As we enter the second half of 2022, the petro mergers & acquisitions environment remains positive for both retail and commercial acquisitions. However, current actions by the Fed to counter inflation by raising interest rates and the resultant cost of money, may begin to dampen M&A enthusiasm, while moderating cash flow valuation multiples and corresponding deal values. Store buyers will be hit with a double whammy in the areas of higher mortgage interest rates and rent/lease capitalization rates (cap rates).
Real estate portfolio buyers will face higher mortgage payments and equity contributions, as loan to value (LTV) leverage amounts may also increase due to higher lender loan security concerns. Correspondingly, buy-and-lease store operators will face a combination of lower post-closing sale-leaseback proceeds and higher rent expenses due to the higher cap rates. Large publicly traded c-store chains enjoy “credit tenant” designations generally superior to other retail or QSR companies. This is partially the result of the resiliency our industry demonstrated during the pandemic and the strength of the underlying real estate. Despite the recent interest rate increases, credit tenant cap rate values remain in the four percent range, as the leases were negotiated prior to the rate movements. They will begin to move higher as future deals are consummated within the higher interest rate environment.
Many former marketers entered into long term leases with these large national chains in order to forestall the tax consequences of an outright real estate sale. They will unfortunately see the underlying value of their leases diminished as cap rates increase. For example: a currently leased site that earns $45,000 in annual rent at a 4.5% cap rate would be valued at $1,000,000 ($45,000/.045=$1,000,000). Assuming that the cap rate for the same c-store operator/tenant increases from 4.5% to 5.5% due to rising interest rates, the underlying value of the same lease would be $818,182 ($45,000/.055=$818,182) or $181,818 less if the marketer decided to sell that lease. For those that hold leases on multiple sites, the value impairment would be quite significant, if the initial exit plan entailed flipping the leases. This secondary, post-closing cash tranche from a lease sale is what drove many deal values to historic highs. This value impairment only affects those that planned on selling the lease/s prior to their termination. For those that plan on holding the leases for the long haul, there’s no harm, no foul, beyond their rental income being less than it would be under a new lease with the sale tenant.
On the commercial side, rising interest rates, combined with the increased cost of fuel is a two edged sword. To manage monthly receivables and credit float, smaller fuel and lubricants distributors will be challenged by higher levels of lender credit requirements and guarantees. Those that cannot contend will be forced to limit operations or exit the industry. Conversely, well-healed operators will experience previously unavailable acquisition candidates and opportunities.
If there is anything good to come out of this Biden-inspired inflation mess, it is that small and mid-sized marketers may finally be able to make an acquisition at more traditional purchase multiples. For the growth oriented, it’s time to create (or dust off) a tactical growth plan that includes:
• Creating a profile of a preferred acquisition candidate and geographic area.
• Develop a target list of candidates and then confidentially contact each on the list to establish an early dialog. Become the top-of-mind buyer candidate in the event one decides to sell.
• Amass and segregate available equity for when an opportunity arises.
• Enlist reliable lender partners. Jointly pre-determine your optimal deal capacity.
Put simply, growth oriented marketers should “keep their powder dry” and be prepared to pull the trigger when an appropriate acquisition arises. Rest assured that opportunities will be plentiful over the months to come.
Possessing over thirty five years of downstream petroleum experience, Mark Radosevich is a strong industry advocate. He is 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 mark@petroactive.net and by phone at 423-442-1327.