Commercial Loan Default

News reports in the last few days indicate that small Lackawanna County banks are increasing reserves for potential failed commercial loans.  This should come as no surprise as banks around the country have already, or will in the near future experience increased default on commercial loans.

The reasons are complex but understandable.  Commercial real estate is frequently purchased using a fifteen or twenty year payback plan (amortization schedule.)  However, built into that is a usually a reset of the interest rate and review of the performance of the real estate pledged for the loan, typically every five years..

With the general level of business down, commercial businesses have been hurt.  Locally, retail is the hardest hit, with manufacturing second, office rental third and apartment rental the least.

In a typical downtown office building, we might find shops on the first floor and offices above.  Most landlords are experiencing higher vacancy retail and reduced office rental.  Firms may be reducing the size of rented offices, or moving to lower priced space or lower priced properties.  The result is less income for the landlord.  At the same time, the landlords may be experiencing increased costs.  The PPL electric rate increase is a good example.  Rates will increase by about 30% on January 1.  Total electric buildings will be hit particularly hard.  At the same time, tenants will be reluctant to accept rent increases, even those that are clearly justifiable.

When the bank does its five year review, income may be down and expenses may be up.  Commercial real estate is valued the amount of money left after all the bills are paid, called net income.  A reduced net income means the property is worth less than before.  National figures are as high as 50% less.  Local values are probably not as dramatic.

However, whatever the change a bank may be wary to renew the loan on the same times when the asset securing the loan has diminished in value.  Problems are particularly acute when the owner has borrowed a substantial amount of the value of the property (called highly leveraged or aggressively leveraged in real estate terminology)

Assume we have a property originally appraised at $1,000,000.  The owner aggressively leveraged the building and borrowed $900,000, putting $100,000 down.  At the five year review, the principal has been reduced by $50,000 leaving a balance of $850,000.  The landlord’s net income declined by 10% and as a result, the building is only worth $900,000.  In additional to the decrease in value, the bank is currently taking a more conservative approach to lending and will only loan 60% of value rather than the 90%.  In this case, the bank might renew the loan at $540,000 forcing the landlord to put up an additional $310,000 of cash or collateral  If he has the cash or collateral, he can survive but if not, foreclosure is around the corner.  In extreme cases, owners have simply given the keys to the bank.

As a renter, you may find this scenario academically interesting but unrelated to your situation.  So what if the landlord defaults?  First, all leases are null and void in a foreclosure.  So let us assume  you just made substantial improvements to your office and the current landlord, who was happy to have a tenant at all, gave you a break on the rent for the next five years in exchange for your investment.  The bank or new owner arrives after the foreclosure, sees your beautiful office and low rent and gives you a whopping rent increase.

The lesson is to “choose carefully.”  Select a landlord who has a record of success and one whom you know to be a conservative, substantial owner.  Avoid doing business with those who are “on the edge.”

MEI Employee Featured in Press

Justin Bullaro was one of the subjects of an article in the October issue of Happenings Magazine.  Like many members of the MEI maintenance staff, Justine is a graduate of the Lackawanna County Vocational Technical School.  The article discusses his decision to follow his career path in Northeastern Pennsylvania rather than seek employment elsewhere.  

An unsolicited letter from a MEI tenant appeared in the November edition of Hpeenings and is reproduced below.   

Dear Happenings:

I can’t tell you how happy we were to see Justin Bullaro featured in your “Meet the Keepers” (October 2009) copy story and article.  Justin is not only worth his weight in gold here at the Scranton Professional Arts Building but he is genuinely a great guy.  Thank you for the great article… we love Happenings!.

Kathy Colombo Lackawanna Valley Dermatology Associates

Management Enterprises’ President published in Journal of Property Management

Louis Danzico, president of Management Enterprises, has written a recently available whitepaper called “Housing the New Elderly: renovating Geneva House, an apartment building for the aged,” published in the Journal of Property Management and now available from Amazon.com

This digital document is an article from Journal of Property Management, published by Institute of Real Estate Management on July 1, 1992. The length of the article is 2069 words. The page length shown above is based on a typical 300-word page. The article is delivered in HTML format and is available in your Amazon.com Digital Locker immediately after purchase. You can view it with any web browser.

Tips for First-Time Office Renters

So What’s Your Plan?

 Are you a first time renter and currently looking for office space?   Here are some helpful tips on how it works.  

Many businesses begin operations from the owner’s home. Although it may constitute a zoning violation to operate a business in a residential district, a small home business carefully operated is a good startng point.  

A new business should have a business plan. Most Chambers of Commerce are associated with a Business Development Centers and the Small Business Administrtion.  The SBA. will assist you in developing a business plan which can be very helpful.  The cost is iminimal.  Once the business is up and running or if the nature the business demands an office, the hunt for appropriate office space begins.   

Location, location…

If you are a new business, a well known address will add credibility to your company. Could any business located in Rockefeller Center be bad? An exaggeration of course, but you get the idea. If your an established business, you probably are already well known, so location is less critical, but not unimportant.  

Office buildings are classified in the industry as either A, B, or C.  In between are the + and – of each catagory.  Class A is the top notch best building with all the modern ammenties.  Classs B might be older building maintaind in first class condition.  Class C buildings are those that either have not been well maintained or may be so old as to be functionally obsolete.  

The location for your business depends on local custom. In small cities, retail is always first floor and offices are usually upper story, although they can be first floor if properly done.  Service businesses, which deal with the public only by phone, fax or email, can be on a lower floor, particularly if there is a service component such as a computer repair shop.  If the service business deals with the public, it should have a street presence.

 

If you business does not entail customers coming to your office, you can select the building that offers the best package at the lowest price.  However, make sure that the life safety systems (sprinkler, smoke and heat detetors, functional stairwells) are all in place and operating.  

Talk to a few tenants in the building and get a sense of how operations are done.   Look for an owner office on site or professional management by a CPM (Certified Property Manager) or AMO (Accredded Managment Organzaion) firm.  

The next step is space planning.  Think about the number of rooms you need, how the room occupants interact with one another and major office equipment.  A competent building manager will be able to create an office design  based on your needs.  

Negotiating the lease.  Lease rates are based on the operating needs of the building and the improvments or changes you require to make the available space into your office.  Depending on the length of the lease and required improvments, you may be asked to contribute some funds to the contract.  

 

First Things First

Does the building have curb appeal? Does it present an image complementary to your business.Is it in the right location for your business. Lawyers traditionally want to be close to the courthouse, doctors wnat to be near a hospital, and so on.

Does the building offer the amenities you need; parking, highspeed internet?.  How is maintenance handled. Is there on site staff? How about after hours emergencies?  How is management handled. Is there a management company, or is it a Mom and Pop operation (not necessiarly bad.)

Your office/store

Can the space be modified to suit your needs; walls moved, rooms created?   Will management prepare a plan of the finished space. Will they come to your office to evaluate your operation, furniture and equipment and create a plan to fit you.

Who will pay for the renovations?

Can you select paint and carpet?

The Documents

What is the length of the lease.  Are their charges other than monthly rent.  How are rent changes implemented?  Talk to the existing building tenants if possible. They will provide you with the best references.

A long lease precludes the possiblity that you will be asked to move.  A the same time, a new business may want to have an out during the first year of the lease in the event that things don’t go as planned.