In order for the economy to recover, Commercial Real Estate will need to take the first steps towards that recovery. Commercial Real Estate is typically a lagging indicator of declining economy. Why? Because these property owners and businesses that rent from them are corporations with deep pockets and tend to ride out the bad wave till it crashes.
Perfect example; I live next to a Vons Supermarket in a city that once had the highest income per capita in the U.S. Still ranked in the top 25 cities in America. You’d think any business would be able to thrive with that type of microeconomics. Well, before that store went out of business, I had a conversation with the store manager and asked him what happen? He told me that the store had been operating in the negative or 24 months before the corporate offices decided to “pull the plug”. What struck me interesting in that comment was that they were able to keep the doors open and continue to operate for 24 months at a loss? Personally, I could not survive that long. I would last maybe 3 months at a loss then I’d be done. But major Corporations have the ability to operate negatively for much longer. I also asked the store Manager, “What was the motivation to continue to operate for so long with a negative cash flow?” He told me that the lease terms on the property were a major issue. Vons is not at threat of going out of business as a whole; it was just this location that was not performing. If they defaulted on the lease, the landlord would go after them to collect the remainder of the lease payments.
It’s my opinion, and I’m sure I’m not alone, that the worst is yet to come and here’s why. Commercial Real Estate being a lagging indicator on a decline is also a leading indicator for recovery. Commercial Real Estate makes up the largest portion of Employers in the Country. Commercial properties consist of Retail, Manufacturing, Office Buildings, and Multiple Family apartment buildings (the ladder being the safest investment of all in this current market). Employers are finding it difficult to service their debts because fewer buyers are purchasing products. Fewer businesses are able to weather the storm and are folding up Laying-off tens of thousands of employees every month.
That, coupled with the fact that these commercial property’s have loans types different than the typical 30 year fixed loans that most residential properties are tied to now.
Commercial properties have loans types like this; 5/25, 7/30 or 10/30. What this means is that a Commercial Loan is Amortized for 25 years but due in 5 years in a 5/25 type loan.
Do the math, a Commercial loan was originated 5 years ago or 2007 when the economy was near its highest level and sold for the most that property had ever been worth. Today, that property has lost nearly 50% of its value because increasing vacancies and a decrease NOI (Net operating Income) and with Operating expenses continuing to rise at a steady rate of 2-3% a year. Now, in 2012, that loan becomes due in full. The property owner cannot refinance because the property is upside down.
This is the scenario beginning to unfold across the country and around the world.
Smart property owners are beginning to reach out to renegotiate their loans but the issue here is that it requires a skilled hand to know the right formulas that the bank is looking for to evaluate a restructured loan. Be sure you work with someone that can evaluate current situation and has the ability to negotiate with the banks.
The IRS, FDIC and Treasury department are considering extending TALF, Eliminating tax liability for investors of CMBS (commercial mortgage backed securities loans) who work to modify those loans in distress and loosen the guidelines for what is in fact a distressed loan. If the banks don’t restructure these loans it could cause a tsunami of debt, bank failures increased unemployment and potentially financial chaos.
Nearly 10% of all Commercial Loans are currently in default. It’s forecasted that in the next 5 years 20% of all Commercial Loans could go into default if something isn’t done immediately. 80% of Commercial loans are held by local or Regional Banks. The average loss to values of these properties is near 44% since 2008. Commercial lending is basically shut-off at this point.
A commercial property doesn’t need to be in default for a restructure payment. It just needs to show that it cannot continue to be serviced in its current state of income, vacancies and operating expenses.
If you want your situation analyzed or more information on Commercial Litigationg give me a call and I’ll look at the whole situation.
The documents I’ll need to evaluate your situation are:
Last 3 years:
-Income and Expense Report
-Rent Roll with lease expiration dates
-Mortgage Statement
-Personal Financial Statement
-Most recent Appraisal
-Any notices of arrears
-Tax Returns
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