In the first half of 2023, the triple net lease (NNN) car wash market faced headwinds as inventory remained high, debt remained challenging, and buyers became more selective. Average closing cap rates for completed deals and average asking cap rates for marketed deals have risen as a result.
Yet cap rates have not risen as significantly as some expected at the start of this year. And a shifting tone that we have witnessed in the first few weeks of July suggests that the market should improve in the months ahead.
According to B+E research and Co-Star data, more than 70 NNN car wash deals closed in the first half of 2023. The average closing cap rate of +/- 6.52% was 57 basis points higher than the average closing cap rate for deals completed in 2022. The average closing price was +/- $4,420,638.
At the end of June, marketed car wash inventory sat at 142 available properties, with an average asking price of $5,264,813. The average asking cap rate increased by 26 basis points over the past six months to 6.03%. Inventory was up from 89 available properties in January but was down from its peak of 166 available properties in April. For more information, you can view B+E’s NNN Car Wash Listed Inventory Report here.
Typically, the NNN car wash sector sees demand from three unique buyer pools: individuals in 1031 exchanges, individuals motivated by bonus depreciation, and large institutions such as REITs or depreciation funds. Deal flow with individuals has generally been down, but that is not unique to the NNN car wash space.
Year-over-year, 1031 exchange activity is down by roughly half while net lease property inventory is high in every sector. The 1031 exchange buyers that have been active have had a much larger menu of properties to choose from to satisfy their exchanges. With fewer 1031 exchange buyers available to absorb car wash inventory, that has left depreciation-motivated buyers and institutions as the only natural buyers for NNN car wash properties.
Some depreciation-motivated buyers have remained on the sidelines to see whether cap rates will rise further and whether debt will become more attractive in the second half of the year. Those that have been buying have favored properties tenanted by the largest car wash operators in popular Sun Belt markets.
Mister Car Wash, the largest and only publicly traded car wash company in the U.S. (440+ washes), has marketed several sale-leasebacks this year and has successfully captured a large share of individual buyers that have purchased NNN car washes in the past six months. Mister Car Wash has completed more than 10 sale-leaseback transactions this year, mostly with individual buyers and many at cap rates in the low to mid 6.00% range. Though, some Mister Car Wash deals outside of the Sun Belt may have traded at higher cap rates.
Take 5 Car Wash, the second-largest car wash company in the U.S. and a subsidiary of publicly traded Driven Brands (410+ washes), has also marketed dozens of sale-leasebacks this year. The large number of available sale-leasebacks from the top two car wash operators has made the market more challenging for small (< 50 units) and mid-size (50-200 units) operators seeking to tap individual buyers via sale-leasebacks and for sellers of older properties with seasoned leases that have been forced to compete with sale-leasebacks offering full 20-year lease terms.
In some cases, small and mid-size operators have successfully attracted individual buyers for one-off deals in strong markets at cap rates in the low to mid 6.00% range. Some have also recently completed large portfolio transactions with REITs at cap rates ranging from the high 6.00% to low 7.00% area. REITs have been more selective about the transactions that they pursue this year as most generally have full deal pipelines. But they have been active buyers, completing more than $200 million in transaction volume in the first half of the year according to B+E research and Co-Star data.
Notably, there has been an influx of new REITs and depreciation-motivated funds seeking to purchase NNN car washes this year as entry points for acquisitions have become more attractive. At least one major public REIT completed its first-ever car wash portfolio transaction in 1H23. The total transaction price was rumored to be in the $50 million range.
At B+E, we have noticed a dramatic shift in tone since entering the second half of 2023. Institutions should continue to be active buyers going into year-end, and 1031 activity seems to be picking up. But most importantly, depreciation-motivated buyers are back and are gearing up for year-end purchases.
Many market participants have been concerned that depreciation-motivated demand for car washes might wane this year due to the bonus depreciation benefit being reduced to 80% from 100%. We have seen nothing to suggest that depreciation demand will be any less robust this year than it has been in the past several years.
Car washes remain one of the most attractive real estate assets available for depreciation even after the benefit reduction. And we believe there is an element of FOMO in the market from buyers that either did not take advantage of the benefit when it was at 100% or from those who want to take advantage before the benefit is reduced further to 60% next year. Find more information about the benefits of a cost segregation analysis on car wash properties for tax purposes here (all investors must consult a tax advisor regarding their personal tax decisions).
With REITs providing a backstop bid in the low 7.00% cap rate range and the segment’s most important buyer pool returning to the market, we expect NNN car wash deal volume to pick up significantly in the coming months, and we expect cap rates to hold steady, with most non-institutional deals closing within the low to high 6.00% range.
It is possible that cap rates could drop beneath that range as demand picks up. But it seems unlikely that cap rates will sink below 6.00% until inventory dramatically decreases or financing rates get lower. Properties in desirable markets with lower price points that can be purchased with all-cash are most likely to fetch the lowest cap rates in the coming months.
A potential headwind that could counteract increased demand would be a large year-end supply surge similar to the one that we experienced last year. In a six-week period from October to November 2022 more than 100 NNN car wash properties were brought to the market as sellers made a last-ditch effort to capture year-end depreciation-motivated buyers. A similar inventory surge in 2023 could put upward pressure on cap rates.
We acknowledge an inventory surge as a moderate risk and we do not expect that all available NNN car wash properties will trade before year-end. But we do expect to see robust deal activity, stable cap rates, and an eventual reduction in NNN car wash inventory as the year goes on.
