COVER STORY, JULY 2009

BUYER BEWARE?
In the wake of the restructuring of Chrysler and General Motors, will real estate investors view car dealerships and manufacturing facilities as great deals or lemons?
Coleman Wood

© Chrysler

The spring did not bode well for two of the once “Big Three.” Chrysler filed for Chapter 11 bankruptcy protection in April, followed shortly thereafter by General Motors. Both companies are seeking to significantly trim the number of dealerships they operated as part of their restructuring plans. GM will reduce its number of dealerships by 2,641 — a decrease of more than 40 percent from its current level of 6,246. Chrysler will shed 789 dealerships, many of which will be closed by the time this magazine arrives in readers’ mailboxes.

Once the parking lots are empty and the signs are taken down, what is next for these thousands of vacant car dealerships? Many of these properties are located in high-visibility areas along retail corridors. Will expanding automakers from Japan and South Korean be able to come in and find success with these old lots, or is redevelopment the best alternative?

“Car dealerships are almost easier to redevelop, because there is less of an improvement on them and less of something that someone would think was useful,” says Richard Knitter, principal with Oak Brook, Illinois-based Great Realty Advisors. Most dealerships consist of a large parking lot with a small, one- or two-story building on it, so redevelopment usually just means leveling the property and starting from scratch. Knitter calls it a blank slate, in which you can develop almost anything you want.

A former Dodge dealership located on Roosevelt Road in the Wheaton, Illinois. The property was appraised by Great Realty Advisors and is being marketed by CB Richard Ellis.

“Alternatively, it’s harder if you’re stuck with a Circuit City,” Knitter adds. Retail boxes were originally built to another store’s specifications so, when it comes time to redevelop it, the new company has to work around things such as different column spacing and loading docks in different locations. Companies with fewer building design demands will find great opportunity in occupying vacant retail spaces — since vacancy nationwide is on the upswing, they have more options — but for companies that need a building constructed a certain way, dealerships provide them with the closest thing to greenfield development.

“It’s easier for the car dealership to get knocked down. What happens to be a problem is sometimes the city that it is located in used to make a boatload of money off the sales tax of the cars, and they don’t want the site rezoned [for some other use],” Knitter says, adding that cities sometimes shortsightedly think the site should remain a dealership because the amount of property tax they would collect from some other use is usually smaller than the tax generated by car sales.

Another problem comes up if a developer wants to rezone a former car dealership. In the case of older lots, the zoning characteristics of the area may have changed over the years, meaning a dealership may be surrounded by things other than other dealerships or retail. City planners would want to keep the type of businesses in the area uniform, which could pigeonhole developers into building a certain type of project. An additional challenge arises with lots that have sat vacant for more than a year or two. If a lot sits vacant for long enough, it can be deemed abandoned, which would revert the property back to its original zoning before becoming a dealership. The buyer would have to make sure its new use for the property is conforming to this original zoning or go through the red tape of getting the property rezoned. 

“If you’re buying a dealership, thinking that you can just turn it into a shopping center when the time comes, you have to consider what the underlying zoning is…[and] it’s not quite clear to me that the opportunity is as smooth as has been suggested,” says Ken Hoffman, a partner with the real estate section of law firm Holland & Knight.

Hoffman agrees that dealerships offer great opportunity for redevelopment because little demolition is needed, but rezoning will be one of the major roadblocks buyers will face. The fact that many dealerships are located side by side in “Auto Mile” areas does not make it easier.

“It is hard to know whether or not you can put another use on a vacant car lot that will be compatible with the rest of the uses in that zone. You almost have to hope for more dealerships on a street to go out of business, so that you can re-characterize the land that has been devoted to the dealership as multifamily land or shopping center land,” Hoffman says.

But dealerships are not the only buildings going dark as part of Detroit’s automotive woes. In the wake of General Motors Chapter 11 filing, the company announced plans to close or place on standby several of its manufacturing and distribution facilities. By the end of 2011, two assembly plants will be closed and two will be put on standby capacity; three stamping plants will be closed and one will be put on standby; six powertrain plants will be closed; and three parts distribution centers will close. Nine of the facilities are located in the Midwest.

As for Chrysler, the company already shuttered two assembly plants in St. Louis and Newark, New Jersey, in late 2008. By the end of 2010, the company will also close three more assembly plants, an engine plant, and a stamping plant. Another stamping plant is also closing, but operations are being moved to a new facility that is under construction. All of the affected plants are located in the Midwest.

“In general terms, it’s a situation that has been a long time in the making,” says Cameron McCausland, director of brokerage services and principal with the Southfield, Michigan, office of Colliers International.

The Midwest auto industry has been struggling for years, McCausland adds, and many people saw bankruptcy as the inevitable conclusion for at least one of the automakers, something that McCausland believes will eventually make the companies stronger given time. In the short-term, though, the closing of these large industrial facilities is going to put a strain on their respective markets, and McCausland believes that it may be hard to fill them with new tenants.

“When you’re the largest automaker in the world, and you don’t need the facilities, who else does?” he asks.

Once former Chrysler and GM dealerships hit the market, they will present enormous opportunities for buyers — for sellers, it is a different story.

“You have an oversupply of these properties now,” says James Mitchell, director of Marcus & Millichap’s National Automotive Group. “Just within the last 60 to 90 days, hundreds of these properties have flooded the supply pipe and many more are coming. The number of buyers hasn’t changed that much, but now their selection has increased dramatically, so they take much more time, kind of picking and choosing which properties work best for them.”

But increased competition among sellers is not the end of the obstacles. Many of the contracts potential buyers sign are contingent on being able to get their redevelopment plans (including zoning) for the site approved. For retail redevelopment projects, you also have to factor in that a buyer will want a significant number of tenants signed on before beginning construction. Finally, there is financing to consider. Mitchell says that banks are so wary about funding a vacant development site in the current economy that an owner must be willing to put up a significant amount of cash or have considerable equity in the project. Regardless of the difficulties, Mitchell still thinks buying a dealership can be a sound investment.

“There is definitely interest [from buyers],” Mitchell says. “We’ve had a very enthusiastic response from developers, private investors and owner/users who understand that car dealership real estate is some of the best out there.”

Its value is no longer as a car dealership, though. Auto sales are plummeting across the board, and it is rare to see a new dealership looking for space or an existing one looking to expand. Chrysler and GM are all but permanently reducing the size of their companies and it is not likely Ford will try to expand, as it does its best to stay in the black. Japanese automakers, which have captured an increasing amount of market share in recent years, are also doing their best to stay profitable while staying competitive with each other. There is also increasing competition from the two Korean automakers, Kia and Hyundai.

“Hyundai and Kia are kind of second-tier; they have definitely made huge strides over the last 5 years, but they have a ways to go, too. They are looking to fill space, but are they going to be aggressively taking market share? I wouldn’t anticipate that,” Mitchell says. There has been increasing talk about Chinese and Indian automakers entering the American market in the coming years, but how long that could take and how successful they would be is up for speculation. What is certain is that the majority of these vacant sites will have to find a new use in order to secure a new lease on life.

Looking to the future, Mitchell believes that sites in stronger markets and better locations will turn over within a 2-year period. Sites in more distressed markets — especially in Western cities such as Phoenix, Albuquerque and Las Vegas, and in Midwestern cities such as Cleveland — will probably still see a fair amount of vacancy over the next 5 years. Dealerships in far suburban and exurban markets will also have a harder time finding buyers, since location will be key to redeveloping the sites.

While buying vacant auto dealerships for pennies on the dollar may seem like the next big real estate trend waiting to happen, the complications involved in redeveloping a site and the inability for many to just sit on a land parcel that is producing no income, may keep much of the speculation from occurring. For long-term investors, though, acquiring and redeveloping a 2- or 4-acre parcel can present enormous opportunities for the future. Empty parking lots are going to be a regular sight for the next few years, but patience will eventually yield new opportunities.

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