The Valuation Quagmire

As commercial real estate enters the second year of its downward slide a new problem is arising for many commercial borrowers. Valuation!

Because of the down economy many business have failed and left large swaths of commercial, retail and office space vacant. The large numbers of vacancies are causing the value of current leases for some industries to be discounted and is pushing down the rent per square foot of available space.

This downward spiral is affecting Values which exacerbates a larger problem. Many loans are entering their 'call' period. A call is where a loan is reevaluated to determine if it still meets the lender's original standards and guidelines.

If the property does not meet the lenders guidelines for gross and net revenues and for it's LTV requirement then the loan is 'called' due. The problem facing many with commercial loans on real estate is this.

While they may be making their payments on time, the Loan to Value ratio (LTV) and the Debt Service Coverage Ratio (DSCR) are way to low. The loans will be called 'due' even though their payments are on time.

This impending foreclosure deluge could flood the market this summer. The only thing that will stop it is if the government is successful at restarting the Commercial Mortgage Backed Securities (CMBS) market that collapsed last year.

Another factor that could help is if the government loosens the regulations on TALF (Troubled Asset-Relief Fund) and allows the fund to start guaranteeing some of these underwater assets. Whatever happens, there are sure to be some opportunities for savvy investors.

Now may be the time for real estate investors with large residential portfolios to consider liquidating some of those assets to take advantage of the new opportunities that will be available in small commercial.

The Second Wave

“In describing the increase in CMBS loans going into special servicing, Fitch Ratings uses the term "rising tide," and that phrase could also apply to the Q1 jump in CMBS delinquencies.”

This is the opening line of an article written by Paul Bubny, an author and expert on Commercial finance. In the article he goes on to describe the coming wave of foreclosures in the Commercial Mortgage Backed Securities market.

Delinquency rates are as high as 3% in multi-family unit loans and the increase in the overall rate of delinquency has increased .62% over this same quarter last year. While loans that are late are expected to increase over the next two years, a large number of non-performing assets are expected to go into foreclosure in the near term.

The reason for the rising number of loan defaults is because of the tight credit market. As more loans mature between now and 2012, there will be more and more foreclosures.

The only solution to this problem is to somehow loosen current stringent credit standards. The good news in all of this is that the Feds realize this problem is coming. Unlike the housing credit crunch, there is no illusion that the economy is strong enough to withstand the coming onslaught.

Everybody is aware of the problem and plans are being made to deal with it. We’ll watch and hope that a viable solution is in place soon.

In For The Long-Haul

To many investors are in the game for the short term. They see big money (or here big money) and never realize it because they lack commitment.

The truth is that it takes commitment to succeed at any thing. For those looking to make the transition into small commercial from residential investment property, I have a questions for you.

What is your commitment?

Think carefully and then make your answer the right one. Be committed for the long-haul, commit to learn the business, break through the barriers and withstand the learning curve and you'll find you can turn your cash flow business into a Cash Flow Monster!

Go With The Flow

My mother always taught me to be a leader, not to follow the pack, to be out in front and be different. That works well when you are the head of an organization but it doesn’t work so well in other areas.

One of the areas that this sort of thinking doesn’t work well in is lending. This type of thinking can be especially troublesome when trying to borrow money from a lender.

I see a lot of investors, developers and contractors that attempt to bend the lender to their will instead of understanding what lenders have to offer and then developing a strategy that fits within those parameters.

What ends up happening when individuals or companies expect lenders to flex instead of being willing to flex themselves is that lenders choose not to do business. That’s right, no soup for you!
When it comes to obtaining a loan it makes since to shift gears. Instead of having a leader of the pack mentality, change to a ‘Go with the flow’ way of thinking.

Going with the flow means learning what is required and conforming to what is desired. Once understanding is achieved then a business plan to adhere to the constraints of the lender can be established.

Think about all the loans that are out there… There are literally too many to mention, but the rules say that these loans are inflexible. Lenders are unwilling to adjust their guidelines because this creates immense risk to their financial stability.

Opportunity exists everywhere in today’s real estate market but real estate investors are missing out on this opportunity because of their desire to have things as they were. The problem is that ‘things as they were’ was a very bad business plan and the collapse caused by lending problems is exactly what created the opportunity we see in the market today.

Everything in the real estate business is a give and take. This truism definitely applies to lending. How much opportunity are real estate investors and developers loosing by not playing by the rules of today’s lending market place?

Think about this, while investors bemoan the cost of a hard money loan, a blanket loan or a bridge loan, the projects they could be working on are being snapped up by other investors that are playing by the rules.

Sure, there is a cost of opportunity and that cost is easily calculated and can be worked into the transaction to make sure that the numbers work. However, there is also a cost of inaction. I refer to this as the Cost of Lost Opportunity.

What is the cost to the real estate investor, developer and contractor that loses a deal because they would not operate within the confines of current lending standards? What is the cost of allowing a competitor’s business to grow while one’s own business languishes and stalls? Think about it…