In a previous post, "What is 'Just Compensation' For Gas Station Acquisitions," we explored various methods for valuing gas stations and car washes in an eminent domain action, including a recommendation by a gas station appraisal firm, Retail Petroleum Consultants, to approach such valuation assignments as "special use properties". Retail Petroleum has issued another useful article, "Value Trends in Gas Stations and Car Washes," which examines recent trends driving the valuation of such properties in California.
Retail Petroleum explains that because gas stations are typically special-use properties sold based on a going-concern value, there are two primary valuation metrics buyers and sellers use in the market: (i) the Gross Profit Multiplier method, which measures value based on the gross profit generated by the property, and (ii) the Capitalization Rate approach, which measures value based on the net operating income generated. The article concludes that the vast majority of gas stations are run by small businesses, meaning operating expenses can vary dramatically from property to property, and therefore the Gross Profit Multiplier may be a more reliable method for valuation. However, the article explores certain nuances that should be considered with each approach, depending on the particular gas station being valued:
- Gross Profit Multiplier Mirrors Real Estate Market Trends: Based on statistical data, the Gross Profit Multiplier valuation method has trended more consistently with the real estate market, whereas capitalization rates showed an opposite trend through the recent recession (i.e., capitalization rate trends indicated increasing gas station values during the recession and falling values after the beginning of the recovery, which clearly did not occur). This needs to be taken into consideration when deciding what "cap rate" to utilize for purposes of valuation.
- Capitalization Rate Approach Considers Risk: Post-recession, most stations saw an increase in cash flow with improved fuel margins, higher convenience store sales, and heightened sales at car washes and quick-serve restaurants. However, a higher net income generally results in increased risk to a buyer (there is a greater risk of continuing that above-market income stream into the foreseeable future), and capitalization rates are therefore impacted. This risk may not be as fully recognized by simply looking at gross income, and the size of the gas station's income therefore needs to be taken into consideration when deciding what multiplier or cap rate to utilize.
- Capitalization Rate Approach Recognizes Pool of Buyers: Properties with a higher net operating income will generally be higher-priced and will therefore have a smaller pool of buyers, which would also impact capitalization rates. For properties with lower net operating income, many more potential buyers can bid on the property, thus pushing capitalization rates into a lower and more constant range. As a result, for gas station and car wash going-concerns, an appraiser must consider the relationship between the property's income and the appropriate capitalization rate to be applied.
Retail Petroleum concludes that both methodologies should be carried out in any appraisal of a gas station, c-store, or car wash:
They can both provide useful insight into how buyers, sellers, and other market participants value these property types, which can be quite complex. Differing locations, improvements configuration and condition, profit centers, underlying land values, and a multitude of other factors can influence values.
However, value indications from a gross profit multiplier may be more consistent because of the more consistent market data available, whereas capitalization rates will tend to be somewhat less reliable due to the nature of accounting for operational expenses within small businesses.
For a detailed analysis of the two approaches and current statistical trends, take a look at Retail Petroleum's article.
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