Parking Cash in Niche Properties
Parking properties offer investors diversification, steady income and a chance at handsome appreciat
By Mike Wilford
Robert Caplin is leading the advanced management seminar on parking facility funding at the Intertraffic NA/Parking Industry Exhibition in September in Baltimore.
We have all circled the same city block searching for the highly coveted and elusive legal parking space. In Chicago, and in many other cities, finding on-street parking in the central business district (CBD) can be a maddening proposition and virtual impossibility. But this dilemma also provides clues to the often-overlooked potential of parking properties as real estate investments. This under-followed, unloved and misunderstood niche real estate opportunity offers a host of advantages and potentially lucrative returns.
History of Private Ownership
The paid parking industry in Chicago has been pioneered and dominated by closely held private firms. Two of the most prominent players were the Prussian family and the Warshauer family, both of which are presently involved with large national owner/operators of paid parking facilities.
For many years, these family-run businesses controlled choice urban sites that were developed into surface lots and parking structures that could generate significant cash flow with minimal operating expense. There was little need to invest in technology or streamline operations. The garages served a basic need, and owners had no incentive to do anything more than minimal maintenance. As a result, the image of dark, dirty, uninviting and sometimes dangerous parking garages lingers today.
Parking properties are still largely in the realm of private entities, although not exclusively. With the exception of several large national parking companies -- most of which were formed through mergers or acquisitions of small private operators -- large institutional investors continue to shy away from parking properties as investments.
Many parking facilities are too small to be considered by the insurance companies and pension fund behemoths looking to place $100 million in marquee trophy assets. The lack of understanding among lenders, the absence of anchor tenants in most parking properties, and the nuances from the operating side of the business have conspired to keep these assets from becoming mainstream. Nevertheless, this has created opportunity for private investors and other entrepreneurial buyers looking to diversify into this niche.
Natural Barriers to Entry -- Good News for Investors
In Chicago, and in most metropolitan areas, certain macro trends and natural barriers to entry inherently limit competition. Consider the most obvious: the declining number of on- and off-street parking spaces.
In Chicago, the number of surface parking lots in the downtown West Loop, once a haven of inexpensive options for those willing to walk a few extra blocks, has begun to shrink. The new ABN Amro corporate headquarters at 540 West Madison St. is just one high-profile example of how new development is eliminating parking options in the CBD. Continued development of prime River North and GreekTown parcels is also steadily reducing parking options around town. Although the reduction in parking spaces signals more frustration and higher costs for consumers driving downtown, it also points to rising income streams for parking properties.
Zoning trends also provide a favorable backdrop. In Chicago, the re-write of the antiquated zoning code, in conjunction with the latest version of the Central Area Plan, is being designed to keep vehicular traffic to the perimeter of the Loop. It has now become difficult, both financially and politically, to build a new parking structure in the Loop. Mayor Richard M. Daley and city planners have no incentive to add inexpensive parking options that would increase traffic downtown. Parking rates are clearly headed higher, and this is good news for parking facility owners and investors.
Another key benefit for the parking asset investor is the ability to react to the market instantly. Parking contracts are usually of a short-term nature, often never trending out beyond 30 days, so any rate change will affect the owner's cash stream immediately. The nature of these parking contracts also mitigates risk. If the parking operator overestimates what customers are willing to pay, these rates can be quickly adjusted to find the right pricing structure. Fundamentally, the market for parking is a simple and visible function of supply and demand.
Constant Monitoring Required
As with any investment that offers upside potential, there are also significant challenges involved with parking properties. Financing purchases can be difficult, because many lenders do not fully understand the business. Unlike other asset classes, most parking properties cannot rely on anchor tenants to provide security in the traditional sense. The short-term nature of parking contracts also necessitates continual marketing and monitoring of the market. Are your rates competitive? Is your asset underused at certain periods? Either the owner or manager must be willing to be involved in day-to-day operations.
Another challenge comes from spiralling parking and real estate taxes, which typically are the largest expense items associated with these assets. Taxes can rise dramatically on short notice, and there are no pass-throughs as with retail properties. With municipalities everywhere facing budget shortfalls, it is unlikely that tax rates will decline any time soon.
Public works projects can also provide unforeseen disruptions in income. In Chicago, the Wacker Drive reconstruction over the past several years re-routed traffic numerous times and hampered operations at several parking properties. Scaffolding from private development projects can also obstruct signage and have a material impact on monthly receipts. Disruptive corporate events -- such as a relocation or bankruptcy -- are virtually impossible to account for in any risk analysis. And finally, one of the most notorious issues for parking lot investors is employee theft. These impediments have conspired to keep most conventional real estate investors away from parking properties.
A Virtual Annuity
But for those willing to address the challenges comes the potential for reward. In Chicago, where the macro trends favor ownership and the diversified economy provides a viable draw to the Loop, the downside is limited. Owners willing to reinvest in aging properties and streamline operations can reap further gains.
Buying an underused parking asset in a high-density neighborhood is an excellent option for diversifying any commercial real estate portfolio. With a sound strategy, these properties can generate annuity-like cash flow. They also offer a natural hedge against inflation, considering that parking rates in Chicago have increased about 7 percent annually over the past decade. Total returns on paid parking investments can be significant, even with today's cap rates at about 7 percent.
Given the current low interest rate environment, the natural barriers to entry and the attractive yields, these properties are an excellent place to park money while investors wait for alternative land use. Furthermore, this natural income play also offers potential above-average returns as land values rise and redevelopment of the site becomes a viable option. When the development cycle turns and builders consider options, they call owners of parking garages first.
From Underused to Profitable
A classic example is the Bismark Parking Garage, located at the northwest corner of Randolph and Wells streets in the heart of the Loop. Situated one block from City Hall and the State of Illinois Building and across the street from the Cadillac Palace Theater, the facility's ability to attract tenants at peak and off-peak hours is one of its inherent strengths. Nevertheless, the investment was not without its challenges. Over 15 months, we committed about $500,000 to repair the neglected property and implement a variety of operating improvements. Chief among these was the installation of pay-on-foot machines to convert the property from a cashier-operated facility to one of total automation. This transition to pay-on-foot technology not only improved customers' exit times by about 50 percent, but also eliminated shrinkage. Capturing a huge amount of data on usage is a byproduct of the pay-on-foot technology and will be used to further analyze and improve operations.
Another major component of the asset strategy was rehabilitating the physical structure, including extensive concrete repairs, painting the interior to brighten and color-code the floors, and installing new signage. Maximizing use of the 4,000-square-foot ground-floor retail space, which is traditionally underutilized in older parking facilities, was also a priority. The previous tenant, a poor fit for the neighborhood, was bought out and replaced with Washington Mutual.
The return on investment has been dramatic. The renovated Bismark Parking Garage is now open 24 hours a day. Its improved functionality has resulted in significantly higher monthly revenues, particularly from evening and off-peak hours. Lower labor costs, the elimination of theft and additional retail income have contributed to the improved performance.
Robert M. Caplin is a Principal with Next Realty. He can be reached at firstname.lastname@example.org.
Article Abstract from August, 2005