Why Net Lease Investors Should Avoid Car Wash Deals

Car wash net lease investment properties have been one of the darlings of the net lease sector over the last few years as the business model has transitioned to being subscription-based, operators have become more sophisticated, and tax incentives like bonus depreciation have made these very attractive investments for retail or 1031 investors. The excitement and development in the car wash space has provided many investors with what they expected to be a long-term passive investment but has ended up being a nightmare for some owners and a ticking time bomb for others. The major threats that are affecting net lease investors who own car washes are:

1. The number of car washes, specifically the express model, in certain markets across the United States, has increased 2-5x in the last five years.
2. Average revenue per car wash location has been on the decline as consumers have more options to choose from.
3. Operating expenses for taxes, insurance, labor, maintenance, management, etc, have consistently increased.
4. This average decrease in revenue combined with an increase in expenses has put substantial operational strain on operators resulting in increasing lease defaults, bankruptcies, a re-structure or complete pause of growth, or subleasing to other operators.
5. As the average consumer’s economic status decreases evidenced by an increase in credit card debt, home and auto mortgage rates increasing, student loan payments resuming in September and inflation, there is strong reason to believe that over the next 12-18 months, many consumers who get their car washed, specifically subscription members, will be making a financial decision to decrease frequency or eliminate their car wash subscription if faced with choosing between that and putting food in the refrigerator.

Growth and Saturation

In a testament to the ever-evolving nature of the business, certain markets across the United States especially major markets of Texas and Florida with dense cities and inexpensive land have witnessed a remarkable surge in the number of operating car washes over the past five years. The next five years show no signs of slowing down, as approximately 3.1 million square feet of car wash space are under construction across the U.S., according to CoStar Group.

The car wash industry, long considered a stable and mature sector, is now experiencing a renaissance of growth, with some areas reporting a 2-5x increase in the sheer volume of operating/new development car wash facilities. This unprecedented expansion has not only captured the attention of entrepreneurs and investors but has also left industry experts, private equity firms, and established groups indecisive about how much market share is left.

First Big Player to Admit Distress

Driven Brands, a major player in the car wash industry, has been rapidly expanding its network with the construction or acquisition of 400+ express locations in the last two years. However, this aggressive growth strategy has not come without challenges, as roughly one-third of their car washes now face competition from new entrants within a three-mile radius. In response to this competitive landscape, Driven Brands recently adjusted its 2023 revenue guidance, lowering it by $50 million. This move reflects the dynamic and competitive nature of the car wash market, highlighting the need for businesses to adapt to changing conditions and continue to innovate to maintain their market position.

In their Q3 earnings report, Driven Brands announced that they are closing 29 locations that haven’t even reached their third anniversary. They attribute this to sites that are 13+ years old, suboptimal real estate, significant competition in the area, and ALL performing in the red.

Even smaller regional operators like a brand called Swiftwater in San Antonio have gone completely belly-up recently, leaving 18 locations vacant or re-leased to local operators. Having now spoken with many of those owners who thought they purchased a long-term lease property – none of them show a clear path to recoup their initial investment.

Neighborhood Spot to Corporate Operation

When speaking with owner-operators who have stayed on after many of their local competitors exited the market during the private equity buyout boom, they consistently note an uptick in their volume. They attribute this growth to the fact that these major corporate acquisitions have transitioned what was once a well-managed small business into a more corporately-run service with less emphasis on customer experience and consistently have large turnovers, as shown by the number of openings on Indeed and other job sites. (Indeed.com)

Bonus Depreciation Phase-Out

Investors need to consult their CPAs to gain guidance on how the phase-out will affect their tax benefits as we enter 2024 and the acceleration moves from 80% to 60%. This will more than likely increase cap rates as the value of car washes will include fewer tax advantages as we approach 2027.

Zombie Customers

Zombie customers are individuals on an unlimited plan who seldom utilize their subscriptions. Some of these consumers might not even be aware of their membership, or they simply don’t make the most of it as originally expected when they signed up. It’s worth noting that these customers comprise 25-30% of most memberships, and if they were to suddenly disappear, it would be a cause for concern.

Rocket finance is experiencing rapid growth among consumers with disorganized finances. It’s coined as “The money app that works for you,” and its main features include tracking subscriptions, sending alerts when payments are nearing due dates, and monitoring your service usage. This, in combination with the expanding options for car washing locations, has presented challenges for owners in forecasting their memberships and achieving their goals.

A Decision Net Lease Owners Need to Make

Net lease owners must decide whether-or-not they are confident enough in their location and that their operator can sustain a profitable business while being subject to rental increases and rising operational costs. Owners need to look forward five to 20 years in the future – however long they plan to own their assets – and trust that their property will be just as successful with an increase in competition and expenses – all while the consumer may see a significant decline in personal purchasing power. The most important question is, do you want to be in this investment for the next five to ten years or would your equity be safer in a different net lease investment?

Caleb Jackson and Landan Dory handle net lease transactions at Partners Real Estate Company.