When deciding whether or not to build or buy a billboard – or even what type of billboard – the big decision maker needs to be the rate of return. In this Billboard Mastery podcast we're going to explore how to determine the rate of return, what's normal in a good billboard deal, and why that one item should be your ultimate decision maker.
Episode 152: The Big Boss Is Rate of Return Transcript
Even when you own your own billboard company, you still have a boss, and that boss is the rate of return. This is Frank Rolfe with the Billboard Mastery Podcast. We're gonna talk about the fact that the big boss at the end of the day in everything you do as a billboard owner simply ties back to the financial rate of return. Now, what am I talking about? What I mean, rate of return. Most billboard investments, whether you're building a billboard or buying a billboard, need to be evaluated to see what the return is on the money that you're spending, what is called cash-on-cash return.
Let me give you an example, tell me which deal is better. You have two different billboards that you can build. One is made out of telephone poles. It's gonna cost $4,000 to build it, and that sign makes $2,000 a year of net income. So how do I derive the rate of return? I make a fraction, $2,000 on the top in this case, 4,000 on the cost on the bottom, and I divide the top by the bottom. I divide 2,000 by 4,000. What do I get? Well, that's a 50% per year rate of return. That's very impressive. That's very good. Remember that Warren Buffett became the world's richest man from time to time because he had a lifetime batting average for about 60 straight years of 19.7% annually. If you can get 50% annually, well, you're doing two... More than two times better than Warren Buffett did. So you can never go wrong doing a deal that's got a 50% cash-on-cash return. But yet you're weighing the idea of doing that billboard against this other one. This other one is one you're looking at buying. It's not in a great location, but it's a steel monopole. And that sign you can buy for $30,000. But here's the problem, that sign only makes about $7,000 a year of net income. So if you take 7,000 and you divide that by 30,000, what do you get? Well, it's good. It's better. It's still 20-something percent. So that's not bad, right? No, that's not bad, but it's not as good as 50%.
And then here's this third one. This third one you're gonna build from scratch. This is a big monopole in a prestigious area right on the interstate highway. Sign's gonna rent for a good amount of money, but a big lot rent on it too. And you're gonna spend $100,000 building this big old 14x48 monopole. And you're all excited 'cause that thing is gonna make about $15,000 a year of net income. But hold on a minute, that's only a 15% cash-on-cash. And that means even though that big, glamorous monopole sign looks a lot cooler to own, the problem is it doesn't make as much money. Nowhere close. Those two other signs, one making over 20, one making over 50%, those are the ones you should shoot for. You always want to go with a good cash-on-cash return. So then it brings forth the question, what's a good cash-on-cash return? In my career as a billboard owner, the goal was always to hit 20% or better cash-on-cash return. I would model out what I thought the cash-on-cash return would be, how much net income it would make, and I would multiply that times five. That was my fast-in-the-field way to figure out if a sign worked or not. So if I found a location and I figured out what it would rent for, let's say it rented for $500 a month per side, that would give me 500 plus 500, 1,000 times 12 months. 12,000, right? And then I took away from that my land rent. Let's say my land rent in this case was gonna run 30% because this location was pretty good. So take about $3,600 off off that. And now where you at? Well, let's see, you're at about what? About 8,000, 80-something hundred dollars. And then you gotta take away your power and your insurance and your operating cost and installation. And let's see, when you get all done with that, you net down to about, say, $5,000 in that sign of actual profitability. And my rule was five times that, which means I couldn't spend more than 25,000 bucks.
So then the question is, can I build this sign for 25,000 bucks? And you might say, "Well, you can't as a monopole." "Okay, what else?" "Could I do it as an I-beam?" "Well, you might be able to do it as an I-beam." "Okay, could I put a V on it?" "Nope, can't put a V on it." "Has to be back-to-back to hit 25,000." "Could I put on real, real expensive lights?" "Nope, nope, can't do that. Got no money." That's how I always kept myself in the right spot because I knew as long as I was hitting 20% cash-on-cash return, I would always be fine. Because there's one more element of risk that people don't talk a lot about in our industry because I think they're afraid to, but that's that not all billboards last forever. Sometimes you can build a billboard and what happens? Someone builds a building on it, makes you take it down. Or also maybe just your lease just expires.
If you go with a five times NOI format, that will keep you out of trouble most of the time because that means you'll pay off your debt typically within about seven years. You might say, why not five? Because you have to add interest on there, right? But if you look at what it is, if you're paying principal and interest on the loan, normally it's about a seven-year payout. And that means even on a 10-year lease, you would have three years of free cash flow before the lease ends. And at least you got all your money back before the lease ends in case you can't renew it. What's crazy is when people go at much lower rates of return. Let's say you're a big old sign owner. Let's say you are Clear Channel or something and you're gonna go ahead and buy or build a sign that payouts at only 10%. Well, okay, here's the problem on that movie. At 10%, it's gonna take you 15 or 20 years to pay that sign off.
Let's say your lease is only 10 years in length. Your lease will come up and you still owe money on the sign. And what if you can't get it renewed and you have to move it? Well, you lost money on the deal. What if someone decides to build a building on that property and tear you down in year nine? You lost money on that deal. You can go with lower cap rates on commercial real estate. Sure, you can buy an industrial building or you can buy a house and slap a 30-year mortgage on it, but they can't take that away from you. You have insurance if a fire takes it away or a storm. But in our industry, there's always the element of risk, the always element of cancellation, always the element of development that could cut things short. And I just don't think you can put more than a 20% cash-on-cash return on the deal and still feel really good about it. It also means when you start evaluating some of these things that people do that are very, very expensive, like digital signs, from a rate of return standpoint, those deals look very, very risky indeed.
Personally, myself, I would rather have a portfolio of old wooden telephone pole signs to one digital sign. I've got more diversity in my portfolio then, and I know I'm gonna have a higher cash-on-cash return. The bottom line is every deal you look at, whether you're gonna buy it or you're gonna build it, you've gotta come up with the formula, the algorithm, and understand it like the back of your hand to derive the cash-on-cash return. And once you are able to do that, try and stick with only things that are 20% and higher. That's the best way to make money in this industry. This is Frank Rolfe with the Billboard Mastery Podcast. Hope you enjoyed this. Talk to you again soon.