Four- star solutions

As petrol margins have been squeezed and forecourt retailing has been stepped up, the business of valuing filling stations has become vastly more complex. And it wasn't easy in the first place. By Adrian Camps

Imagine the scenario: you are instructed to carry Out a rent review on an office block or warehouse -no problem. It is within your expertise, and there is some comparable information so far so good.

There is, however, a difficulty: you can inspect the property, but you are not allowed to measure it. You have to estimate the floor area, based on your perception of the property and negotiate it with the opposing surveyor. As an added complication, the floor areas for some of your comparables will be assessed on a similar basis, and you will not be certain of the floor area used when the transaction was agreed. Sounds like a nightmare? Actually, it is a familiar problem for surveyors negotiating ground rent reviews on petrol stations.

It is often not appropriate to supply fuel-throughput figures for sites when negotiating ground rent reviews, which assume a "cleared site" approach. The reasoning is that if the site were cleared and available to let with planning consent, the acquiring party, possibly an oil company, would have to make their own assessment of the likely site performance, and make their rental bid accordingly.

The assessment of a site's performance is complex and requires a traffic count and competitor analysis. The "turn-in ratio" - namely the proportion of vehicles that actually enter the site - is then assessed. Often this lies between 25-4% of the traffic volume, but depends on the road type (single or dual carriageway), the amount and nature of the competition and the location (rural, transient or urban). The positioning of the access and general convenience of the site to motorists also have effects.

In exceptional circumstances, the turn-in ratio can be higher. Normally, one assumes a 25-litre (5.5 gallons) purchase and therefore a typical site assessment might be, for example:

Traffic volume of 14,500 vehicles per day x 365 days x 25 litres x 3% = 3.97m litres.

Problems with comparables

In this recessive market, there has been little acquisition activity, resulting in a dearth of rental and capital evidence. Some transactions have clearly been the result of oil companies "buying volume" in an attempt to dilute fixed costs, while other acquisitions are not always what they seem the problem being demonstrated as follows.

Suppose a major oil company takes a lease on a site formerly run by a more minor brand that was achieving 5m litres pa The major company will probably predict a likely increase in volume of, say, 15% to reflect "brand loyalty", customer reward schemes, and general site re-imaging. If they acquire the site for 80,000 pa as a rack rent, will the site assessment analysis suggest 1.6p per litre (80,000 5rn litres) or 1.4p per litre (80,000 by 5.75m litres)?

Oil companies rarely publicise their volume predictions for a Site, so often the "incorrect" analysis is used, based on the volume before the takeover. The analysis problem is further compounded by the performance of the shop and car-wash, particularly in rack rent situations. If the shop was turning over, say, 250,000 pa (excluding VAT)

before acquisition, a refit and proper merchandising introduced by the oil company may well increase the turnover to, say, 350,000. In the first instance, if the shop was assessed on turnover, the sum may be 250,000 x 20% to gross profit x 20% to rent = 10,000. If the acquiring oil company predicted an increase to 350,000, then the rent attributable to the shop could be 14,000 on the same basis. Clearly, in the case of a rack rent, if the shop rent ofl0,000 pa is included

in the 80,000 rent in the first example, the rent per gallon will fall to 1.4p per litre or 1.2p per litre if the projected fuel turnover is used. Using the projected shop turnover, the figures would be I .232p per litre or 1. l5p per litre. This example therefore produces a differential of 16% either way from the average. The situation can be complicated further by the inclusion of roll-over and jet car washes.

Adding fast food outlets and bakeries to forecourt shops makes filling stations more valuable

State of the market

There has been a dramatic decline in the number of forecourts, from 20,641 in 1986 to 14,824 at the end of 1997, a loss of 28% in nine years. This decline is even more significant when viewed against the increase in hypermarket forecourts included in the figures.

At the end of 1990 there were 434 hypermarket sites and by the end of 1997 this had risen to 934. Between 1990 and the beginning of 1998 the hypermarkets share of the fuel retail market grew from 5% to around 23%. The recent fall in the price of oil has temporarily improved margins on forecourts, but for much of the last five years the petrol industry has experienced drastically reduced and sometimes negative margins on fuel sales. This period commenced in the early 1990s with the growth of hypermarket petrol sites, which introduced large-scale discounting. The oil companies started to lose market share and BP was one of the first to respond in October l994 with Dr Rolf Stomberg announcing that BP was "taking on the hypermarkets" by introducing competitive pricing enabled by "greatly reduced costs".

Esso followed suit with Pricewatch, which went nationwide in January 1996. It promised to check hypermarket fuel prices within a 3 mile radius of Esso sites, and competing petrol stations within a 1 mile radius, and "be among the lowest in the area". Shell introduced its own scheme and the result of this price war has been the closure of many sites, mainly occupied by dealers and small oil companies. Even the large oil companies have been involved in mergers or cost-cutting exercises to survive: hence

TENANT'S IMPROVEMENTS

VALUES DEPEND ON THROUGHPUT

Rack rent reviews are often more straightforward than ground rent reviews because site trading information is often available. Problems arise, however, because of the frequency of site redevelopment. Unlike office or warehouse buildings, which are unlikely to experience tenant's improvements beyond partitioning or air-conditioning, few oil companies will have sites older than 15 years which have not been redeveloped or substantially improved. Most leases have the normal disregards relating to tenant's improvements and, although it is relatively easy to assess the change in value by increasing the size of the shop, it is far more difficult to determine how a forecourt redevelopment affects fuel throughput.

A "three pumps in line" forecourt with attended service and limited tankage, redeveloped to a modem configuration with an increased number of self-service pumps and a canopy, could have a dramatic effect. Often the lease directs us to disregard the rental value of such improvements, so it is necessary to assess the site potential in its unimproved state. This is difficult, can cause considerable argument and often results in valuers agreeing to treat such reviews as ground rent reviews. (The reasoning being that a tenant acquiring such a site would probably carry out an immediate redevelopment.)

The costs of running a petrol station vary little, whether sales are running at 2.5m or 5m litres, so rents tend to rise in a more than proportional rate compared with volume.

Values and rent are also dependent on the site's attractiveness to an oil company. Few major oil companies would purchase or rent a site with a throughput potential of less than 5m litres, although some may agree to supply it as a dealer site. The other factor having a bearing on the value, apart from the site's facilities, is the margin on fuel sales which the site can achieve. A site selling fuel at the current discounted price of 64.9p per litre will clearly be less profitable than a site in an area of little price competition which can maintain a price of, say, 69.9p per litre. As indicated above, there are many regional variations in pricing and therefore margin.

There will be a difference in value between "tied" sites and those free of tie, depending on the terms of the supply agreement. The margin provided for in the supply agreement will be affected by the supplying oil company's pricing policy in the area. The retailer benefits where the supplying oil company has a policy of supporting the price at the site, at its own cost, to keep the site competitive with those in the locality. Without such a policy, the retailer will either be forced to forgo margin to adjust his fuel prices to remain competitive or experience a fall in fuel throughput

the BP/Mobil merger; talks between Gulf Elf and Marco; and Shell's acquisition of Gulf and negotiations with Texaco.

Between February 1990 and early February 1998 real gross fuel margins have fallen by about one-third. The real price of fuel dropped by 34,7% for unleaded and 3 2.8% for leaded fuel. These figures exclude VAT and duty, and make an adjustment for inflation. It should be appreciated that there are regional variations in fuel pricing and the data in the chart on the previous page is based on a national average Margins in some areas may therefore be lower.

Profitability enhancement

Many operators have sought to maximise the potential of existing shop facilities by entering into agreements with supermarket operators or suppliers such as Alldays, Budgen Londis and Spar. They benefit from the associated buying power, logistics network and merchandising skills. Other companies have taken the bolder step of forming joint ventures with supermarket operators, and are redeveloping sites to provide 300m2 (3,230 sq ft) shops and associated facilities. Examples of such agreements are BP/Safeway and Esso/Tesco.

Large convenience stores are often successful where there is an extensive residential area surrounding the site and a lack of good-quality existing facilities. In certain areas, these units are subject to considerable loss from shoplifting, and the

large stores operated on a 24-hour basis require very high staffing levels, which reduces profitability.

The overall margin of an average forecourt shop may be about 20% or 25%, excluding tobacco goods. As the shop becomes bigger, more low-profit items are stocked and the pricing becomes keener, thus reducing the overall margin closer to supermarket levels. Other facilities which are being used to beef up profitability are:
Off-licences
Dry cleaners
Fast food outlets and bakeries
Car washes
Cash dispensers
Business and fax facilities
National Lottery and Electric company concessions
Nozzle advertising
Forecourt video advertising
Bulk oil dispensers

The ability to gain an off-licence varies considerably from area to area, but, when correctly located, such facilities are very profitable.

We are now seeing takeaway food facilities in forecourt buildings across the country; these range from Burger King and McDonald's, to Dunkin Donuts and pizza. While some sites work well, others are not always so successful because of staffing costs, wastage and a relatively high initial investment. Success depends on selecting the right location for the right product.

Car washes can still add significantly to the profitability of a site, if they are in the correct location. Highly populated urban areas with the correct demographic profile are preferable. The market is reaching saturation in some areas, resulting in lower wash prices and reduced profitability.

Conclusion

Petrol station operators are breathing a sigh of relief because - temporarily -the low oil price has returned margin to the forecourt. However, most operators see this as only a brief respite, and feel sure that the number of sites will be reduced still further.

This site-closure programme will be especially concentrated in rural areas, unless government or oil company assistance is made available. In every area, site operators will continue to move towards additional profit centres to secure long-term profitability.

Adrian Camps FRICS lRRV M lnst Pet is a consultant with Turner Morum Roadside and principal of AMC Petroleum Consultants, based in London