Investment Analysis

Out of Gas

Many factors drive fueling station owners to default.

Gas prices increased 20 percent during the first half of 2012. Lower oil prices decreased the pump price earlier this summer, but in late July, prices started climbing once again.

Paradoxically, one of the businesses most negatively impacted by higher gas prices is the gas station. When consumers pay more at the pump, they might think that gas station owners are flush with profit. Yet many unexpected variables can affect the profit margins of gas stations.

Coming off the recession, lenders are faced with an increased number of defaulted or distressed loans on gas stations. Commercial real estate and other professionals who encounter these troubled assets should understand how various factors, including current ownership trends and valuation practices, affect the profitability of gas stations.

Profit Points

A common misperception is that the major oil companies own and operate the majority of American gas stations. In fact, of the more than 100,000 U.S. fueling stations, less than 1 percent is owned by the oil companies. The vast majority belong to independent operators who are subject to the whims of an extremely volatile marketplace and are in no position to share in the record profits enjoyed by their suppliers.

Most gas station owners find that higher prices mean less profit for them. As gas prices rise, owners must purchase increasingly expensive fuel, and, depending on their fuel supply contracts, they are often forced to sell it at a loss in order to stay competitive.

Unlike other types of income-producing commercial real estate, gas stations are valued using the gross profit multiplier, which is the sale price of a going concern (or value of a proven property operation) divided by gross profit. A going-concern value takes more into account than the value of the real estate; it also includes the intangible enhancement that an operating business enterprise provides, according to Stephen J. Morse, president of Retail Petroleum Consultants.

Why are so many independently owned gas stations suffering now more than ever? The answer is complex. First, there are macroeconomic factors at work. Global politics impacts fuel prices and operators have no control over the actions taken by OPEC and foreign countries. In the U.S., higher unemployment rates mean less disposable income in consumers’ pockets, which leads to decreasing levels of fuel consumption.

Microeconomic trends also come into play. There may be an increase in competition from new gas stations opening nearby. Surrounding businesses may have laid off workers, decreasing the potential customer base. Infrastructure changes, such as commercial development or road work, may have diverted traffic away from the gas station.

In addition, a higher sales tax or new mandatory government regulations may have added expenses for which the station owner is unprepared. Such requirements can be costly, and operators may not have the financial resources to meet them.

Pump Pain

While all these variables are contributing factors, higher gas prices remain the No. 1 factor in the downfall of many gas stations. As gas prices climb and consumers are forced to spend more on fuel, they are less likely to make other purchases. Convenience store products sold at most gas stations provide the highest profit margin of all goods sold. Fewer c-store purchases, due to a decrease in income and fewer visits to gas stations, negatively impact operators’ bottom line.

When gas prices soar, consumers are also more likely to comparison shop, using the Internet to find stations with the least expensive fuel. They may opt to drive less, or even invest in more fuel-efficient vehicles, resulting in less gas sold. Credit cards are also a more popular payment method and credit card fees can cut into a station’s gross profit margin significantly.

Default Options

All of these factors have lead to gas station owners defaulting on their loans, leaving lenders with few avenues for financial recourse.

One option for a lender dealing with a defaulted gas station loan is to sell the note to a third party, often at a tremendous discount. This is a quick fix for getting a bad loan off the books, but it may not be the best solution for every lender.

Another option is to foreclose on the property, seize it, and operate it as a bank-owned asset. This solution works best for properties that are already in good working condition and are not in need of costly improvements. Lenders who choose to operate the gas station themselves must keep in mind that they will become the owner, with all of the attendant risks and liabilities of operating a business.

If the lender has concerns, another option is to appoint a receiver, which will shield the lender from ownership liability. The receiver is then responsible for protecting and preserving the property, troubleshooting as necessary, and often marketing and selling the property in receivership.

Finally, the lender may choose to modify or extend the existing loan, deciding on new terms with the interests of both borrower and lender in mind.

As America continues its uneven path to recovery, troubled gas stations are a commercial real estate trend that cannot and should not be ignored.

Stephen J. Donell, CCIM, CPM, ARM, is a state and federal court-appointed receiver and president of FedReceiver in Los Angeles. Contact him at steve.donell@fedreceiver.com.

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