A West Coast perspective of what's to come in 2012

The following is a very thorough and inside view of the carwash industry's past, present and future on the West Coast, particularly in California. As a consultant, owner and operator in the Los Angeles area for more than 15 years, I am forced to deal with a variety of variables to ensure that my clients and I can still run a profitable carwash business in the current economic and political climate. I am used to running a full-service style carwash because that is where the highest overall profit seems to lay. As you will see, trying to maintain this model in the current environment is getting more difficult every year. Some of us consultants are starting to rethink our approach. The full-service model might start to become a thing of the past, and for good reason as you will see.

I have taken the time to interview some of my closest colleagues in this business, and one good friend of mine in particular is Paul Dadgar of the Irvine Advisory Group LLC. He has been with me on the front lines and in the "trenches" for a long time, and he agreed with me on several key factors as it relates to the carwash industry in terms of its past, present and future. The following is a summary and a concise outline of events and factors that have led us up to the current state.

History

2003-2007 for California and all other Western States

The rise in the valuation of full-service carwashes follows the:

1. General rise in price of income producing commercial property;
2. Cheap cost of funds and available capital;
3. Liberal lending practices of commercial banks working in harmony with agreeable appraisers that provided 3rd party acknowledgement;
4. Increase in the number of foreign buyers, including those taking advantage of the U.S. government's provision (see below) allowing foreign investors to qualify and acquire an investment visa to come into the U.S. and use this as a method to then seek citizenship for themselves and their family members; and
5. Aggressive brokers.

Immigrant Investors

• Individual invests $500,000 in a high unemployment area (150 percent of national unemployment rate) or $1 million elsewhere and hires 10 people within two years, or invests in a regional center and may use job multiplier studies instead of direct employment. Because this category has been controversial, INS processing times are slow and unpredictable.

• None of the investor categories have language, education or business experience requirements.

Additional issues

Rising markets and conditions hide and cover for the inexperience and lack of understanding of investors who simply rely on increasing real estate prices, inflated prices, consumer confidence and market-driven sales between similar investors often buying from one another through their brokerage networks.

Many carwashes were bought by investors. These investors, although they may have had certain business experience, did not fully understand the carwash industry, nor did they hire consultants or other professionals to help them develop this understanding. In addition, many of these same investors proliferate illegal operational practices.

Labor issues

Many of these buyers, who were intentionally or apathetically going along with the status quo, hired an overwhelmingly Hispanic labor force and took advantage of their status as illegal immigrants, in some cases abusing the labor force from a financial perspective. This practice was learned and propagated as "business as usual." Those that participated in these practices are part of the reason why certain parts of the Western United States were able to keep the price of the full-service carwash artificially low.

Cash payments to labor equaled lower worker's compensation, lower payroll taxes and provided for higher margins due to non-taxable income.

Here comes the recession

By late 2007 and early 2008, carwashes were trading hands for prices officially in a valuation range of over 10 times their earnings before interest, taxes, depreciation and amortization (ebitda). We have seen deals in the 12 to 15 times range. Unfortunately these valuations also reflect financial information that was also skewed, making these Net Interest Margins (NIMs) actually higher. Even with the required down payment, the debt on these properties reflected up to a true 10 times NIM.

1. Consumers experience a rapid rise to $4+ gas prices, which ultimately came down then rose again more slowly to comparable pricing in some areas (gas prices are a huge factor in so far as the upsell and frequency of the customer).
2. Then a market crash and the realization that the U.S. and the world was in the worst recession since the great depression.
3. Produces the "new normal" with lackluster consumer confidence and tightening of discretionary spending, especially for non-essential purchases such as a full-service carwash.

These issues exasperated failing carwash owners, and, in many cases, they stepped up the practices they had come to consider "ordinary" in order to pay their inflated debt service.

Now the default rate among several classes of commercial property increased, including those in the carwash industry.

Borrowers begin defaulting on loans from 2008 up until today. These same owner operators — never fully understanding how to operate in the best of conditions — now do not know how to respond. Consumers in markets with artificially low pricing do not understand when prices are increased and now do not have the resources; therefore the consumer is reducing the frequency of full-service carwash visits. And, as a result, volumes since 2007 have come down as much as 50 percent up until 2011. The more successful locations have seen 30 percent reductions.

Other issues that compound the problem of bad business practices include:

1. California Labor Dept. enforces AB 1688, and the new enforcement division begins an aggressive campaign to collect fines and penalties.
2. Along with the state of California, the Federal Labor Department and other municipalities are hungry for funds and are also targeting the carwash industry.
3. Unionization attempts focus on the carwashes with the worst operations and biggest offenders as they are an easy target.

Current state of affairs

Here's how things stack up now:

1. We see a new "normal" with continued financial and real estate market volatility and added on recessionary pressures.
2. High default rates are put on full-service carwash operations.
3. Lenders are fearful of filing notices of defaults.
4. Lenders are allowing operators to stay in business for long periods without making a payment — as much as 18 months in some cases — until the federal government and auditors force the issue.
5. Full-service carwashes are for sale, but at asking prices that still reflect an untenable debt service.
6. Lenders are finally biting the bullet and beginning to sell defaulted notes for up to 50 percent or more off of the original loan amount — but this may still not reflect the true "value" of the transaction.
7. Appraisers are now gun-shy and ultraconservative, further forcing pricing downward (lack of sales in the marketplace provides limited comps).

New investors trying to build express exterior and flex washes are finding California to be difficult to develop because of the high costs for obtaining conditional use permits.

But, they cannot convert most full-service carwashes (those built in the past 15 to 20 years) to a flex or express format due to:

1. Location issues;
2. The physical layout of buildings, canopies and tunnels on property; and
3. The size of the property.

Meanwhile, operators do not know how to respond to the need for sophisticated:

1. Marketing strategies;
2. Branding;
3. Operational expertise;
4. Labor management; and
5. Best practices.

In conclusion

The result is a very stationary — almost stagnant — market that leaves very little wiggle room for error in the case of new investors and inexperienced operators, and in some cases actually starts you out in "the red." This is an investment that I cannot recommend to my clients even if they have experience. As a result of these very turbulent headwinds and fluid circumstances, my colleagues and I are now starting to advise our clients to look towards the express and flex models, even if the task seems daunting, as the new paradigm in the carwash industry. For many reasons, which I will explain in much greater detail in a future issue, these models have been extremely successful in the last few years on the East Coast, and we are now looking to start emulating these successes out on the West Coast. My next article of "Consultants Corner" will be on what the ideal express and flex model should look like, the reasons for their success and some of the best ways to approach this type of investment. Until next time…

Hold on to your hats,
Chris
www.carwash-consultant.com