As consolidation activity ramps up in the highly fragmented car wash industry, several car wash operators have now reached the size and scale required to attract both institutional and private investors.
Their strong credit profiles, combined with the industry’s outsized growth potential, the frenzied pace of private equity-driven acquisitions, and the availability of 100-percent bonus depreciation on car wash properties, is more than enough to compel investors to enthusiastically pursue these net lease assets.
Consider Tucson, Ariz.-based Mister Car Wash: as the only publicly-traded company that focuses exclusively on car washes, it generated $96 million from sale-leasebacks in 2021 after debuting on the NYSE last summer.
“I really think … the success of Mister Car Wash and then the institutionalized car wash sale-leaseback [is driving consolidation],” says Stephen Horn Jr., executive vice president and COO of National Retail Properties, which happens to be one of Mister Car Wash’s biggest landlords. The net lease REIT owns 121 Mister Car Wash properties, which account for 4.5 percent of the REIT’s rent base.
This year, Mister Car Wash expects to generate $140 million to $150 million from sale-leasebacks in 2022, according to CFO Jed Gold. The company plans to spin off some, if not all, of the real estate it acquired as part of the purchase of Clean Streak Ventures LLC, a portfolio company of MKH Capital Partners, in 2021. The deal included 23 operating locations and 10 development locations, Gold said during the company’s first quarter 2022 earnings call.
“We plan to be opportunistic and disciplined with the timing of our sale-leasebacks and aim to maximize the proceeds and economics of these transactions,” Gold noted, adding that there could be “some variability in the timing.”
Unknown impact of inflation or recession
The modern express car wash industry has yet to suffer through a prolonged inflationary environment or a recession unrelated to the COVID-19 pandemic. As a result, the investment community is watching the sector closely, curious if American consumers will continue to allocate part of their budgets to washing their cars.
The express car wash market is valued at roughly $11 billion and is expected to expand at a compound annual growth rate of 4.0 percent to 4.8 percent through 2028, according to Grand View Research Inc. Conveyor car washes are consistently the most profitable in the car wash sector in the U.S., where more than 72 percent of drivers use professional car wash services an average of 13 times per year.
Operators including Mister Car Wash and Charlotte, N.C.-based Driven Brands, which owns roughly 350 car washes in the U.S., along with another 650 or so locations internationally, point to car ownership trends as insurance against both inflation and an economic downturn—nearly 282 million vehicles are on the roads in the U.S., and their average age has increased to almost 12 years. In general, people are taking better care of their cars by keeping them clean and tidy, and during a recession, it’s less likely that consumers will feel confident enough to buy a new car.
“[Driven Brands] is still early in our car wash journey, and [we] have massive conviction in the future growth and profitability for this business,” says President and CEO Jonathan Fitzpatrick.
Driven Brands has monetized its real estate for its automotive and collision repair businesses—Take 5 Oil Change, Meineke Car Care Centers, and Maaco—and will take advantage of that opportunity for its car wash locations when it needs funds to grow, according to Fitzpatrick.
New membership model lures private equity investors
Though a large segment of investors has traditionally shied away from the car wash business because of seasonal and weather-related highs and lows, a new operating model has smoothed out the lumpy cash flow: the subscription or membership model, which offers unlimited washes for a monthly fee and generates a stable, predictable cash flow.
Driven Brands, for example, has more than doubled its wash club subscriber base from 220,000 to more than 530,000 over the last 18 months, which marks the company’s entrance into the car wash business, according to Fitzpatrick.
Likewise, Mister Car Wash added 125,000 net new members to its Unlimited Wash Club in the first quarter, bringing total membership to nearly 1.8 million as of the end of March. On a year-over-year basis, membership increased by 28 percent.
This stable income, coupled with the promise of future growth, is particularly appealing to private equity players. For example, Houston-based WhiteWater Express Car Wash recently partnered with a second private equity investor, Freeman Spogli & Co., to continue its expansion through a combination of buy and build strategies. Its first private equity investment from SkyKnight Capital in 2018 helped WhiteWater grow by 10 times to more than 60 locations across multiple geographies over the past three years.
Keep the op-co, ditch the prop-co
Frequently, when private equity firms acquire a car wash company structured as an op-co/prop-co—meaning that the company both operates the business and owns the real estate—they transact a sale-leaseback deal simultaneously, according to Jack Chang, an executive director with commercial real estate services firm Cushman & Wakefield who specializes in single-tenant sale-leasebacks.
For a recent example, look no further than Getty Realty Corp.’s $35-million sale-leaseback with WhiteWater Express. The New York-based REIT invests exclusively in freestanding single-tenant properties where consumers spend money in their cars or on their cars—think convenience stores, automotive centers and car washes. As of March 2022, its portfolio included 1,014 freestanding properties located in 38 states.
At about the same time that Freeman Spogli & Co. invested in WhiteWater Express, Getty took possession of 10 of the operator’s units in the Midwest. As of the end of March, WhiteWater and Zips Car Wash each represent two percent of the REIT’s annual base rent (ABR), while Go Car Wash represents a little over six percent. In total, car washes account for 10.3 percent of Getty’s ABR.
After a very busy 2021, Getty’s car wash acquisition activity hasn’t slowed down in 2022. During the first quarter, the REIT closed sale-leasebacks totaling $42 million with Go Car Wash, Splash Car Wash and others.
REITs have an advantage
The timing of private equity acquisition and sale-leaseback deals is particularly important because including real estate changes the overall deal multiple. Moreover, given closing costs and other transaction fees, it is not cost-effective to include the real estate in the initial deal only to spin it off later, Chang says.
Usually, REITs have the advantage over other buyers when it comes to sale-leaseback transactions as part of a private equity deal. Certainty of close is critical for these deals, Chang notes, and REITs, with their access to debt revolvers, rarely back trade deals.
Over the past 20 months, Chang has been involved in more than $500 million in car wash-related sale-leaseback deals. Most recently, he represented a top-15 car wash operator in the sale-leaseback of four properties in the Southeast. Four of the largest net lease REITs made offers on the portfolio, which ended up trading at a cap rate in the high fives/low sixes.
“Private equity firms want real estate investors who know how to execute efficiently,” Chang says. “That’s why we see a lot of these car wash sale-leasebacks sold to institutional buyers.”
Interest rates will impact cap rates
Though industry experts anticipate that higher interest rates will impact cap rates on net lease car wash properties, most feel confident that transaction volume will continue to be strong as long as institutional capital continues to saturate the sector.
“Car washes are one of the most popular types of net lease investments,” says Jim Ceresnak, associate director with B+E Net Lease. “We continue to see interest from REITs, funds and individual investors that traditionally buy drugstores, banks and fast-food restaurants.”
Ceresnak and the B+E team closed seven net lease car wash transactions totaling $35 million during the second half of 2021. The transactions traded at cap rates ranging from 5.5 percent to 6.5 percent, with an average cap rate of 5.99 percent.
Many of B+E’s deals were driven by investors who wanted to take advantage of the 100 percent bonus depreciation deduction outlined in the Tax Cuts and Jobs Act of 2017, according to Ceresnak. However, this bonus depreciation will be available only until the end of 2022. After that, it decreases to 80 percent in 2023 and continues to decrease by 20 percent each of the following years until it completely phases out by 2027.
Cap rates for net-leased car wash properties located in the Sunbelt states, specifically in California, Arizona, Texas, Florida and Georgia, are typically the strongest, according to Austin Blodgett, senior vice president of investment sales for RealSource Group, a Newport Beach, Calif.-based real estate brokerage firm.
For operators with 10 units or fewer, cap rates range from mid- to high-6 percent, while operators with roughly 20 units garner cap rates nearly 100 basis points lower, depending on the location and lease term. The largest operators, which typically have the strongest credit and corporate guarantees, are trading in the low-5 percent range, and even into the mid-4 percent range, Blodgett says.
During the first quarter alone, The RealSource Group sold more than $51 million in express car wash sale-leasebacks. The deals, totaling 10 single-tenant net-leased sites throughout the Midwest and Southeast, were leased to two operators and showed strong sales and EBITDA. Blodgett notes that transactions represent the first sale-leasebacks for both owners, each of whom operates fewer than 10 units.
“We generated multiple all-cash offers … and procured a different buyer for each transaction to achieve the highest price possible,” Blodgett says, adding that the properties were existing locations with new 20-year leases, like the majority of the single-tenant car wash properties that have traded recently.
Many car wash operators have expanded their greenfield development programs in the last 18 months, Blodgett notes. “We can expect to see more new construction properties and pre-sales to be sold later this year in third and fourth quarter 2022, which is great news for investors,” he notes.