How the car dealership buy-sell market could shift in the next year

There may never be the perfect time to sell your dealership. Dealer principals who consider selling are motivated by many reasons; some are related to market conditions and others related to personal goals. Thus, it is rare in our industry to find a dealer who is 100 percent certain that (a) selling is the best option and (b) now is the best time to sell.

I won't give advice regarding personal reasons to sell, but the market conditions that exist right now have opened a window of opportunity that may not come around again for a while. If there is ever a time when the stars are lined up for sellers, that time is now.

Consider how the following factors affect buy-sell activity and dealership valuations, and how these factors may change in the next year.

Cost and access to capital: Buyers care about two things: the cost of borrowing capital and access to capital. When access is high and cost is low, more buyers are on the hunt. These conditions create a seller's market. That is what we have now, and have had for quite a while.

In a seller's market, dealership groups are not the only potential buyers. In recent years, other entities have entered the space, such as private equity groups and independent used-car dealerships looking to expand into franchises. All this competition has been great for sellers.

But now the cost of capital is going up. The Federal Reserve has signaled several more rate hikes in the year ahead. As the cost of borrowing rises, there will still be buyers, but the environment won't be as competitive.

Access to capital may also be affected. Goldman Sachs has stated that in the U.S., there is a 38 percent chance of recession in the next 24 months. If this happens, banks will tighten lending policies. Also,many buyers have used Small Business Administration loans to fund deals. As risk increases, the government may decide to shrink its SBA loan portfolio, further restricting access to capital.

Even if dealership groups can get financing, will they? In an uncertain environment, the attitude tends to be that unless they can find the perfect deal, they won't take the risk.

Consumer demand: What goes up must eventually come down. As rising rents, gasoline costs and food prices continue to affect consumers, they will be less able and willing to purchase new vehicles. If a recession is in the cards, consumer demand for new vehicles will inevitably drop. This may have a negative impact on dealership valuations starting in 2023 and beyond.

Profit-margin squeeze: Dealers have enjoyed historic high margins on both used and new vehicles, but we are seeing these margins begin to decline.

Cox Automotive predicts that inventory will remain tight and prices will remain high through the end of the year.

However, some manufacturers are pressuring dealers to not sell above sticker price. And once supply chain issues are resolved, profit margins will likely return to pre-pandemic levels.

Strong valuations: During the pandemic, dealers learned to do more with less. They cut unnecessary expenses, slashed marketing budgets and operated with fewer employees. But as inventory scales up and the market becomes more competitive, it will be difficult to maintain these efficiencies.

In today's market, both large profit margins and increased efficiencies are contributing to high valuations of dealerships. As these profit margins and efficiencies erode, so will valuations.

Another factor affecting valuations is that during the pandemic, many sellers asked buyers to not include 2020 results in valuations, so that valuations were largely based on pre-pandemic results. Going forward, sellers will no longer be able to factor pre-pandemic valuations into their sale price. As a result, buyers will give more weight to 2021 results, which is good for sellers.

For dealers thinking about selling their dealerships, there may never be another time when the stars are aligned the way they are now. Low cost and high access to capital, robust consumer demand, large profit margins and increased efficiencies are all contributing to strong valuations and a seller's market unlike anything we have ever witnessed, or may witness again.