Real estate investment trusts, or REITs, were a hot topic at the National Automobile Dealers Association convention in New Orleans a year ago. But this year, as dealers prepare to meet in San Francisco, the dealer REIT business has chilled.
One of two REITs that exhibited at the New Orleans show last year has folded. Of the five REITs that were poised to buy new-car dealership real estate a year ago, only one - Capital Automotive REIT of McLean, Va. - is actively buying dealership properties.
And Capital Automotive is the only automotive REIT to go public, though a newcomer, Mar Mar Realty Trust of Charlotte, N.C., has filed a registration statement with the federal government. (See story, Page 36i.)
As a source of capital or a potential exit strategy, REITs seem to be the ticket. But the market for their stocks went sour last year, making it difficult for REITs to raise expansion funds through initial public offerings.
Some dealers and manufacturers have reservations about REITs, and it is clear now that REITs are not for everyone.
'REITs are only good if you want to retire or expand aggressively,' says Sheldon Sandler, CEO of Bel Air Partners, a Princeton, N.J., investment firm that serves dealers.
Free up capital
Business owners sell their property to a REIT in exchange for cash or shares in the REIT. The REIT leases the property back to the business owner, who continues to run the business on the site.
'We are still seeing a lot of dealers interested in REITs,' says Dave Jarrett, partner in charge of dealer services for accounting firm Crowe Chizek in Chicago. 'The real estate is a big use of their capital. The REIT frees up the capital they have invested in real estate and gives them more capital to use if they want to expand their operations.'
Investment firm ABN AMRO in New York says that on average, about 50 percent of the dealer's equity is invested in real estate. Dealers are seeing a return of 3 percent to 6 percent, based on inflation. But the average dealer has a 29 percent return on equity from operations, according to NADA statistics. The numbers make a convincing case for unloading real estate to expand operations.
Some of the public dealership groups are working closely with REITs as part of their acquisition strategy. When the chains have to buy the real estate to get the deal done, they sell the real estate to a REIT and use the cash from the sale to fuel more expansion.
'We have a better use for our capital (than owning real estate) as a growth company,' says Sid DeBoer, chairman of Lithia Motors Inc., a publicly held dealership group based in Medford, Ore. DeBoer sold property to Capital Automotive.
'We have an understanding (with Capital Automotive) to give them the first chance to look at each piece of real estate we decide to sell to a REIT,' he says.
Dealers who are selling out can use the REIT to increase the price they fetch for their businesses. A dealer is likely to get a better total price by splitting up the business and the real estate, thus broadening the field of prospective buyers.
'Dealers who separate the real estate from the business are more likely to get a better price for the real estate,' says Sandler.
The tax advantages are also appealing. When a dealer chooses to receive shares in a REIT, the dealer can defer capital gains taxes.
'A lot of these dealers bought properties a while back, and they would have to pay a huge tax if they sold the real estate,' says Deborah Feldman, vice president at ABN AMRO.
If sons or daughters don't want to operate the dealership when the dealer retires or dies, the dealer can give them shares in the REIT instead.
Investors receive steady dividends, since REITs are required by law to pay 95 percent of their income to shareholders as dividends.
Capital Automotive says its investors are getting a 10 percent return on their shares.
The problem with REITs as an estate-planning tool is that many dealers already have retirement plans in place, says Skip Harkness, a 20 group consultant for NADA.
'I do not think the dealers' financial planners had REITs in mind when they set up a trust for retirement. I don't think financial planners understand REITs well enough,' Harkness says.
Many of the financial planners also work for life insurance companies, he says. If the real estate is sold to a REIT, the dealer will only need to insure his or her operation. The financial planner won't be happy if the dealer decides to sell to a REIT because it will lower the planner's commission. 'He might cancel the insurance,' says Harkness.
The conflicts don't stop with financial planners. Some relatives also are unfamiliar with REITs and balk at the concept. Some dealers have had to abandon plans to sell to a REIT in order to keep peace in the family, Harkness says.
And dealers themselves could have trouble parting with their real estate. 'Dealers have traditionally felt their real estate was the family jewel,' says Sandler.
Manufacturers also have concerns. The factories worry that REITs could overpay dealers for the property, which would inflate rents.
'If the rent factor makes sense, we don't have a problem with it,' says one Ford Motor Co. official who asked not to be named. But he says he is concerned that REITs could overcharge dealers to fatten their own income stream.
David Kay, CFO of Capital Automotive, says his company has good rapport with the factories. The rents are about what dealers paid for a mortgage, he says.
Accounting firm Crowe Chizek cites a general rule that 8 percent to 10 percent of a dealership's gross profit should go to rent and equipment. The dealership's total overhead should not exceed 40 percent of gross profits.
But potentially high rents are not the only issue. Dealers enter long-term rental agreements of 10- to 30-year terms. Market demographics can change over that time. Some automakers wonder if the lease allows them to relocate.
'The dealer could be on the hook,' says Don Stephenson, manager of market representation and dealer development for Toyota and Lexus divisions. 'These dealerships have limited uses and come with (potential environmental) liabilities. I talked to one REIT and found they had no plan for alternative uses (for the dealership sites).'
Stephenson is especially concerned about what could happen in an economic slump. Dealers traditionally have owned their real estate under a separate corporation and leased the property to their dealerships.
'One thing dealers have been able to do when they owned the real estate themselves is when times were thin they could make a little money on the real estate side,' he says.
Stephenson is also worried dealers could be overcharged on rent. An inflated long-term rent could scare away potential buyers if the dealer decided to sell the business.
And the dealer does not need another high, fixed expense. Said Stephenson: 'That's money that could go toward merchandising cars or expanding the franchise.'
Donna Harris is an Automotive News staff reporter based in Washington, D.C.