Deciding Between Leasing and Purchasing When Adding Shop Locations
Written by John Yoswick, Autobody News
Published April 6, 2021
Here’s a tip: Investors might be interested in buying your shop’s real estate.
Gary Chou, executive vice president of commercial real estate brokerage firm Matthews Real Estate Investment Services, said outside investors such as real estate investment trusts (REITs) have recently begun to see collision shop properties “as a legitimate investment product.”
“That’s helped push values of collision properties up, because it basically increases the buyer pool overall,” Chou said.
Chou was speaking last fall during the first MSO Symposium panel discussion in the event’s nine-year history focused on issues related to real estate---and the speakers focused on some topics that could be equally of interest to single-location collision repairers as well.
The new interest among investors in body shop real estate, for example, offers another option for a shop owner who sells the business to a large MSO---which is unlikely to want to buy the real estate---and wants to cash out the property rather than continue as landlord.
Much of the discussion centered around whether a collision repairer adding a shop location---whether a second or 16th---should purchase or lease the new location’s building and real estate.
Chou said smaller MSOs often view the purchased land as “a retirement play,” while larger MSOs consider “efficiency of capital”---what will get them a greater financial return.
“There’s no right or wrong,” said Chou, as long as someone purchasing considers whether they would do better freeing up that money to open additional shops.
Will Johnston, chief corporate development officer for Service King, agreed there’s not one definitive answer to the purchase-vs-lease question.
“It really depends on where you are in your growth and how aggressively you’re growing,” Johnston said. “You may decide that your pace of growth is such you want to lease that property because you want to save capital to go after additional shops. But if you’re growing with brownfields and take-overs and will be adding a lot of value to the facilities you take over or that you build, you may want to benefit from the value [in the property] you put in there as the operator.”
The terms of any lease can be very important, Johnston said, particularly when you decide to sell your business.
“The lease you’re negotiating now might be the lease that you’re assigning over to a buyer of your business later,” he said. “It will affect the valuation [of the business] and certainly will affect the ease of getting that deal done. Typically in an acquisition, it’s the third-party landlords that can potentially really gum things up. Because they’re not the ones about to make a big payday. They may very well see it as their chance to renegotiate items within the lease.”
Think carefully even about an arms-length lease you put in place with yourself or an affiliate LLC, Johnston said, because a buyer of your business may look at that lease and “expect those same terms.”
Panelist Ben Hidalgo of Net Lease Development agreed, suggesting anyone leasing commercial property to or from others find an attorney who understands leasing for a specific use. A collision repair business that has even just one poorly crafted lease among its two or three or 10 locations can get “held hostage” to that, particularly at the time the owner hopes to sell the business.
“Get a good attorney, not just a friend who does it,” Hidalgo said. “Don’t skimp on that. Get an expert in retail leasing, to get a lease that will protect you long-term.”
An attorney with sufficient leasing experience will know what’s been problematic for other clients in the past, he said.
Dean Fisher, president of Driven Brands’ collision group, which includes CARSTAR and Maaco, also offered his take on the purchase-vs-lease decision during the panel discussion. He said most of his company’s franchisees have fewer than 10 locations and tend to buy the real estate at most or all of their shops.
“Most of them look at real estate as a form of the asset base that they’re building, utilizing the business to pay for the asset base,” he said. “So they’ll typically try to purchase the real estate as part of their retirement or sale model.”
He said real estate in this industry is unique, often requiring many modifications to a property, lease-holder improvements that may make leasing less advantageous.
“When you purchase a piece of property, often that mortgage is less than you would be leasing it for on a triple net lease,” he said. “There can be some profitability that you can specifically take out of that payment to yourself that creates some favorable tax opportunities for you.”
All that said, there are some risks involved in purchasing the real estate, Fisher noted: EPA risks if it is a brownfield, zoning issues, easements, tying up too much wealth in the industry even if it’s in two different asset classes.
“Too many don’t weigh the potential cost of all that,” he said.
He also cautioned anything driving up real estate values does not automatically increase the lease payment a shop owner who sells the business but retains the real estate can expect from the new shop operators. That remains “contingent big-time” on the cash flow of the business, so a period of business retraction “devalues the lease value” as well, Fisher said.
Johnston said there is one set of circumstances when it is often in your best interest to purchase shop real estate: when your landlord on a property is considering selling to someone else.
“You might have had a cozy relationship with that landlord. It might even be someone who sold you the business,” Johnston said. “But if they’re now flipping that real estate, you have to consider whether the person buying that real estate is buying it because they want you there as a long-term tenant, or if they are buying it because they want to redevelop that property.
"It may be advantageous to you to consider buying it if you think there’s a risk of losing what is otherwise a very valuable operational asset. No one wants to have to go find another body shop and relocate a successful operation.”