Bonus Depreciation

Client: Technology Entrepreneur

Transaction: Acquisition

Granite Capital was approached by a client who incurred a five-million-dollar gain on the sale of a speculative real estate holding. The client’s primary objective was deferring the gain. The secondary objective was to provide cash flow with little management needed in a lower-risk asset. A 1031 exchange was not viable to defer paying taxes on the gain. Engaged in the latter part of the year, the Granite team had a tight window to devise and execute a strategy. Understanding the client’s risk profile, short-term objectives, and long-term objectives, Granite narrowed down the options to real estate that allowed for a significant amount of the purchase price to be written off in the first year using bonus depreciation rules. Granite recommended the client purchase one or two institutional, long-term, NNN express car washes. 

Due to the equipment-intensive nature of express car washes, approximately 90% of the purchase price was eligible for depreciation in Year One. Additionally, express car washes operate on a subscription-based model, offering more predictable and consistent cash flow. In terms of operating margins, the business is mostly automated and self-serve for customers, so labor is minimal – operating margins are high. Through its network, Granite identified two high-quality, well-located car washes with experienced operators and closed on both before year end. To streamline the transaction and allow for greater execution speed, the properties were acquired with cash and refinanced several months later. The properties have absolute, NNN leases with 20-year initial terms and four options to extend the lease for successive 5-year terms. The rental rates increase by 1.0% each year during the initial term.

Services Rendered:

• Assessing real estate asset classes for depreciation potential

• Sourcing properties

• Underwriting/Analyzing properties

• Property touring

• Broker engagement

• Letter of Intent creation

• Purchase and Sale Agreement negotiation

• Performance of due diligence

• Debt sourcing, analysis, and recommendation

• Escrow management

• Cost segregation management

• Asset management

Summary: $5M Gain to Offset with Tight Timeline

Car Wash 1:

Purchase Price: $4,775,000

Equity: $1,767,000

Year One Depreciation: $3,820,000

Cash Flow plus Principal (Yr. 1): $215,727

Free Cash Flow (Yr. 1): $156,306

Cash-on-Cash Return (Yr. 1): 8.9%

Car Wash 2:

Purchase Price: $4,665,000

Equity: $1,665,000

Year One Depreciation: $3,732,000

Cash Flow plus Principal (Yr. 1): $207,000

Free Cash Flow (Yr. 1): $147,741

Cash-on-Cash Return (Yr. 1): 8.9%

Frequently Asked Questions:

• What is an Express Car Wash?

  An express car wash is commonly defined as a mostly automated car wash that utilizes a conveyor belt system with substantial equipment to transport and wash a vehicle through a tunnel.

• What are the possible benefits of owning an Express Car Wash?

  • Tax-efficiencies via bonus depreciation (IRC §168(k) amended by the Tax Cuts and Jobs Act of 2017) – 100% of the improvements can typically be expensed in the first year of ownership through bonus depreciation using a cost segregation study. This can translate to 70% to 90% of the purchase price being expensed in Year One depending on the location. The phaseout of bonus depreciation will likely begin in 2023 and continue each year where the maximum amount of expensing in Year One will decrease in 20% increments each year until reaching zero. For example:

    • 2022 – 100% bonus depreciation

    • 2023 – 80% bonus depreciation

    • 2024 – 60% bonus deprceciation

  • Consistent and predictable cash flow

  • Little to no management ("Mailbox Money")

  • Express car washes typically have absolute, triple-net leases

    • An absolute, triple-net lease is defined as a lease where the tenant pays the landlord monthly rent and is responsible for all expenses of the property (utilities, property taxes, insurance, maintenance, repairs, etc.).

• Can you provide some examples of who might benefit from purchasing an express car wash? Please consult your tax accountant to see if you qualify.

  • A business owner selling their business for a large gain with a spouse who qualifies as a real estate professional

  • A real estate professional with a substantial gain

  • A married couple with substantial ordinary income where one individual qualifies as a real estate professional

    • i.e. Doctor with a spouse who is a real estate professional

    Note: These situations typically involve an individual who qualifies as a real estate professional or an individual with a spouse who qualifies as a real estate professional as defined by the IRS.

• How much do express car washes typically cost?

  $4,000,000 to $8,000,000

• What are current market capitalization rates (net operating income divided by purchase price) for express car washes, and why do they vary?

  • Current market cap rates vary from 4.50% to 6.50%

  • There are several factors that can affect cap rates: experience of operator (tenant), number of locations, macro and micro geographic location (population density, median household income, vehicles per day passing the location)

• How would you define a strong operator/tenant?

  We would define a strong operator as a company with at least 50 locations, steady growth in location count (not rapid growth in the previous 12 months), an executive team with long-term experience in the car wash industry, and a significant financial backing (usually a private equity group)

• What can be some challenges in purchasing an express car wash?

  • Financing

    • Express car washes usually fall into the specialty retail bucket for most lenders. From a lender’s perspective, specialty retail is often a riskier real estate asset because if the operator vacates the location, the only type of tenant who can fill the vacancy is another car wash.

  • Your personal bandwidth and real estate expertise (time, energy, money, knowledge)

  • Performing due diligence: coordinating and reviewing third-party reports, negotiating lease terms, traveling to the site, touring the market, etc.

  • Strong demand for premium locations with experienced operators (getting your foot in the door)

  • Convincing a seller or operator that you are experienced in real estate transactions and that you can provide a high degree of certainty that you will be able to complete the transaction

• How can someone overcome the challenges?

  • Having the ability to close all cash

  • You can usually get financing after you purchase the property (depending on your banking relationships, the strength of the location, strength of the operator)

  • Working with advisory groups who have strong reputations and experience to source/analyze properties, negotiate on your behalf, use their reputation, provide off market opportunities, and lead the transaction through close of escrow