Gas Station/C-Store Going-Concern Valuation PRESENTED TO Appraisal Institute Annual Meeting Sheraton July 27 - 29, 2015 Dallas, Texas PRESENTED BY Stephen

Gas Station/C-Store Going-Concern Valuation

PRESENTED TO

Appraisal Institute Annual Meeting

Sheraton

July 27 - 29, 2015

Dallas, Texas

PRESENTED BY

Stephen J. Morse

Founder, Chief Appraiser

Retail Petroleum Consultants LLC

4464 McGrath Street, Unit 117

Ventura, California 93001

805.815.4350 Office

805.669.3939 Fax

E-Mail: [email protected]

Always Accurate, Always on Time

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INTRODUCTION

Founded by Stephen J. Morse in 2002, Retail Petroleum Consultants, Inc. (RPC) has provided a wide array of appraisal, litigation, and related consulted services to the petroleum and financing industry. RPC has appraised over 3,000 service stations, car washes, and convenience stores (c-stores) in California alone. RPC also provides appraisal services in Arizona, Hawaii, Oregon, Washington, and Nevada and plans to target the entire U.S. This volume of work has created an extensive cost, sales, and operational data base allowing RPC to provide timely comparable based appraisals and expert consultation for petroleum related properties.

Specializing in going-concern valuations, we offer a complete line of real estate and business analyses including appraisals, market studies, litigation support, feasibility, and volume projections for the following property types;

Gas Stations/C-Stores & QSRs,

Car Washes/Quick Lubes

Truck Stops/Travel Centers

Alternative Fueling Stations

Stephen J. Morse is a certified general real estate appraiser licensed in Washington, Arizona, and California. Ask about our quick turn times and going-concern appraisals with allocation of real estate, business, and M & E. We offer dependable service to a wide variety of clients including lending institutions, attorneys, oil companies, and individual operators. Please visit our website at gasvaluation.com.

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Gas Station/C-Store Going-Concern ValuationAPPRAISING GAS STATION/C-STORES

Appraising a gas station and c-store as a going-concern is a complex assignment. Identifying whether or not the cash flow from business operations is sufficient to cover not only the real estate assets, but the cost to assemble the labor, brand, operation agreements, vendors, etc., can be a difficult task best suited for a service station specialist. Separation of tangible and intangible assets as required by most lenders can be difficult for appraisers not experienced with going-concern valuation and special use properties like service stations.

When appraising an operating service station as a going-concern the typical price per square foot analysis of building or site area may not be the most appropriate means of valuation. Such an analysis may be appropriate in the Cost Approach for estimating underlying land value, it is not considered appropriate when appraising an operating gas station as buyers/sellers generally rely on sales volume, gallons sold, and profit, and less on the size of the building or lot. The following bullet points highlight some important considerations often overlooked when estimating and allocating a service station going-concern value.

•Identify type of station and ownership interest•Analyze Financial Ratios and Profit Multipliers, and rely less on physical units of comparison such as Square Feet or Number of Dispensers.•Prove that the Going–Concern is sufficient to support the concluded value for the Real Estate and any FF & E.•Use like kind leased fee, leasehold, or fee simple sales for extracting rates and related units of comparison. •Consider the affect of “Fuel Supply Contracts”, “Forgivable Loans”, related Rebates and/or Incentives, Franchise Fees, etc. •The risks associated with the business may be different than those associated with the real estate and/or FF & E. Appraisers should be careful not to use real estate capitalization rates to estimate going-concern or business only values.•Allocations made by buyers and sellers are often Tax, Financing, or Depreciation driven and may not be appropriate in a Market Value Appraisal.•Allocate Going-Concern value to Real Estate, Personal Property and/or FF & E, and business per USPAP.

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Gas Station/C-Store Going-Concern ValuationGAS STATION/C-STORE OWNERSHIP

Fee Simple

Ownership unencumbered by lease, often referred to as owner occupied. Dealer or operator owns all components of the going-concern including land, buildings, removable and permanently attached Machinery and Equipment (M & E), and business and or intangibles. Historical Profit and Loss statements including fuel gallons sold and fuel supply agreement are critical for a credible valuation. Lenders will typically underwrite real estate and a portion if not all M & E. Business value if applicable may be underwritten separately.

Leased Fee

Service station is leased arms-length with the real estate owner or landlord receiving rental payments for land and buildings. Fueling improvements may also be included. Tenant owned business and removable M & E items are excluded from valuation. Tenant credit rating and lease terms are necessary for a credible valuation. Lenders will underwrite leased real property assets. Short lease terms and poor tenant credit rating may impact valuation.

Leasehold

Also referred to as a business only valuation. Business cash flow and lease terms are necessary for a credible valuation. Landlord may be Major Oil Company or individual. Major Oil Companies must abide by PMPA (Petroleum Marketers Practices Act) whereby leases are renewed at market rates into perpetuity with tenant having first right of refusal. Lenders underwrite tenant’s business cash flow. Short lease terms between individuals that are not Major Oil Companies present unique challenges.

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Gas Station/C-Store Going-Concern ValuationINFORMATION REQUEST LIST

1.Copy of any leases encumbering the subject, including any renewals, amendments and exhibits. These may include ground leases, QSR leases, service bay lease, etc.

2.Individual store contacts (to schedule inspections)

3.Detailed Profit and Loss statements for the past three years plus current year-to-date statements

4.Future sales projections and/or budget

5.Fuel Supply Contract, Volume Incentive Plans, Rebates, Forgivable Loans, or any related dealer-supplier agreements

6.Copy of current tax bills (both secured and unsecured) and details of any tax appeals in progress

7.Details and costs of any recent capital improvements completed or proposed (i.e.; roof repair, parking lot resurfacing, etc.).

8.Approximate year building(s) was constructed. Year of any addition or major renovation (i.e. new roof, exterior remodeling, asphalt paving, replacement of major mechanical systems)

9.Fueling Equipment Information- Pumps, Dispensers, USTs, etc., Date installed, manufacturer, type, size, etc.

10.Any previous appraisals or market studies

11.Historical Fuel sales volumes, past three years on an annual basis, and trailing 12 months or year to date, # of car washes annually

12.Construction details and costs - necessary for newly constructed or proposed projects, not required for older properties

13.Site and building plans, ALTA survey (if available)

14.Title report

15.List all ownership changes in the last three years, both real estate and/or business.

16.If the facility is being acquired, or is currently under contract, please include a copy of that contract which includes all terms and conditions of the transaction, listing package if property is for sale, sales information if property recently sold, land acquisition information if relevant (new construction)

17.Please identify any known environmental issues or remediation, responsible parties, etc.

18.A schedule of any furniture, fixtures, and equipment to be included. Please provide date acquired, cost, manufacturer and model number and book value if available.

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GAS STATION/C-STORE VALUATION

Fee Simple (Going-Concern Valuation)

Going-Concern cash flow converted to value factoring gross profit by a GPM (Gross Profit Multiplier) or applying an OAR (Overall Capitalization Rate) to NOI (Net Operating Income). Average GPMs for modern urban located service stations generally range between 3.00 and 5.00. Average OARs are generally between 8.00% and 12.00%. Cost Approach used to allocate going-concern assets by residual technique; if residual is positive business value is present, if negative no business value is realized and the subject may suffer from functional and or external obsolescence.

Gross Profit X GPM = $ Going-Concern Value

NOI ÷ OAR = $ Going-Concern Value

Going-Concern Value - Cost Approach = $ Business Value (Functional/External Obsolescence)

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GAS STATION/C-STORE VALUATION (Continued)

Leased Fee (Real Estate Only Valuation)

Annual income received from tenant (rent) less expenses is converted to value by dividing net income by an OAR. Long term triple net (NNN) leases of improved real estate to National credit rated tenants such as Chevron or Shell trade for the lowest risk supporting OARs generally between 5.00% to 7.00% as these tenants will pay rent regardless of whether or not the service station cash flows.

Leases to individual dealers that are not credit rated have much greater risk and support higher OARs at 7.00% to 10.00% or more depending on the perceived spread between tenant’s annual cash flow and rental payments.

Lease terms, environmental and maintenance responsibilities, removal of improvement(s) and or USTs (Underground Storage Tanks) at lease termination, branding, age and condition, etc. also effect OAR selection. Leased fee value is arrived at by dividing net annual rental income by the selected OAR.

Net Annual Rental Income ÷ OAR = $ Leased Fee Value

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GAS STATION/C-STORE VALUATION (Continued)

Leasehold (Business Only Valuation)

Tenant’s annual business income less expenses is converted to value by dividing NOI by an OAR. Additionally, a DCF (Discounted Cash Flow Analysis) may be employed, especially if the lease is short term. Lease terms have the greatest effect on OARs. A long-term lease that is below market with no tenant responsibilities at termination creates the least amount of risk to the business owner and lower OARs. Conversely, a short-term lease that is above market with tenant responsibilities at lease termination creates significant risk and higher OARs. Landlord’s such as Major Oil Companies must abide by the PMPA (Petroleum Marketers Practices Act) giving tenants renewal leases at market rates and first right of refusal should the leased asset(s) be sold.

OARs for business only transactions are typically higher than leased fee or fee simple OARs beginning near 12.00% and can go as high as 30.00% or more.

NOI (Business Income) ÷ OAR = $ Leasehold Value

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Gas Station/C-Store Going-Concern ValuationAnalyzing Financial Statements

•Preferably 3 complete years of detailed annual P & L Statements•Tax returns are of little use and should only be considered as a last resort•Avoid annualizing due to seasonality and inventory (fuel) fluctuations•Adjust for add backs (depreciation, amortization, interest, rent, etc.)•Be consistent with comparables and subject•Fuel taxes as COGS (Arco AM/PM)•Credit card fees as Operating Expense (NACS)•UST fees as Operating Expense

General Rules of Thumb

•C-Store Gross Profit 30% to 35%•Fuel Margins vary greatly and are at all time highs in California $0.15 to $0.30 Plus•QSR (Quick Serve Restaurants) and Repair gross profit including labor 40% to 60%•Small Automatic Car Washes gross profit 85% to 95%•Operating Expense as % of Gross profit 50% to 70%

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Going-Concern Sale Comparables


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Valuation

Value Allocation

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Alternative Fueling

•Ethanol (Fermented Crops)•Natural Gas (CNG and LNG)•Electricity•Hydrogen (Fuel Cell)•Propane (LPG)•Biodiesel (Recycled vegetable oils and animal fats)•Methanol (M85)

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• CNG (Compressed Natural Gas)• LNG (Liquefied Natural Gas)• DGE (Diesel Gallon Equivalent)• GGE (Gasoline Gallon Equivalent)• NGV (Natural Gas Vehicles)• ASTs (Aboveground Storage Tanks)• USTs (Belowground Storage Tanks)• SCF (Standard Cubic Feet)• RNG (Renewable Natural Gas)

Strong potential for transition of diesel to CNG/LNG. Ratio of gasoline autos to NGVs is about 1,100 to 1 although many manufacturers produce NGVs with Honda in the lead with its Civic GX.

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Gas Station/C-Store Going-Concern ValuationPros of CNG/LNG•Abundant source of US natural gas•No refining Necessary•Pipeline infrastructure already in place•Reduces harmful emissions•Safer tank storage on vehicles•Stable pricing compared to oil•Lower maintenance costs due to clean burn

Cons of CNG/LNG•Larger storage tank size•Expensive to build/convert•Limited driving range•Limited number of CNG/LNG fueling stations•Non renewable and still considered a fossil fuel•Fracking (water pollution, earthquakes, etc.)•Emits carbon dioxide when burned•Stored under high pressures

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Compressed Natural Gas

SBA’s Recent Changes to Standards of Operating Procedures

“Clean” Versus Contaminated Gas Stations

The above articles can be found on our websitewww.gasvaluation.com

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Compressed Natural Gas: The Cost-Effective and Abundant Alternative of Today

Insight into America’s Shift towards a More Sustainable Fuel Alternative

July 2015RPC Monthly Article

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Retail Petroleum Consultants (RPC) specializes in complex valuations of gas station properties throughout the United States. A shift is evident as new alternative fuels become more readily available and accepted by the general public. One of those fuels with promising potential is CNG. Its clear to see increased use, production, and transition towards this fuel source over the past several decades based on the EIA (Energy Information Agency) chart below.

Source: U.S. Energy Information Administration, Monthly Energy ReviewCNG Market

CNG and LNG stand for Compressed Natural Gas and Liquefied Natural Gas respectively. Natural gas is a clean-burning alternative fuel, which has become increasingly popular for use in private, commercial, and public transportation vehicles, due to its lower emissions and cost, compared to conventional fuels. With improved technology, it will be possible to have fewer emissions than what power plants produce to power electric vehicles at the same rate. Engines tend to run quieter than their diesel equivalents with similar efficiency. CNG is significantly less expensive than gasoline or diesel. It remains one of the cheapest ways to power vehicles and machinery at about half the price of gasoline. It is also one of the most abundant fuel sources available, especially in the US where natural gas represents 26% of its total energy sources. Unlike petroleum based fuels that are expensive to extract and refine, natural gas has much lower extracting costs and no refining. LNG is more expensive than CNG as it must be cooled for storage but is more readily available than CNG since it does not require pipelines for delivery and transport. According to the United States Department of Energy, natural gas accounts for roughly 25% of the energy consumed in the United States with some exports, especially to Mexico. About one-tenth of 1% is being used to power vehicles. The California Natural Gas Vehicle Coalition counts over 170 public-access natural gas stations in this state alone with an increasing trend.Compressed natural gas (CNG) is natural gas that is stored under pressure, at over 3,100 pounds per square inch. Although CNG does not contain lead and the maintenance costs for CNG vehicles is reportedly lower than hydrocarbon-fuel-powered vehicles, CNG requires a greater amount of space to store than conventional fuels since it is compressed gas and not a liquid. 23

This affects fuel storage on vehicles as well as at distribution facilities. This has been the primary hurdle for use in on road trucking where conventional diesel trucks have ranges of 1,000 miles or more based on 4 MPG and tank sizes of approximately 400 gallons (duel tanks of 200 or more gallons per side). Liquefied Natural Gas (LNG) eliminates some of the fuel storage capacity issues with more efficient storage than CNG. Residual gasses or “boil off” of LNG can be compressed and be stored as CNG. However, there is more risk with LNG given its more volatile nature. CNGStations.com states on their website that there are close to 120,000 NGVs (Natural Gas Vehicles) in the United States; the most of them consisting of trucks and municipal vehicles. Altogether, there are about 10 million natural gas powered vehicles in the world with a significant amount of vehicles in China. To cater for this need, it is estimated that there are only about 14,500 alternative fueling stations in the US with well over 700 CNG fueling stations on a national scale, including non-public stations increases these figures significantly. Only about half of these stations are made open to the public. In contrast, there are more than 125,000 gasoline stations in the US. Many vehicle owners are reluctant to switch to CNG as an alternative fuel because of the difficulty to refuel if they drive to locations that are not equipped with CNG stations. Furthermore, EPA (Environmental Protection Agency) and the California Air Resources Board (CARB) have strict certification and compliance requirements further complicating CNG fueling. The cost of converting or building a new facility to store and dispense CNG can be costly, which may have hampered increases in the use of this fuel. Conversion is also a liability and has inherent risk not to mention CNG is a highly flammable gas at very high pressures. NGV.com (Natural Gas Vehicles) estimate typical conversion costs from $8,000 to $16,000 with only certain vehicles approved for conversion including the Chevy Silverado, GMC Sierra, Ford Crown Victoria, Ford Grand Marquis, Ford Taurus, Lincoln Town Car, Ford f-150, 250, 350, 450, and others. The initial investment to convert or develop a facility, along with the ongoing maintenance costs, have been a large concern, considering the number of CNG vehicles on the road is far less than vehicles using conventional fuel. If a company or civic municipality decides to convert their fleet or transit vehicles to CNG, the initial investment can be amortized over a period of time, helping them to realize cost savings and benefits into the future. Natural gas production in the US was at an all-time high as of March 2014 with the EIA quoting 72.7 Bcf/d (billion cubic feet per day). The market forecast for 2015 is neat 75.0 Bcf/d. Most US production of CNG is primarily from gas wells and shale gas trapped in fine grained sedimentary rocks. RNG (Renewable Natural Gas) as favored by the EPA includes bio methane from sources including landfill gas, wastewater treatment, algae growth, etc., that can be processed and used as CNG. These discoveries have increased production significantly since 2007, reducing costs to consumers and manufacturers increasing consumption. Natural gas prices are affected by supply and demand with limited alternatives for production near term resulting in wide price swings when near term demand shifts. Simmons & Company estimates demand for US produced natural gas will increase from its current high at about 73.0 Bcf/d to nearly 90 Bcf/d by 2020. Mexico is one of the greatest consumers of US natural gas with pipelines being created to serve this need in Arizona and Texas.

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Additional sources of demand include China who gets 5% of their total energy from natural gas compared to the top producer, the US, who gets 26% of their total energy from natural gas. Conversely, China has 1.5 million NGVs (Natural Gas Vehicles) compared to the US with only 250,000 NGVs. The price of natural gas is relatively cheap and about one third the price of gasoline in the US and one fourth the price of CNG abroad giving US manufacturers using natural gas a competitive edge.

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California CNGAs previously mentioned there are nearly 15,000 alternative fueling stations in the US with over 700 CNG stations Nationwide. California accounts for most these facilities with 176 CNG stations followed by Oklahoma with 80 CNG stations, and Texas with 53 CNG Stations. Los Angeles accounts for most California CNG stations with a total of 9 followed by Anaheim with 5 and San Diego with 4. Most industry experts (excepting the Major Oil Companies with a stake in continued petroleum use) see a positive influence on local economies due to CNG production and use. California’s Low Carbon Fuel Standard (LCFS) requirements for 2020 will only enhance continued use and production of CNG. According to ICF International “LCFS compliance could create 9,100 new jobs in California and result in $1.4 billion to $4.8 billion in social benefits, such as reduced air pollution and increased energy security by 2020”. This will enhance and provide increasing motivation for continued development of alternative fuels and CNG. Furthermore there are significant incentives and grants for alternative fuels with the Renewable Fuel and Vehicle Technology Program (AB 118) calling for $10.0 million in NGV purchase incentives, $1.5 million in infrastructure, and $20.0 million in biofuel production. An additional $16.0 million was approved for 2,572 light to heavy duty vehicles. Research into hybrid NGVs continues with the CEC (California Energy Commission) providing $2.7 million in grants. Westport who manufactures CNG engines is offering 1,000 dges (diesel gallon equivalents) though 150 Ford dealerships with CNG provided through Clean Energy stations up to 750,000 gge (gasoline gallon equivalent). Vehicles must be purchased by the end of 2014 with fuel credits used by 2019.

In 2013 the Los Angeles Public Works Fleet converted to NGVs. The Los Angeles Department of Water and Power received a $300,000 grant for a CNG station. These same grants help to fund a two dispenser facility operated by Trillium off Highway 99 in Tulare, California similar to the subject. Trillium plans on building 3 more CNG stations by the end of 2014 in California with additional stations planned for Texas and Ohio. Trillium in a CNG leader stating “We don’t build anything unless we have a contract with someone whose going to use it, and then those customers will phase in NGVs over the course of say 3 years”. Most Trillium facilities include four or more vehicle fueling lanes with pumps dispensing 10 dge per minute. These facilities primarily represent non-public access stations with public access stations and use increasing. Of the 40 million gallons of CNG though Trillium facilities in 2013, 36 million were to non-public users with the remaining 4 million to public users. Natural Gas Fueling StationsThere are two primary types of CNG fueling stations; fast-fill and time-fill. The subject represents a combination of these stations offering both fast-fill and time-fill. Fast-fill includes high pressure fueling that takes about the same time as filling a diesel tank would. Because of the heat created through gasses flowing through the lines, total fuel capacity is reduced. Fast-fill stations can be located on relatively small sites with the equipment taking up an area not much larger than a parking space. Fuel is delivered to the station via local utilities through underground pipelines at a much lower volume than when dispensed to customers requiring the need for compressors and secondary storage.

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Time-fill stations on the other hand use lower pressures and can fuel multiple NGVs at once, but at a much slower rate than their fast-fill counterparts. These facilities are best suited for fleet fueling where vehicles can be stationary for several hours during fueling. Time-fill stations ensure a complete fill at 3,600 psi. Storage is not generally necessary are vehicles are filled directly from the utility’s gas line via a gas compressor.

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CNG dispensers have a similar appearance as a diesel dispenser. According to Cummins – Westport a typical CNG fueling station includes a compressor, gas dryer, storage vessels, dispensers, and underground piping. An LNG station includes LNG storage, a pump/dispenser, and underground piping. LNG fuel is dispensed as a liquid similar to gasoline or diesel but at much colder temperatures (-260 degrees Fahrenheit) requiring the user to wear gloves and protective clothing to avoid freezing burns. Cost for stations varies greatly depending on application. The EIA reports average pricing for LNG facilities between $1.0 and $4.0 million. CNG facilities are priced much lower with the Department of Energy quoting an average price of $400,000 for a small fast-fill station and upwards of $1,700,000 for larger facilities.

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Based on cost and availability CNG should prove to be a recognized and abundant fuel source in the United States for years to come. Infrastructure is already in place with most homes plumbed for natural gas. Conversion of gasoline engines is relatively simple though costly. CNG’s greatest hurdle is storage capacity and range, limiting its use in trucking and long haul transportation. For the commuter traveling less than 100 miles round trip CNG may someday prove to be the go to fuel source.

Compressed Natural Gas: The Cost-Effective and Abundant Alternative of Today Insight into America’s Shift towards a More Sustainable Fuel

Alternative

The creation of these articles supports Retail Petroleum’s mission to provide clients and industry advocates with timely information and insights about our ever-evolving industry. Retail Petroleum Consultants is led by company directors Steven Morse and Csaba Konkoly. The partners at Retail Petroleum fund the articles and back the opinions found herein. The information was not commissioned by any business or institution. For further information visit us at www.gasvaluation.com.

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U.S. Small Business Administration (SBA) Recent Changes to Standards of Operating Procedures (SOP)

Qualified Appraiser and Remaining Economic Life

June 2015RPC Monthly Article

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Retail Petroleum Consultants (RPC) specializes in complex going-concern valuations of gas station and car wash properties throughout the United States. In today’s market most financing for these property types are performed by SBA lenders. The purpose of this article is to address two important issues as they pertain to gas station and car wash going-concern appraisals, 1) new appraiser requirements (qualified source) and 2) 25-year remaining economic life threshold. Let’s begin with SBA’s current appraisal requirements as taken from their most recent SOP (Standard Operation Procedures). These documents can be accessed at www.sba.gov.

APPRAISAL REQUIREMENTS The regulations governing appraisal requirements are set forth at 13 CFR §120.160(b).

A. Commercial Real Estate 1. SBA requires a real estate appraisal if the estimated value of the Project Property is: a) Greater than $250,000; or b) $250,000 or less, if such appraisal is necessary for appropriate evaluation of creditworthiness. 2. The appraiser must be: a) Independent and have no appearance of a conflict of interest (such as a direct or indirect financial or other interest in the property or transaction); and b) Either State-licensed or State-certified with the following exception: when the Project Property’s estimated value is over $1,000,000, the appraiser must be State-certified.

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3. The appraisal report must be prepared in compliance with Uniform Standards of Professional Appraisal Practice (USPAP) and use one of the following options: a) A self–contained appraisal report; or b) A summary appraisal report. Note: USPAP now requires “Appraisal Report” and Restricted Appraisal Report” options (SBA will not accept restricted reports).

4. In order for the appraiser to identify the scope of work appropriately, the appraisal must identify SBA as the client or an intended user of the appraisal, as those terms are defined in the Uniform Standards of Professional Appraisal Practice SOP 50 10 5(F) Subpart C (USPAP). The CDC may also be identified as the client or an intended user. It is acceptable to SBA if the appraisal identifies the Third Party Lender as the client and SBA as an intended user. The CDC may not use an appraisal prepared for the applicant. The cost may be passed on to the borrower.

5. If the loan will be used to finance new construction or the substantial renovation of an existing building, the appraisal must estimate what the market value will be at completion of construction. (“Substantial” means rehabilitation expenses of more than one-third of the purchase price or fair market value at the time of the application.) After construction is completed, CDC must obtain a statement from the appraiser that the building was built with only minor deviations (if any) from the plans and specifications upon which the original estimate of value was based. If the appraiser cannot provide such a statement, then the CDC cannot close the loan without the SLPC’s prior written permission.

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6. If the loan will be used to acquire an existing building that does not require construction, the appraiser should estimate market value on an as-is basis. If the appraiser estimates the value other than on an as-is basis, the narrative must include an explanation of why the as-is basis was not used.

7. If the appraisal engagement letter asks the appraiser for a business enterprise or going concern value, the appraiser must allocate separate values to the individual components of the transaction including land, building, equipment and business (including intangible assets). When the collateral is a special purpose property, the appraiser must be experienced in the particular industry.

8. An appraisal must be submitted and approved by the SLPC (except on PCLP loans) prior to closing. If the appraisal comes in: a) at 90% or more of the estimated value, the CDC may close the loan but must include a written explanation in the loan file if the appraisal is less than the estimated value; or b) at less than 90% of estimated value, the debenture must be reduced or, if available, the CDC must secure additional collateral or additional investment from the borrower and/or guarantors that will be added to the required Borrower’s Contribution and will be sufficient to address the gap in value. If additional collateral or additional investment is not available, but the applicant demonstrates strong, consistent cash flow sufficient to support the debt, then the SLPC can approve the appraisal and the CDC may close the loan.

9. An appraisal must be submitted to the SLPC with the application under the following circumstances: a) Equity in land owned for 2 years or more is being contributed as part of Borrower’s contribution; b) The real estate is Third Party Lender’s OREO; or c) The Project is not an arms-length transaction (e.g., family members). Section 5.0 of the SOP 50 10 5(H) effective May 4, 2015 denotes the following change:

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Updated Business Appraisal Requirements for 7(a) Loans Also in Chapter 4, SBA is updating the requirements for a business appraisal in the 7(a) loan program. First, SBA changed its terminology from “business valuation” to “business appraisal” to align with the terminology used in the lending industry. Second, SBA is adding a new accreditation to the list of qualified sources to perform a business appraisal: Accredited Business Certified Appraiser (ABCA) accredited through the International Society of Business Analysts. Third, SBA is updating the business appraisal requirements for change of ownership transactions involving a Special Purpose Property. If an applicant business operates from a Special Purpose Property (for example, car washes, hotels, gas stations with or without a convenience store, golf courses, medical facilities or bowling alleys), the going concern appraisal must be completed by a Certified General Real Property Appraiser with experience appraising the specific business/property type. Such appraisals must allocate separate values to the individual components of the transaction including land, building, equipment and intangible assets. Finally, the Certified General Appraiser must have completed no less than four going concern appraisals of equivalent special use property as the property being appraised, within the last 36 months, as identified in the qualifications portion of the Appraisal Report.

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25-Year Loan MaturationAside from allocations of real estate verses intangibles where there will always be differing points of views, the major concern we see with SBA lenders and special use gas station and car wash properties is that of remaining economic life. Since loan maturities are tied to economic life, appraiser’s estimated remaining economic life is critical to the success of the loan. SBA recognizes maximum loan maturities for real estate at 25 years and equipment at 10 years. This poses special problems for gas station and car washes that have significant amounts of “equipment” included in the assets to underwrite. If the fueling improvements (USTs, dispensers, canopy, signage, EVR, etc.) or attached car wash conveyor system are considered as “equipment” it would be difficult to quality borrowers given such a significant portion of their loan would be collateralized by short lived assets. However, because these “equipment” items are permanently attached RPC allocated them as real estate. However, these items have much shorter lives than buildings alone and when blended together results in economic life as if new at 25 to 30 years. This leaves little room for age life depreciation as a facility older than 5 years may not have enough remaining economic life to meet the 25 year maturity threshold. With the abundance of short-lived items comprising a significant portion of the overall value, these properties generally need substantial renovation every 20 years or so not to mention the ever-changing regulatory landscape, which adds another unknown wrinkle to the effective life of the fueling improvements.

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Economic Life Vs. Physical LifeUnlike most commercial properties where it is commonplace to put aside replacement reserves, this is not the case with gas station and car wash operators. The wear and tear and these property types is perhaps greatest of all with expensive government regulations and compliances that often require significant upgrades and capital outlays that are unforeseen. For these reasons economic lives for car wash buildings, gas stations, and c-stores are accelerated. This is proven by the appraiser relied upon cost manual published by Marshall and Swift that shows most commercial buildings with 35 to 55 year lives while gas station, car washes, and c-stores have reduced economic lives between 20 and 45 year lives. Simply stated, economic life is how much longer the improvements will contribute value to the underlying land whereas physical life is how much longer will the improvements last. In many cases existing gas stations are razed for new development, their existing improvements still had physical age left, but economically the improvements were at the end of their lives. Physically, a c-store building or UST for that matter could physical remain in place (physical life) well in excess of its economic life, but due to changes in technology, government compliance, and competition these improvements will likely be replaced and or modified long before they physically wore out. Generally speaking economic life is less than physical life, especially for aged special use properties. Gas stations and car washes depreciate faster than other commercial property types, though SBA seems to treat them no differently than a restaurant or industrial building. RPC uses 40 year economic life for a typical c-store building and will report shorter lived fueling improvements and site improvements separately. When remaining economic life is below SBA thresholds there are options available to the appraiser that adhere to USPAP or SBA guidelines while maintaining appraisal reliability.

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Replacement Reserves If gas station operators put aside replacement reserves economic lives of the buildings and equipment would be increased, while in response cash flow would be reduced. The operator is simply trading cash flow for extended economic life of their real property. We have provided just such an analyses to assist with insufficient remaining economic life. Remaining Physical Life We have been asked by some lenders to add narrative stated, when appropriate, that the remaining physical life of the building exceeds the 25 year threshold, though it may not in terms of remaining economic life. Providing this type of language has allowed SBA some leniency as to remaining economic life. This may be due to SBA’s interpretation of what they deem to be economic and physical life. However, we could not find SBA referenced definition of these terms. Renovation and Upgrades A final option when remaining economic life thresholds cannot be met though timely and costly is renovating or upgrading the facility such that economic life is extended to meet and or exceed loan maturity thresholds. This is particularly attractive for buyers of older facilities that may not qualify under current SBA guidelines. In summary we learned that there are new appraiser experience requirements for special use going-concern properties that may reduce the pool of competent appraisers. We discussed the problems often encountered with the 25 year threshold and remaining economic life but in turn offered several reasonable and proven solutions. It appears that SBA is making efforts to address these issues. We are hopeful that SBA will continue to review and modify current policy as to special use going-concerns, and implement additional SOPs that address reserves, renovations, and physical remaining life.

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U.S. Small Business Administration (SBA)Recent Changes to Standards of Operating

Procedures (SOP): Qualified Appraiser and Remaining Economic Life

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Contamination:“Clean” Versus Contaminated Gas Stations

How Do Market Buyers and Lenders Address Contamination?

March 2015RPC Monthly Article

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Contamination is somewhat commonplace in gas station properties, especially for older properties built prior to the EPA 1998 mandate that required all single wall underground storage tanks (USTs) be replaced with double wall fiberglass tanks (refer to Title 40 Code of Federal Regulations (CFR) Part 280, "Technical Standards and Corrective Action Requirements for Owners and Operators of Underground Storage Tanks"). Contamination and gas station properties often go hand in hand. How are market participants in this sector addressing contamination? Logically speaking, one would assume that a contaminated gas station would sell in the marketplace for less than a non-contaminated site, all other factors considered equal. But is this discount material and supportable in the market? A significant amount of older USTs have leaked with many sites under remediation or “clean” but subject to market perceived stigma. Many gas stations have sold with ongoing remediation, the buyer typically being indemnified by the Major Oil Company who held title at the time of contamination and is the responsible party for remediation.

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In the context of gas stations as used by the Major Oil Companies contamination is defined as follows: Contamination means Hazardous Materials on, at, or in the groundwater, surface water, drinking water, soil or other subsurface strata, sediment, land surface or ambient, workplace or indoor air at, or in the physical buildings, structures, improvements or fixtures on, or migrating to or from the property. Along these same lines, it would also be logical to assume that a previously contaminated site, now “clean” would sell for less than a site that was never subject to contamination, all other factors considered equal, due to “stigma”. Again, is this discount quantifiable? The Appraisal institute defines stigma as follows: Stigma is an adverse public perception regarding a property; the identification of a property with some type of opprobrium (environmental contamination, a grisly crime), which exacts a penalty on the marketability of the property and hence its value.

Though most market participants agree some discount may be in order for contaminated or stigmatized sites, the results of our studies are surprising. Contamination and stigma are perhaps the most difficult discounts to prove in the marketplace. We expect market buyers to discount contaminated sites or sites with stigma but to what extent? Several factors may affect this discount, if any.

Having appraised thousands of gas stations Retail Petroleum Consultants (RPC) has interviewed market participants regarding the purchase of contaminated gas stations. These market participants include buyers, sellers, Major Oil Companies, mid-level oil companies and jobbers, single and multiple unit operators, banks, attorneys, and financial institutions. Their feedback was surprising.

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One of the primary factors affecting regarding contamination and stigma discounts is alternate use. Although gas station may represent the highest and best use at the time of sale, it may only be a matter of time before land value exceeds that of the operating station or going-concern. This is often the case in affluent areas, coastal communities, and downtowns like Los Angeles, New York, San Francisco, etc. Fuel supply agreements and remediation often extend gas station interim use given additional costs for demolition, UST removal, and time necessary to remediate. Municipal restrictions and Planning can also extend the interim uses like in San Francisco where the City believes there are not enough gas stations to serve the public, therefore making it very difficult to remove operating gas stations for development to alternate use.

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Assuming a gas station site can be re-developed to alternate use, the level of allowable contamination is much different for an operating gas station than would be for say a residential project. Most buyers purchasing contaminated gas stations for continued use tend not to discount their purchase if the responsible party is a Major Oil Company who indemnifies the buyer. These agreements are transferrable to new buyers. Without the indemnity agreement these stations may not sell or be leveraged by a financial institution. We interviewed several major banks that actively lend on gas station properties, hoping to isolate an interest rate or related capital cost increase for contaminated or stigmatized properties. Their comments are summarized as follows:

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“…wouldn’t lend on a contaminated property, or increase the rate if the contamination meant there was more work on their part…” “The interest rate would not be affected. The issue has more to do with future contamination risk and loan sizing. Higher risk, or special purpose properties in general may be priced higher by some lenders.” “Would not affect the interest rate, but there would be a lot more scrutiny of the gas station and a reluctance to loan.” “...willingness to loan would be based on if the contamination had been cleaned and certified as such, or the credit history of the borrower was strong.” “With a history of contamination, it would affect more than the rate. We wouldn’t entertain the loan at all. However, if you meant to say just that there was contamination in the past that was now cleaned up, it would probably not impact the rate. I don’t know of too many stations that don’t have a clean-up record. If there was continued cleanup, again we probably wouldn’t get involved until it was resolved. If ongoing monitoring was only thing left, we might charge an extra half point as we would also need to continue monitoring to make sure nothing else went on. I’d have to consider this situation more carefully.” “The level of contamination generally wouldn't affect the rate. If we are comfortable with the clean-up plan and responsible party, then it comes down to the Loan to Value and strength of the Guarantor.” “If the remediation is completed, then it wouldn’t affect the rate. If it’s ongoing, then we’d need to confirm if there is indemnification from the gas company, such as ConocoPhilips, Chevron, etc. If not, then we mostly won’t be able to do the loan.” “…the processes of evaluating environmental risk typically do not include loan terms (e.g., interest rates) or worthiness of the deal. The environmental risks (i.e., chemical contamination issues) are part of the considerations credit officers use in evaluating the overall risks of a particular deal.”

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The responses varied amongst the lenders surveyed, though it was apparent that none could identify a supportable increase to the interest rate due to contamination (or stigma). More so, the contamination issue was dealt with on a case by case basis with nominal effect on lending rates as long as the site has been remediated or is being remediated by credit rated responsible party such as a Major Oil Company. RPC gas station appraisals includes a caveat assuming a “clean site”, any cost to cure detrimental environmental conditions are to be deducted from the concluded value. However, these costs are rarely known without costly environmental reports and somewhat of a moot point given these cost would be incurred by the responsible party.

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What do market buyers have to say? Surveyed buyers of gas stations for continued gas station use do not support a discount for contamination or stigma, unless the responsible party is not a Major Oil Company or the ongoing remediation somehow increases their cost of capital or impairs the utility of the site. In summary it seems as long as there is an indemnity agreement as is the case with most contaminated gas stations and the Major Oil Company is the responsible party, the market does not support a material discount for contaminated gas stations.

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What does the market data say? In a perfect market one could perform a paired sales analyses where the only variable between two identical gas stations is contamination or stigma. Unfortunately, gas stations are special use properties with a myriad of variables affecting value. Performing paired sales is simply just not possible with any degree of reliability. Many have tried, but with poor results and little to no correlation of data. The above chart was compiled from the RPC database and cross referenced with contaminated sites as analyzed by Richard Neustine MAI, CRE, FRICS. The data shows the lack of statistical relationship between contaminated gas stations and those not contaminated. No matter how the data is analyzed, no statistical correlation could be found between sale prices of contaminated gas stations versus non-contaminated gas stations.

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Contamination:“Clean” Versus Contaminated Gas Stations

How Do Market Buyers and Lenders Address Contamination?

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Always Accurate, Always on Time

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Documents

Gas Station/C-Store Going-Concern Valuation PRESENTED TO Appraisal Institute Annual Meeting Sheraton July 27 - 29, 2015 Dallas, Texas PRESENTED BY Stephen