October 24, 2013
Interviewed by: David Snow
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Solutions Financing in Automotive Retail

Jason Fox of W.P. Carey and Franklin McLarty of RML Automotive, of one of the largest auto-dealership groups, discuss a strategic partnership to help the dealership monetize the value of their real estate assets.

In 2012, W. P. acquired nine U.S. auto dealerships totaling 380,000 sq. feet. While the bread and butter of the firm’s portfolio dealerships are to sell and service major auto brands, these experts say the real criticality is real estate.

Jason Fox of W.P. Carey and Franklin McLarty of RML Automotive, of one of the largest auto-dealership groups, discuss a strategic partnership to help the dealership monetize the value of their real estate assets.

In 2012, W. P. acquired nine U.S. auto dealerships totaling 380,000 sq. feet. While the bread and butter of the firm’s portfolio dealerships are to sell and service major auto brands, these experts say the real criticality is real estate.

Solutions Financing in Automotive Retail

With Franklin McLarty of RML Automotive and Jason Fox of W. P. Carey

David Snow, Privcap:

Today we are joined by Franklin McLarty of RML Automotive and Jason Fox of W.P. Carey. Gentlemen, welcome to the program.  Thanks for being here.

Jason Fox, W. P. Carey:

Thanks for having us.

Franklin McLarty, RML Automotive:

Thank you, David.

Snow: Our subject today should greatly interest people in the automotive retail sector, people who own car dealerships and the financial challenges many of these businesses face. You both know a lot about those challenges and have structured a solution I’m fascinated to hear about.

Starting with a question for Franklin: You’ve built your business in the automotive retail sector, where you continue to grow. Could you paint an overview of the challenges these businesses face in growing?

McLarty: Our family’s been in the car business for almost a hundred years, so we’ve watched the evolution of the dealer network. The OEMs—Original Equipment Manufacturers—rely on this network to transact with the public.

Though you have a variety of competing factors today, it’s a very capital-intensive business, and that’s clearly a pressure that dealers face. Automotive dealers nationwide spend significant capital on the real-estate component, and our partnership with W. P. Carey has allowed us the flexibility to meet that need.

Snow: Jason, can you talk about the attributes of many automotive retail businesses, from a real-estate perspective, that are attractive to W. P. Carey and fit into its strategy?

Fox: When we look at transactions, we’re mainly focused on several factors: one is the credit behind our tenant. We certainly look at the criticality of the real estate, then at its underlying fundamental value. This industry is highly cyclical, for many reasons—some of which are misconceptions.

That’s certainly true on the new car side, where manufacturers like Ford and Chrysler experience fairly big swings in production.

However, in the dealership space, it’s much more stable. New cars go up and down, but during those counter-cycles, used car sales increase significantly. Throughout the term, and even more so in a down cycle, you have parts and service, which are a mainstay of dealership operations.

So, we see this stable cash-flowing component of the business, where parts and service cover 70% of the fixed cost of the average dealership. That adds some stability you wouldn’t typically see, which is important for us from an underwriting perspective.

We also see it as a good opportunity. Few institutional investors are currently targeting this with a well-capitalized balance sheet, and there is an opportunity to come in. W.P. Carey has the ability to raise capital and offer sale-leasebacks with an expansion component or upgraded facility. Also, W.P. Carey can acquire financing for new purchases for some dealerships.

Snow: Let’s get back to the RML story. Franklin, can you talk about the circumstances that led your business to seek a financial solution and how you structured a deal with W.P. Carey?

McLarty: Certainly, David. We grew quite rapidly. We’re one of the top twenty largest dealers in the nation and we’re less than ten years old. Our family partnered with Bob Johnson and his team at RLJ Companies and began to take advantage of the distress in the market through a lot of acquisitive activity.

We wanted to continue to grow, so we looked for the best return on our equity investment. We also looked at the return we get on our operational investments versus the real estate—there’s a substantial difference between the two. Finding a good, long-term real estate investor who’ll be a flexible landlord, offering long-term clarity in who that landlord will be and how they’ll behave, allows us to invest most creatively.

Fox: That’s an important part of what W.P. Carey has to offer. We have a long history of owning assets for the duration of lease terms. As Franklin looks for flexibility, whether it’s in lease consents, or working with a floor plan financing lender that needs cooperation from the owner. We have experience with that—you know your landlord because a relationship has developed.

More importantly, we’re willing to capitalize for a long period of time. We’d like to put further money into our investments, helping us extend lease terms, which is our business. We don’t want to be in the re-tenanting business; we want a tenant that will have some longstanding history at this property. By continuing to reinvest in that property and extend leases, we can have that, plus more continuity.

Snow: So far, you’ve done two transactions in the automotive retail space.  Briefly, can you walk us through them and describe the main characteristics of the structure?

Fox: The first transaction was a sale-leaseback we did with RML here with Franklin helping to lead the charge. It involved eight dealerships, in multiple states. We diversified across brands, with Mercedes, Ford, Chrysler, Nissan, Toyota, and others.

This gave Franklin an opportunity to consolidate their landlord relationships. Instead of dealing with a number of owners, where each individual owner had several partners, they could deal with one landlord whose business was to own this real estate, and to communicate and maintain a partnership with the tenant.

McLarty: Jason’s absolutely right. Often times in a transaction, we’ll acquire a dealership from someone and, for whatever reason, they decide they want the passive income of being a landlord. That’s usually fine, but sometimes things change in their landscape: They may have health issues, other family members get involved, and the relationship becomes less professional and more complicated.

We focus our attention and corporate resources on operating the business, not on complicated real-estate negotiations. To have one institutional landlord whose interest is purely in being a long-term triple-net lease landlord gives us the clarity and certainty we need to aggressively grow our business, whether it’s by improving operations or acquisitions.

Fox: The second transaction we’ve done with them is a different scenario in which we’re helping them finance a new acquisition. They had targeted North Dallas as a location and, opportunistically, a Toyota franchise was available. We’ve separated the real estate from the operations; we’re coming in at close to buy the real estate and lease it to RML on a long-term net lease basis.

RML and their owners are coming in to buy the operations of the Blue Sky. In the end, we got what we want: a long-term lease with a creditworthy tenant, providing a stable income for our investors, and Franklin’s money is tied up in the operations, where they can get the type of returns they want.

Snow: Since you guys know a lot about the real-estate landscape in the automotive retail world, how often do the automotive dealers themselves own the land and the property from which they operate?  Is it significant?

McLarty: It is significant, though there’s some divergence between the owners of the operation and the owners of the real estate. They’re related, but not necessarily in the same “nuclear family.”

Often, you’ll have a strong operator who’s built a longstanding track record in the industry. They may have ten or fifteen percent ownership in the operations, then they’re backed by an institutional sponsor and a high net-worth individual who has traditionally owned the real estate.

The challenge there is potential conflict between the ownership group and the operations, since one is on both sides—the real estate and operating company—where the other is only on the operational side. We like the alignment it gives our operators, who usually have some equity participation in the day-to-day operation by having an institutional third-party landlord.

Snow: Jason, W.P. Carey has done two transactions so far. It sounds like you remain interested in this automotive retail sector. Are you still prowling for new deals?

Fox: Absolutely. This industry meets many things we look for in a long-term net lease. The tenant’s credit worth is very important in looking at transactions and, obviously, that will vary on a deal-by-deal basis.

More importantly, criticality is also a key component of our underwriting and is very apparent in this industry.  The real estate is the operations in many cases, so it fits them all.

Lastly, we have raised a lot of money. We have opportunities to put into different industries and, given the lack of institutional capital focused on only real estate in the automotive market, there are opportunities to find ways to invest money at good yields.

Expert Q&A with Jason Fox of W. P. Carey

What is a sale-leaseback?

Fox: In a sale-leaseback transaction, a real-estate owner or user sells its real estate to an investor such as W.P. Carey and, in turn, leases the real estate back under a long-term triple net lease. They retain ownership responsibilities for the property, including paying the taxes, maintenance, and insurance.

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