Thinking of selling your car wash? Now is an excellent time to do so. The car wash industry is on the rise and many markets are red hot. Gross sales and net income are up as the economy has recovered and the American consumer is spending money again. Ticket prices continue to go up and there continues to be an influx of wash buyers, both new and experienced. Because of all this good news, the next few years will be a great time to sell for many owners.
But the devil is in the details. Understanding how appraisal companies and banks look at and underwrite transactions will help you prepare and maximize your sale price making sure you squeeze every dime out of your wash.
First and foremost, many transactions are completed with the help of financing from banks. The majority of buyers have limited amounts of cash and need financing. For example, with SBA loans most buyers come in with 10 percent to 20 percent down, and with conventional loans most come in with approximately 25 percent to 35 percent as their down payments; the rest is financed.
If you have a cash buyer, that is great. You should be able to avoid the formalities of banks, but cash buyers are rare. So for most sellers, preparing for a bank underwrite and traditional appraisal report is essential to be able to maximize the sale price. The key is to report as much net income on your tax returns as possible.
VALUE – CLEAN UP YOUR TAX RETURNS
Calculating values is complicated, but most car wash values are normally based in large part on a multiplier of the net income (also known as EBITDA, or earnings before interest, tax, depreciation, and amortization) that is reported on the seller’s last three years of tax returns. This is also called the income approach by appraisers.
So the more EBITDA that is reported on the tax returns the higher the value will be. And again it is the EBITDA that is reported on tax returns, not internally prepared financial statements, that drives value.
There are a couple of different cash flow multipliers out there for putting a value on a wash. Capitalization rate (aka cap rate) is one that is used by many appraisal companies (and throughout the commercial real estate industry). This ratio divides the EBITDA by a market-driven percentage. Cap rates on washes fluctuate widely throughout the country. On the East Coast or in California, we see cap rates as low as 8 percent. In less competitive markets a 15 percent cap rate is not unheard of.
Here is an example of how value is calculated by the capitalization rate ratio:
$600,000 Gross Sales
If the average cap rate in the market were, say, 12 percent then the value of the wash from this approach would be: $1 million value ($120,000 net income/12 percent cap rate = $1,000,000 value of the wash).
So again, the more EBITDA that is shown on the seller’s tax returns the higher the sale price should be. Conversely, say a seller got greedy with Uncle Sam and only reported $80,000 of net income (not the $120,000 above), then the wash’s value would drop a lot: $666,667 value ($80,000 net income/12 percent cap rate = $666,667 value of the wash).
That is a $333,333 difference in sale price based on just $40,000 of cash flow. Many sellers shoot themselves in the foot this way. It is very common.
UNCLE SAM – INCOME TAXES
As mentioned, many sellers make this mistake. They under report to save on income taxes but instead trap themselves when they go to sell. For example, that $40,000 of additional income from the example above would probably result in an increase of income taxes of around $12,000 for the year. So the seller lost $333,333 in sale price to save $12,000 in taxes! This does not make a lot of sense. But many small business owners (not only in the car wash industry) make this mistake all the time.
On the buyer side it is also a common problem. That is, they have a very difficult time finding a seller that reports all of their income. They search high and low for a wash, but cannot find one that shows enough EBITDA to justify the asking price and/or to cash flow the loan.
CASH FLOW – DEBT COVERAGE RATIO
Another major component that underwriters look at when reviewing a loan request is the debt coverage ratio (DCR). This ratio is tied to the value component just discussed above. They are connected. Here you are looking at what the cash flow will be after the borrower pays all expenses including the proposed mortgage payments.
Most banks have a minimum debt coverage ratio of a 1.25, so this also impacts the total debt a property can support and thus impacts your ability to maximize your sale price.
Here’s an example:
$1,000,000 Sale Price
$100,000 Down Payment
$900,000 Loan Amount
$70,404 annual mortgage payments ($5,867 per month, based on 6 percent rate and 25 year amortization schedule).
Here is the actual calculation:
$120,000 of net income/$70,404 annual mortgage payments = 1.7 debt coverage ratio
With a 1.7 DCR this is a deal that would easily qualify and close based on that level of cash flow even at 90 percent financing/loan to value. But if the seller under-reported on their tax returns and for example only reported $80,000 of EBITDA then the deal would not work and the seller would have to hope that a cash buyer would come along or the seller would have to roll the dice and offer the buyer a land contract (i.e., seller financing). Here is the DCR calculation with less net income: $80,000 of net income/$70,404 annual mortgage payments = 1.14 debt coverage ratio.
This loan would not get approved. There is not enough cash flow to support the loan payments, and, further, the cash flow would not support the value, so the seller would either have to lower the purchase price or the buyer would have to come up with a lot more cash.
Plan your sale a couple of years in advance. Clean up your tax returns and report all of your income to maximize your sale price as well as increase your pool of potential buyers. Don’t shoot yourself in the foot by trying to save on income taxes. Remember that the majority of buyers need financing so you will likely have to “play ball” with the banks if you want to get as much as possible from your wash.
Jeff Rauth is a commercial loan officer at a bank that funds car washes nationally. Purchase, refinance, renovation and full ground-up construction financing is available. Loan amounts up to $5,000,000 with financing up to 90% loan to value. You can contact Jeff at (248) 885-8797, firstname.lastname@example.org or visit his blog at http://www.cfa-commercial.com/car-wash-loans/.