely purchase real estate because private equity prefers capital-light models; they typically resell the property immediately to institutional investors after acquisition.
- Owners pursuing rapid growth should prioritize buying the business over the property to maximize cash-on-cash returns (30% vs 16%), while preserving capital for acquisitions.
THE OVERLOOKED ASSET THAT UNLOCKS WEALTH
As the collision repair industry’s leading mergers and acquisitions advisors, Focus Advisors has talked to hundreds of collision repair entrepreneurs. We’ve seen how owning one’s real estate creates significant wealth. We see three primary value drivers:
1. INCREASING VALUE UPON AN EXIT.
If the business owner is looking to sell their enterprise, they’ll become the landlord for the buyer. The buyer will sign a long-term, triplenet (NNN) lease with rent determined as a share of the business’s revenue. Higher rent and a reduced cap rate enhance property value.
2. DIVERSIFICATION UPON AN EXIT.
By selling their business, but holding onto the building, body shop owners can diversify so the total value is no longer tied to their success alone.
3. HELPING FINANCE GROWTH.
Owners can borrow against their real estate equity to finance acquisitions or buy “build-tosuit” brownfield or greenfield developments.
REAL ESTATE AND CONSOLIDATION IN COLLISION REPAIR
The U.S. and Canadian collision repair industries are consolidating rapidly. Most consolidators are funded by private equity and don’t own property. They don’t want to tie up their expensive capital in long-term assets that create wealth slowly. There is much greater risk involved in profiting from an acquired business than there is for buying property that will never lose all its value.
Occasionally, consolidators will buy the seller’s business and real estate in one transaction. This happens if the seller would like to have a total exit. Immediately after closing on both the business and the real estate, the consolidator re-draws the lease to make it more favorable to their longterm objective and promptly sells it to an institutional buyer.
We’ve observed that selling both the real estate and the business at once surrenders a great degree of value.
VALUE DRIVER 1: REAL ESTATE INCREASES VALUE UPON AN EXIT.
When collision repair owners explore an exit with a buyer, and keep the real estate, they enter a long-term lease. This lease is typically triple-net (NNN) and amounts to 5-6 percent of the seller’s last 12 months of sales, unless local fair market rents are significantly different. The lease is typically 10 years and should include rent escalators and extension options.
When valuing their property, many owners use a real estate broker to provide them with local rents or comparable property values. But that’s not how to value collision repair-occupied real estate. The lease tends to be based on existing sales. For operators generating a high volume of sales out of a small footprint, come exit-time, they will be able to secure an above-market rent.
However, the primary value driver is “cap rate compression”. Commercial real estate is valued based on two things: net operating income and capitalization rates.
The net operating income (NOI) for a property is the revenues generated by the property less the operating costs of running the property. In a NNN lease structure, the tenant pays for operating costs separately from the rent they pay.
The second component is how highly investors value that income stream, as measured by the capitalization rate. Less risky properties have lower capitalization rates. NOI divided by the cap rate is the property value. A large private equity-backed consolidator is viewed as a “credit tenant”. This means that they have a large balance sheet that attracts institutional investors.
Let’s say a collision repair entrepreneur has the choice of selling their business and leasing their property to a nearby single-shop operator versus a consolidator. And say their business is doing $5 million in annual sales. Assuming a five percent rent factor, their NNN rent would be $250,000 per year.
OPTION 1: SELL TO A LOCAL SINGLE SHOP VALUE OF PROPERTY = $250,000 NOI / 11.5 PERCENT CAP RATE = $2.17 MILLION
OPTION 2: SELL TO A LARGE CONSOLIDATOR VALUE OF PROPERTY = $250,000 NOI / 6.5 PERCENT CAP RATE = $3.85 MILLION
The example shows that a credit-worthy tenant might create 77 percent more value for the property. That is cap rate compression. We advise collision repair owners to focus first on selling the business to the right buyer, then—only once it’s sold and the lease is signed—to sell the property.
Owning one’s real estate might enhance the value of the business itself. That’s because risks involved in acquiring a business with a third-party landlord can erode the confidence of potential buyers or make a deal go sideways. Operators can’t eliminate all the risks real estate presents. We’ve seen our fair share of difficult or unreachable landlords, challenging local land use policies or fire marshals, environmental risks, or informal arrangements or easements with neighbors. The enhanced control and flexibility in the deal from owning the real estate can grow the value of the enterprise, property aside.
VALUE DRIVER 2: REAL ESTATE PROVIDES DIVERSIFICATION UPON AN EXIT.
Real estate ownership allows collision repair entrepreneurs to view selling their business as a diversification strategy. They can sell their business, invest those proceeds elsewhere, and retain the property. By signing a long-term lease, they get to receive “mailbox money”, benefit from cap rate compression, and still have some investment exposure to the collision industry via their tenant.
Sellers have ample choices for investing the proceeds. They can benefit from borrowing against their increased equity in the building. A property with lots of equity built up is a piggy bank for diversification.
VALUE DRIVER 3: REAL ESTATE HELPS FINANCE GROWTH
Real estate is a mechanism for owners looking to grow. They could borrow against their property or divest some of the ownership to outside investors to free up capital. Here’s an example:
Buy a $4 Million revenue shop for $2 Million.
• Put $1 Million down and get a $1 Million note from the seller.
• The business generates $300K in cash flow after debt service; that’s a 30 percent cash-on-cash return. Alternatively, one could buy the real estate under that $4 Million shop for $2 Million.
• Put $400K down and get a $1.6 Million note. This yields more like $65K in net cash flows (NNN rent less covering debt service); that’s a 16 percent cash-on-cash return.
One can choose: 30 percent or 16 percent returns. If they want to grow quickly, they should buy the business, but not the property. If they’re looking to preserve capital for acquisitions, we recommend they’re thoughtful about the risks associated with whatever real estate they lease to avoid any future pitfalls. On the bright side, we’ve seen many collision repair entrepreneurs negotiate advantageous terms in leases and it has rewarded them greatly.
Buying the real estate also gives operators more flexibility when pursuing brownfield and greenfield developments. They have more control over budgets, layouts and timing. Real estate should be a part of evaluating any growth strategy; one should consider its utility for borrowing, tax advantages, operational flexibility, diversification, cap rate compression, etc.
ABOUT FOCUS ADVISORS
Focus Advisors (www.focusadvisors.com) is the leading M&A firm in the collision industry, a FINRA-registered and regulated investment bank, representing MSOs, dealerships, larger single shops, equipment distributors and paint jobbers, helping entrepreneurs create and realize equity value by providing expert advice, raising capital and facilitating the sale of their businesses. With 25 years of industry experience, Managing Director David Roberts, a co-founder of Caliber Collision, has led more than 46 transactions with a combined transaction value exceeding $600 million including Tripp’s Collision, Tom Masano Dealership Collision and Colorado Auto Body.
Investment Banking Services and Securities offered through Independent Investment Bankers Corp., Member FINRA/SIPC. Focus Advisors is not affiliated with Independent Investment Bankers Corp.
