As the U.S.'s auto manufacturers continue to restructure and cut costs, car dealership closings are spiking and generating a glut of excess space that might have a prolonged negative impact on the commercial real estate market, investment sales
There isn't nearly enough demand from other car brands to occupy all the dealerships about to be shed by Detroit's Big Three, and the skyrocketing vacancies in almost every sector of commercial real estate make it unlikely that most sites will be redeveloped in the near future. Rather, brokers expect that dealerships in the best locations in urban markets will be snatched up relatively quickly, while the vast majority of sites will languish and sit empty on highways around the country for several years.
"Not until the market rebounds significantly" will all of the space left by auto dealerships be absorbed, says Geoffrey Millerd, executive director in the capital markets group of global brokerage firm Cushman & Wakefield. "A very small percentage will be taken in the near future and then there will be a big bulk that will sit on the market for quite a while."
Properties on high traffic intersections in major urban markets, including New York,
But markets that experienced run-ups in housing values and excess commercial real estate development, such as Phoenix, Salt Lake City, Reno, Houston and Atlanta, might have a tough time, adds Mitchell.
The U.S. auto industry has been talking about dealership closures for some months, but the recent bankruptcies of Chrylser LLC and General Motors Corp. have significantly increased the number of expected closings.
In February, the National Automobile Dealers Association (NADA), a trade organization representing car and truck dealers, forecast that net closings of car dealerships would reach 900 this year. (The group expected 1,100 closings and 200 openings.) The industry began the year with 20,453 dealerships — down from 22,250 dealerships in 2000 and 30,800 in 1970 — the earliest year for which data is available.
Already, 522 dealerships have closed in 2009. Now, both Chrysler and General Motors are looking to aggressively trim their dealer base even further. General Motors, which filed for bankruptcy protection earlier this week, previously planned to close 1,200 sites by 2012, but has raised that number to 2,775, opting to cut its dealership fleet down to 3,600 from the 6,375 sites it operated at the end of last year.
Meanwhile, Chrysler LLC, which filed for bankruptcy protection in early May, plans to close 789 dealerships, trimming its base to 2,392 dealerships. Ford Motors Corp. — the healthiest of the Big Three — operated 3,787 dealerships at the beginning of the year. It too plans to shutter dealerships, but has not disclosed a number.
That means that by the time the U.S. auto industry completes is restructuring, it will have shed anywhere from 30% to 40% of all existing dealerships, notes Owen G. Cone, senior director with the cars group of Colliers International.
Approximately 25% to 30% of the dealership sites about to hit the market will likely be taken over by other car brands, estimates James Mitchell, director of the national automotive group with Marcus & Millichap Real Estate Services, an Encino, Calif.-based real estate brokerage firm. The rest of the sites, however, face an uncertain future.
In the past, car dealerships were considered attractive acquisitions by developers of strip centers, small office buildings and hotels as many boast good frontage, are in high traffic locations on major thoroughfares and sit on parcels that have already been graded and require minimal site work.
However, auto dealerships also provide developers with challenges. Auto dealerships are inefficient uses of space with vast parking lots and small buildings. For other commercial real estate uses, the sites can support much larger buildings or be chopped up into smaller sites. But in the current climate, developers might be able to find other commercial sites that require less work and time to turnaround and that don't need to be rezoned.
A big box retailer can take over a former Circuit City location quickly, while redeveloping a former dealership could require up to two years to secure the necessary re-zoning and then additional time to demolish the existing building and replace it with a better suited one, says Millerd.
In the retail sector in particular, a recent spate of bankruptcies involving big box tenants including Circuit City and Linens ‘n Things has left plenty of options for those wishing to expand without spending a fortune on
And it's not as if the retail sector is clamoring for more space to come online with many chains slowing on expansion plans. As it is, more than 90 million sq. ft. of retail space will come online in 2009. That's down from the market's peak, but still represents a big chunk of development.
Aside from retail, in recent months, some trade schools and medical clinic operators have been looking at auto dealership locations, according to Cheryl Bloodworth, vice president of transaction services in the Newport Beach, Calif.-based office of brokerage firm Grubb & Ellis. But the amount of interest has been modest. "You have a classic game of musical chairs, except that this time there are too many chairs," Bloodworth says.
Meanwhile, from the real estate developers' point of view, the difficulty of obtaining construction financing and lowered rent projections make investment in most dealership sites rather unattractive. If the price is low enough, they might consider buying a site and holding off on construction until demand picks up. Another option is acquiring the land now — while prices may be low — and then flipping it down the line when conditions are better.
Lastly, in some cases it might be possible for buyers to secure an option to purchase sites later rather than going all in now. That will give potential developers a chance to gauge market conditions and see if the climate improves before committing to a site.
"Some of your suburban centers are pock-marked by vacant dealerships—you can take your pick and there's no demand for them," Mitchell notes. "The dealers are looking at probably 24 months before they can hope to unload that real estate."
As a result, cap rates on dealership properties, which are calculated based on projected income, have been going up dramatically. Mitchell estimates that cap rates on dealership locations now average approximately 9.5% — up at least 250 basis points since the peak of the market in 2007, when dealerships garnered cap rates in the high 6% to low 7%. And as more sites flood the market over the coming months, average cap rates might reach 11%.