How to maximize your shop real estate value before you sell
Key Highlights
- Charging fair market rent ensures accurate EBITDA reporting and reflects true operational profitability, which is vital for business valuation.
- Adjusting rent to market rates can substantially increase real estate value, especially when using income capitalization methods with favorable cap rates.
- Securing long-term, creditworthy tenants with escalator clauses can lower cap rates, boosting real estate valuation and creating additional wealth.
- Owners should treat their business and real estate as separate assets, optimizing each for maximum value during sale or transfer.
- Understanding and leveraging lease terms, cap rates, and market conditions can lead to significant financial gains and a more attractive exit strategy.
Fleet and shop owners who own their facilities may be leaving money on the table when it comes to long-term asset value, especially when preparing for the sale of their business. You can significantly work your real estate (RE) value upwards by understanding the following playbook.
Charge yourself fair market rent
If you own your RE, it’s important you are charging your business fair market rent. Undercharging rent causes problems by boosting and distorting EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)—a metric for profitability. Rent is a large expense and often quite variable on a percentage of sales basis. Undercharging for rent often masks low operational profitability.
For example, imagine you are ready to sell your business (and maybe your real estate). Your business does $15 million in revenue with a below market rent of 4% rent-to-sales, or $600,000 annually. Assume 7-10% rent-to-sales is market rate for your business type, and you bump rent to 7% rent-to-sales, or $1,050,000 annually, because a potential acquirer needs to understand the true profitability. EBITDA would drop by $450,000.
This will impact the business valuation, leaving you with two options: a) make changes to make to your business more profitable; 2) accept the fact that the business’ EBITDA is now correct.
Now that rent is fair market, let’s understand how fair market rent impacts real estate value. Real estate appraisers typically use the capitalization, comparable sales, or cost method to value RE. Many times, the income capitalization method holds the most weight. Rental income divided by cap rate gives you the RE value in this case. When the business rent was $600,000 on an 8% cap rate (established by the appraiser or an investor), that RE was worth $7,500,000. When rent is boosted to a market rate of $1,050,000 annually, and the business is turning a sustainable and reasonable profit at that rent level, the RE value becomes $13,125,000 at that same cap rate. Charging fair market rent for your real estate is important because many acquirers will want to buy your business but lease your real estate.
Get the lease right with the acquirer of the business
How about getting that cap rate down from 8% to 7%? Remember the formula: Rental income divided by cap rate = RE value. Cap rates are assigned by investors in real estate such as REITS, institutional investors and private capital buyers, or 1031 exchanges and are primarily driven downward as investment risk decreases.
A triple net (NNN) lease that’s 10-15 years long with annual escalators of 2-3%, particularly with a large, creditworthy tenant, creates an income stream for a real estate buyer (not the business acquirer) that is durable and low risk. In this case, we could see cap rates drop to 7%. At $1,050,000 in annual rent, the RE value is now worth $15,000,000, not $13,125,000. In this scenario, you’ve seemingly created nearly $2,000,000 in RE value out of thin air! This isn’t pie in the sky math. For investors/buyers, business and real estate acquisitions are all about risk and probability of maintaining and growing cash flows.
Put it all together if selling your business is on your mind
The playbook above applies to service shops as well as manufacturing facilities and distribution real estate. Service businesses typically receive higher cap rates in the 7%+ range while industrial/manufacturing/distribution facilities receive lower cap rates of 5%-7%. The example I provided is based on a theoretical service shop.
We tell all our sell-side auto and heavy-duty clients to think about their business and real estate separately. The wealthiest owners I know typically own their real estate. Fair market rent, strong lease terms, and of course a solid profitable business are foundational to a winning exit, whether the transaction bundles the business with or without the RE.
About the Author
Chandler Kohn
Principal
Chandler Kohn is an investment banker with FOCUS Investment Banking’s Automotive Aftermarket team, where he leads the firm’s Heavy-Duty Truck Parts and Service industry coverage. He advises clients on sell-side and buy-side M&A transactions and capital raising initiatives, with a focus on helping owners scale or successfully transition their businesses.
Kohn is also the host of Know to Grow: A Light to Heavy-Duty Podcast, where he interviews owners, CEOs, and senior executives on best practices and forward-looking strategies for building durable, scalable businesses. The podcast is the only industry-specific platform focused on scalability and valuation within the heavy-duty parts and service sector.
With deep automotive industry expertise, a broad executive network, and extensive transaction experience, Kohn serves as a trusted advisor to small and middle-market business owners pursuing partial or full exits, buy-side strategies, or growth capital solutions.
Coming from a multi-generational family of entrepreneurs whose business employed up to 70 people at its peak, Kohn brings firsthand understanding of the realities of building and operating a small business. This perspective, combined with his deal experience, enables him to create effective one-time private transaction markets for clients, with a focus on readiness, risk, legacy, and outcome.
Kohn lives in Charleston, South Carolina, with his wife and daughter. Outside of work, he enjoys spending time with his family, saltwater fishing, fitness training, and exploring Charleston’s culinary scene. He holds a Master of Science in Finance from Tulane University and a Bachelor of Science in Business Administration from the College of Charleston, and maintains FINRA Series 63 and 79 licenses.