No More Mister Nice Guy!!!

Times have changed. Gone are the days were on the second hole of golf with your Banker you casually mention that your company might miss its debt service covenant due to a delay in shipping a big order. "No Problem", your banker says as he crushes a drive down the middle of the fairway. Good laughs, good times.

Now, your Banker would lose the grip of his club sending his new titanium driver 50 yards down the fairway. Not only that, his boss in the next golf cart is already thinking about how this is going to play at credit committee.

How will it play? Well, not good. Whether its high profile real estate projects experiencing slight delays (read today's Wall Street Journal below the fold), or a business whose quarterly tax payment by the owner tripped a covenant, your banker doesn't care.

Loan portfolio problems persist everywhere and they affect you as a borrower - whether you are applying for credit or adjusting your existing credit agreement. Comforting factors such as the length of the banking relationship, being on the Bank's advisory board, donating to the Bank's charity of choice are butkus. You are in trouble.

The word I'm hearing is that Bank's have itchy trigger fingers resulting in pro-bank loan restructuring or even worse good companies or real estate deals being put in work-out. Loan restructuring usually means higher interest rates, higher fees, and tighter covenants - not to mention the legal costs to change the agreement.

Worse, Most if not all Banks are in the retrenchment mode when it comes to financing capital expenditure investments - especially to those companies that have tweaked the credit agreement. Short pay-back periods, production cost reductions, competitive advantage are reasons to invest in capital expenditures, however, those justifications are falling on deaf ears.

One local borrower - who wants to remain anonymous - mentioned in frustration: "We're just not getting any help from our Bank?".

What can you do? Unfortunately, the only way to make a Bank move on your request is to threaten to leave the Bank. Suddenly, everything makes sense to them - short payback periods, cost reductions leading to increased cash flow. Its sad that it takes that kind of threat given your perceived relationship between you and your Bank.

To accomplish this and to make the threat real, you should always keep other Bank loan officers at your beckon call. Also, you should prepare a financing package way in advance. Time is of the essence. Don't worry about crying wolf regarding threatening to leave or bringing another bank down the prim rose path because many bankers are like the caged mouse eating cheese only to be electrocuted. They keep coming back for more. My gut would time to choose the one banker that actually calls your bluff because he or she is truly has good business sense.

Submit your monthly, quarterly, annual financial information on time - meaning under the allotted time in your credit agreement. While seeming insignificant, being one day late submitting your financial statements is a technical default, immediately bringing your Banker to the restructuring table.

These are trying times for borrowers. Your Bank has become very transactional, versus, relationship driven. Meaning that you can throw away the past 15 years of on-time payments. If your having trouble, I would suggest also getting your attorney up to speed on your current issues. Then read the definition of the "Default Rate of Interest" in your credit agreement. Its not unusual to see your rate increase by 4% over night.

Good Luck.

Storm Clouds Surrounding the Commercial Loan Market!!

"No, as of March 1st, we are no longer offering commercial mortgages with Loan to Values (LTV's) in excess of 85%". That's the message I got yesterday from a commercial lender who prior to March 1st was aggressively offering 95% LTV's. What happened at midnight February 29th? Did the extra day (leap year) in February cause most lenders to change so abruptly?

Here are some of the ingredients prompting the change: This past week, the Wall Street Journal dedicated several columns suggesting that the commercial market was on its way down. To summarize, the Wall Street Journal showed that nonresidential construction was down 1.7% in January versus the prior month, office space sales declined 42% in the fourth quarter of 2007 right as the credit tightening began, and that The International Council of Shopping Centers announced that U.S. store closures could reach 5,770 up from 4,603 last year.

More storm clouds are on the horizon according to another article quoted in the Wall Street Journal. The article suggested that U.S.'s community banks are sitting on a commercial loan time bomb. Community banks have migrated to underwriting more commercial loans as they've been pushed out of the residential mortgage market by Wall Street money. "Small and midsized banks, with less than $10 billion in assets, have a total of $323 billion outstanding loans", the article stated. This represents approximately 285% of the remaining banks' capital.

Let's speculate that approximately 1% of those loans referenced above were written off by the community banks - for a total of $3 billion write off. Not only would that result in several community closing, but it would also reduce the lending capacity of those institutions by at least $32 billion (using a 10x factor due to the leverage employed by most banks). That means $32 billion in potential loans to you and me to buy real estate would evaporate.

Is the sky falling? No, not exactly.

Commercial loan delinquencies are still low at 1.94% in the forth quarter of 2007 (it did rise modestly over the prior year). In the 1990's the commercial loan delinquencies reached 10%, so we still have a long way to go. Many experts suggest the most weakness in the retail segment, which is most susceptible to the downward movement in the national economy. So what does all this mean to you and me, who deal in the small balance commercial loan market? Here's what I think:

• Higher equity requirements. A contraction in the loan to value ratio means higher equity contributions by the owner/investor. Solution: If the cash isn't available to increase the equity contribution to complete the deal, approach the seller about a seller second mortgage. Your primary financing institution will look at the seller second as quasi-equity due to their 1st priority in the transaction.


• As properties come under increased scrutiny, the borrower's underlying credit will become increasingly important. So having a healthy credit score backed by personal liquidity will help you get that deal completed.


• Find other creative ways to finance the deal. For example, you could arrange a master lease agreement with an option to buy (at the current market value) with the owner. Under the master lease agreement you pay the owner a monthly lease payment but you run the property including collecting rent and paying expenses. Your goal is to then increase the value of the property and cash flow during the term of the lease (usually three to five years). Remember your option is based on the value today, not the value your going to create during the lease term. You could also negotiate that a portion of your lease payment go towards the option price.


• Buy on option on the property today for a small upfront fee. This locks up the property while you find a solution to the financing arrangement. Make sure that the upfront option price goes towards the purchase price.

Keep looking at the horizon for those storm clouds and I'll be happy to be your real estate weatherman!! Remember good deals get done!

"Property Play - A Primer for Investors who are considering commercial real estate to build up their nest eggs" by Kemba J. Dunham

In case you missed yesterday's Wall Street Journal article "Property Play - A primer for investors who are considering commercial real estate to build up their nest eggs", here is a review of this great introduction into real estate investing.

In this article, Kemba J. Dunham puts forth a basic outline to consider when looking at commercial real estate. Commercial real estate investments can range between retail strip malls, office buildings to real estate investment trusts (REITS), apartment buildings, and even five family residences. Unlike twenty years ago, financing is readily available for the purchase of commercial properites - making commerical real estate investing an option for the average American. However, as the article states commerical real estate investing is not for everyone and there are key considerations to follow.

First, Ms. Dunham states that every fledgling investor GET HELP. In every market there are commercial real estate brokers that can assist investors in selecting properties. They can add insight into local market rents, comparables, and even lenders. Other key advisors include a real estate attorney, and an accountant.

Second, the article points out several forms of ownership the investor should take title to the property. Direct Ownership or a third party vehicle, such as a Limited Liability Company or General Partnerships are the basic title considerations. Each form has its pluses and minuses. Direct Ownership is means that you take title to the property in your name. Some benefits include favorable tax consequences (consult a expereicned tax consultant), the ability to later conduct a 1031 exchange, and you're your own boss and don't have to share profits. The big downside to direct ownership is the liability - which is squarly on your shoulders.

Ms. Dunham provides a smart consideration to those investors that want to invest in commercial real estate but don't want the headaches of managing the property. In every market, there are capable property management companies that will manage the day to day on the property for a fee - usually 5% to 10% of the gross rent. The article suggest that "when hiring a management company, check out its references and see how well it is regarded locally".

Third, going alone scares many would-be investors, so partnering up with other investors makes sense. Partnering spreads the risk and lowers the personal contribution to get things going. However, an obvious drawback is the fact that you have to share the profits. The article suggests that those who don't want to go it alone find sponsors who buy commercial properties on behalf of small investors for a fee.

It goes on to suggests alternative forms of third party or sponsored ownership methods such as general partnerships, limited liability companies, or tenant-in-common arrangements (TIC). In a TIC arrangement each tenant owns a fractional share in the property. Limited liability companies offer the tax consequences involved in direct ownership while offering a direct liability shield against claims. There is a cost to set up a limited liability company or general partnership and a good commercial lawyer can assist in that process.

The last bit of advice in this great article focused on Triple Net-Lease Properties, which are properties that the tenant covers the utilities, taxes, and insurance in the rent. While the advantge to the owner is just collecting a check every month, the tenant would most likley require a long term lease as incentive to agree to those terms. As Ms. Dunham states in the article, "Because of the long leases, net lease properties can be very illiquid".

Overall, the article is a solid start for anyone looking to enter the commercial real estate market. The best piece of advice is get professional help - a commercial realtor, a real estate attorney, and an accountant.