A new day has dawned in the downstream oil business after this past November’s surprising election results.
Just four short months ago at the Petroleum Marketers Association of America (PMAA) fall meeting in Atlanta, the list of probable legislative issues that our industry would be tackling seemed almost insurmountable, given the prospect of another four years of governmental interference. The chances of a Trump victory was breezily mentioned, but no one gave it much credence.
To every doubting Thomas (including myself), things turned out quite well after the votes were counted. Having served only a couple of weeks in office, the Keystone and Dakota Access pipelines are finally green-lit and other onerous business regulations are being lifted. The upcoming PMAA Day-on-the-Hill in Washington, D.C. should be something quite wonderful to behold, versus the past eight annual events where our industry faced much stress and strife.
The easing of governmental regulatory interference should set the stage for invigorated marketer growth and profitability, which will surely fuel continued business acquisition activity.
But, you can’t have a rainbow without a little rain and unfortunately the age of ultra-low interest rates is coming to an end. Marketers should expect increasingly higher interest rates over the next few years, prompting some immediate action.
ASSESSING REAL ESTATE
Now is the time to take advantage of current low rates. Marketers need to pragmatically assess all stores within their real estate portfolios for refinance candidates to extend the term on currently low mortgage rates or to possibly pull out some ingrained equity if plans include growth through acquisitions. Having a ready war chest will enable proactive marketers to more decisively compete for choice acquisitions against larger regional and national players.
Many current c-store mortgages feature 15- or 20-year amortizations that term out in 5-7 years. For winning stores with long-term economic viability, consider fixing rates and terming the loans out as far as possible. With current interest rate uncertainty, it may even be advisable to consider paying a slightly higher rate in order to extend the term toward the end of the amortization period. Loans without prepayment penalties are also preferred.
LEASE CAP RATES
Dealer lease cap rates are not as closely tied to interest rates and in many instances rents are based upon an amount that a dealer can comfortably and reliably afford given the economic performance of a given store.
Spreads between dealer lease cap rates have been much wider than typical commercial lease spreads that have been tracking around 435 basis points above the 10-year treasury yield.
Interest rates and lease cap rates don’t necessarily move in lock step and with the recent low interest rate environment, the gap has widened by over 110 basis points versus the long-term spread average for commercial leases. This enhanced spread should allow for a short-term cushion against higher rates and resultant leased property value declines.
As interest rates rise, marketers that are leasing better performing stores should consider moving the cap rate beyond a typical 10% level to preserve long term value. In this instance, a $700,000 store at a 10 cap yields $70,000 annual rent or just over $5,800 per month. Moving to a 12% cap rate will increase the yield to $84,000 annual rent or $7,000 per month. This will preserve overall store value as the cost of capital increases and maintain property desirability to future buyers.
Dealer-leased stores generally have only two primary valuation metrics; rental and fuel distribution income. For a seasoned store, the income from fuel sales will be fairly stable, leaving rental income as the best variable to enhance value.
Given the new business-friendly environment and resultant reinvigorated consumer confidence, the future bodes well for the wholesale petroleum industry. For marketers, the challenge will be to maintain competitiveness and business relevance as retail operations become more sophisticated, resulting in greater pressure to both direct and dealer operations.
Proactively addressing the prospect of higher interest rates should be a key tactic in a marketer’s strategic plan for the New Year and beyond.
Possessing 35 years of downstream petroleum experience, Mark Radosevich is the president of PetroActive Real Estate Services LLC, offering confidential mergers & acquisition representation and financing services exclusively to petroleum wholesalers. He can be reached by email at [email protected] and directly by phone at (423) 442-1327, web address www.petroactive.net.