GF599 Unit 3 Tire and Net Lease Industry Review Example

Two Markets, One Decision: A Unit 3 Industry Review for the Tollbrook Sale-Leaseback Capstone

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Purdue University Global

GF599: Graduate Capstone in Finance

Unit 3 Industry Review

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[Date]

Tollbrook Tire and Service and its figures are composite and illustrative; industry conditions are described from the sources cited, which are real.

Purpose of the Review

The Tollbrook question is a financing decision, so the review does not try to forecast tire sales for their own sake. It asks two narrower questions. How durable is the business that would pay fifteen years of rent? And how does the investor value the buildings, since that valuation sets both the price offered today and what the buildings may be worth when the lease ends? Each answer narrows the set of comparisons that make sense.

Section 1: The Service Trade

Demand for tire and repair work follows the number of vehicles on the road, how far they are driven and how old they are. Older vehicles need more repair, and Americans are keeping their cars longer. The average age of light vehicles in the United States reached 12.8 years in 2025, the highest on record, with passenger cars averaging 14.5 years (S&P Global Mobility, 2025). For a chain like Tollbrook, an aging fleet means steady demand for brakes, suspension, alignments and tires, much of it work that cannot be postponed indefinitely.

Two longer trends cut the other way. Electric vehicles need no oil changes, and oil-change visits are often how a customer first enters a service bay. As electric vehicles become a larger share of the fleet, that entry point shrinks. On the other hand, electric vehicles are heavier and deliver torque quickly, and tire makers market specific products for them, which suggests tire replacement remains a durable line of business.

The third trend is consolidation. Private equity buyers have assembled regional chains, and larger competitors can buy tires and parts more cheaply. An eleven-store independent survives on location, reputation and fleet accounts, all of which depend on staying in its current buildings.

Ruled in by this section: a fifteen-year horizon. The business is durable enough to support a long commitment, so a comparison over the full lease term is reasonable. Ruled out: a short-horizon comparison, such as the first three years of cash flow, which would ignore most of what the lease commits the chain to.

Section 2: The Investor's Market

Net-lease investors buy single-tenant buildings for the rent, not for the business inside. Under an absolute net lease, the tenant pays property taxes, insurance and every repair, including the roof and structure, so the investor's income looks much like a bond coupon. The price the investor will pay depends on three things: the tenant's credit, the length of the lease and the rate of rent increases.

Broker surveys of single-tenant auto service property have reported cap rates moving up with interest rates since 2022, as investors demanded higher yields when borrowing became more expensive. Tollbrook's offer at 6.75 percent sits within the range those surveys describe for regional operators on long leases. A national tenant with an investment-grade rating would command a lower cap rate and a higher price; a small chain without public financial statements pays for that difference.

The investor also cares about what happens after the lease. A building suited to auto service, with bays, lifts and a lot sized for vehicles, can usually be leased to another operator if Tollbrook leaves. That residual value is part of why the investor is willing to pay $11,200,000 now.

Ruled in: the buildings' value at the end of the term as an explicit input. If the investor counts on it, so must Tollbrook. Ruled out: comparing only the rent stream with mortgage payments, which leaves the residual value to the side that owns it.

The investor prices Tollbrook's lease the way a bond buyer prices a bond and adds the buildings' end value as a bonus; Tollbrook should price its side the same way, as a borrowing that costs it both the rent and the buildings.

Section 3: Where the Two Markets Meet

Viewed from Tollbrook's side, selling the buildings and leasing them back is a loan. The chain receives cash today and promises fixed, rising payments for fifteen years, after which it owns nothing. A mortgage also delivers cash today and requires fixed payments, but the chain keeps the buildings. The two routes are therefore comparable as two ways of borrowing against the same assets.

Research on leasing supports this view. Fixed lease payments displace debt in a firm's capital structure, so a lease should be valued with the cash flows a firm would face if it borrowed instead, discounted at its after-tax borrowing rate (Myers et al., 1976). Leasing may still be attractive to firms with limited access to credit, because an owner taking back its own building faces fewer hurdles than a bank seizing collateral, which lets financially constrained firms obtain more funding through leases (Eisfeldt & Rampini, 2009). Tollbrook is not tightly constrained: its bank has already indicated willingness to lend against the five strongest buildings.

Evidence on how markets react to sale-leasebacks is mixed and depends on the firm's circumstances. Early work found shareholder gains around announcements in some samples and not others, which points to the specific terms and the use of the proceeds as the deciding factors (Rutherford, 1990).

Ruled in: an after-tax cash-flow comparison of selling and leasing back against keeping and borrowing, discounted at the after-tax cost of secured debt. Ruled out: discounting at the chain's overall cost of capital, which would treat a fixed rent obligation as if it were as risky as the business itself.

Section 4: Risks the Industry Adds

Two industry risks belong in the sensitivity work rather than the base case. First, if electric vehicles shrink oil-change traffic faster than expected, some stores may lose volume, and a fifteen-year lease would bind the chain to locations it might prefer to leave. Second, if consolidation continues, a larger competitor may offer to buy Tollbrook; a buyer would view a long lease at a rising rent differently from owned real estate. Neither risk changes the method, but both will be tested.

Conclusion

The review supports one comparison and rejects two. The project will compare the after-tax cash flows of the sale-leaseback with those of a secured mortgage over fifteen years, including the tax on the sale, lost depreciation, rising rent and the buildings' value at the end, discounted at the after-tax mortgage rate. It will not compare cap rates with interest rates directly, and it will not discount at the cost of capital. The method defense in Unit 4 will set out why in detail.

References

Eisfeldt, A. L., & Rampini, A. A. (2009). Leasing, ability to repossess, and debt capacity. The Review of Financial Studies, 22(4), 1621-1657. https://doi.org/10.1093/rfs/hhn026

Myers, S. C., Dill, D. A., & Bautista, A. J. (1976). Valuation of financial lease contracts. The Journal of Finance, 31(3), 799-819. https://doi.org/10.1111/j.1540-6261.1976.tb01924.x

Rutherford, R. C. (1990). Empirical evidence on shareholder value and the sale-leaseback of corporate real estate. Real Estate Economics, 18(4), 522-529. https://doi.org/10.1111/1540-6229.00535

S&P Global Mobility. (2025). Average age of vehicles in the US rises to 12.8 years in 2025. https://www.spglobal.com/automotive-insights/en/blogs/2025/05/average-age-of-vehicle-in-us