Opportunities Exist in Parking Despite Economy’s Challenges
By Robert M. Caplin
The upheaval in the credit markets has made investing in parking facilities increasingly more challenging in 2008, just as it has in virtually every other segment of commercial real estate. The changes in the marketplace are manifested as more stringent lending and underwriting criteria; significant disparity between bid and ask pricing; lower LTV requiring significantly greater equity participation; and for acquisitions that move to closing, a higher cost of funds.
In spite of these conditions and the rapidly evolving economic outlook that is as volatile as the stock market, the parking industry presents more than its fair share of opportunities. This is in stark contrast to a variety of other asset classes.
A number of factors and market characteristics allow us to be more optimistic about the short- and long-term economic viability of well-located parking facilities.
Perhaps most important, parking facilities are more than simply the “bricks and mortar” that characterize other property types. A unique and interesting real estate niche, parking operations are hybrids: operating businesses that produce cash flow on a daily basis housed within a real estate asset.
For example, when you invest in an office building with consistently high occupancy levels, there are limited opportunities to increase revenues. The business plan is based on tenant retention and planning for future scheduled lease expirations.
Parking garages are businesses in the traditional sense, rewarding focused management with the ability to impact operations and profitability every day. However, they provide the astute owner or manager with numerous avenues for revenue enhancement by constantly reacting to the market.
Ownership of a parking facility, particularly in downtown markets or adjacent to airports, represents the control of a prime, well-located urban land site. Historically, the parking supply in a healthy central business district is a diminishing commodity, reflecting numerous barriers to entry. This translates into increased opportunity for the remaining properties.
Some cities across the country have restricted construction of any new parking facilities to perimeter locations unless they are “grandfathered” redevelopments, replacing an obsolete facility, or are incorporated within a significant new commercial or residential development.
Other cities may be less direct in their approach to limiting garage construction by creating incentives to encourage more commuters to utilize public transportation. One such method being considered is a congestion tax, applying a surcharge or tax on parking in heavily traveled, congested areas such as central business districts in Chicago, Philadelphia, San Francisco and Boston, among others.
Despite these obstacles, parking has exhibited a certain resiliency not found in other segments of the industry.
When a major office building, for example, loses an anchor tenant, there is an immediate and significant economic impact. It takes a comprehensive modernization program and months of marketing to identify and secure a new tenant. There are additional financial considerations, including lease concessions, tenant improvements, broker commissions and legal costs, related to the lease, all of which require a significant outlay of capital.
Parking facilities tend to be buffered from these sudden changes in the marketplace. Certainly, when a neighboring building loses a significant tenant, there will be a residual impact on surrounding businesses. However, parking-based assets do not face the same costs related to re-tenanting; there are no building improvements to consider, no lawyers involved, and no dependence on the brokerage community to deliver potential users, eliminating commissions. Backfilling empty spaces can be accomplished through an aggressive, targeted, internally driven marketing campaign.
Like any real estate asset class, the financial picture that has evolved throughout much of 2008 has changed acquisition underwriting.
Acknowledging the fluidity of the current debt market as of this printing, an acquisition that would have required 20% to 25% equity participation in early 2008 now requires a 35% to 40% commitment.
Additionally, the cost of this debt has increased significantly. Early this year, debt was available below 6%, often with several years of interest-only payments. Today, quotes are closer to 8%, often with no interest-only period.
This is not because parking garages are perceived as a riskier investment opportunity today than before. It is reflective of the cautious outlook of those lenders who are still active. The increased cost of money impacts the underlying value of assets, which can be reflected in appraisal valuations. This often results in additional reductions in total loan proceeds leading to additional increases to the equity required to close.
In this challenging environment, there are still opportunities for the perceptive buyer. These potential acquisitions are more difficult and time-consuming to complete than in the past, and maintaining a disciplined investment strategy is essential.
To the industry’s credit, we have not seen many distressed sales in the parking world to this point. The profile of a parking facility buyer tends to be different than for other asset classes. Parking buyers are not generally high-leverage buyers. As the financial situation continues to evolve, it is possible there may be greater numbers of distressed sales. The effect on portfolio assets will be specific to market and location.
As long as people have a reason to drive downtown, they will need to park. Traffic levels will depend on how much the consumer (the driving public) is willing to alter his habits. If the price of a gallon of gas surges beyond $3 or $4 a gallon, we are likely to see more people gravitate toward public transportation options and test those alternatives. For some, it will be an easy transition. There is a large segment, however, for whom flexibility and control prevail and keep them back on highways and in parking garages.
Other operational impacts will include how improvement dollars are allocated. Non-essential cosmetic changes to a property may be deferred if they don’t immediately translate into maintaining or improving cash flows.
For example, pay-on-foot conversions may increase as owners look to automation to improve cash from operations. For some owners, this can represent a significant capital expense. But even if parking occupancy goes down in the near term, the long-term savings and potential for income growth may be substantial enough to justify the expense of installing automated systems.
Finally, buyers will need to be both disciplined and creative. Sellers have different motivations and needs. Understanding and addressing these issues, particularly in a challenging economic environment, can mean the difference between losing out on an opportunity or making a solid acquisition.
Robert M. Caplin is Principal of Next Parking, a division of Chicago-based Next Realty. He can be reached at firstname.lastname@example.org.
Article Abstract from December, 2008