Commercial Lending

<font size="3" face="georgia,palatino">Yesterday I spoke with a developer selling medical/dental office. He told me that despite the lack of financing in general, doctors and dentists were still able to find financing through SBA loans.</font>

<font size="3" face="georgia,palatino">This is confirmed by an article from NREI Online:</font>

<font size="3" face="georgia,palatino">While office building transactions have fallen off a cliff in recent months, one bright spot many industry analysts point to is the medical office building market, where sales typically range from $10 million to $30 million. According to the latest data from Real Capital Analytics, sales of medical office properties totaled $3.3 billion in the first nine months of 2008, a 13% drop compared with the same period a year earlier. But that dip pales in comparison to the 62% dive in property sales for the entire office market in the third quarter.</font>

Imagine that little retail center near your house.You know the one.

It has your favorite coffee shop, the weird home decor shop, a woman’s clothing boutique, the nail shop, and the national auto parts store.

Over the years you’ve seen the stores change. Different shop owners have come and gone. The coffee shop has been there for a while. The woman’s clothing store is only a year old.

As you drive by you notice a “Going Out of Business” sale going on in the home decor shop. You’ve talked with the owner of the woman’s boutique and she is having a rough time making a profit.

If these two stores close their doors, you wonder who is going to fill this space. What is going to happen to the owner of that little retail center? Where will he find tenants?

The Plight of Retail Stores

Americans are spending less money these days. We built our economy upon the model of consumption and borrowed to fuel that consumption.

With the well of cheap financing depleted, spending has come to a screeching halt. Retailers nationwide are taking a hit. The recent headlines have featured the likes of Circuit City, Mervyn’s, Shoe Pavilion, and Linens ‘n Things.

The Pain on Retail Center Owners

When a retail store closes or “goes dark” the landlord will feel the pain of having a vacant store. (Some leases do have a provision that stores can close but while the tenant continues to pay rent.) This means that she does not have as much rental income to pay the bills she faces for owning the property.

How Vacancy and Rental Rates Affect Value

I shared here the most common method to value income producing property. The most important numbers to determine value are Net Operating Income (NOI) and the Capitalization (Cap) Rate.

Rental rates and the assumed vacancy rate will affect the NOI. NOI is then used to calculate the value of the property based on an expected return to the investor, the Cap Rate.

Slight Changes with Devastating Effects

So how would a 10% decrease in rents, a 5% increase in vacancy, and a 1% increase in Cap Rate affect a properties value?

Notice that the value decreases by 26%.

Also notice that the change in the maximum loan amount decreases by $1.08 million. If the borrower needs to refinance under these new assumptions, the borrower will need to come up with over a $1 million to close the loan. The foreclosure process and bankruptcy are not far away.

The Current Credit Crisis

Currently, some institutional lenders have begun to underwrite retail loans along the lines of this scenario. They are forecasting decreasing rents and higher vacancy rates.

Some lenders are incorporating a higher cap rate as well. (One developer I know said that he hasn’t started a retail project unless it underwrote at a 8% cap rate or higher because of historical cap rates, even during the boom times.)

Unless, a retail property absolutely must be refinanced now, the wise real estate investor would be best served to hold off until cooler heads prevail.

 I posted some afterthoughts on my post yesterday. Head over to Peter Pays Paul to check it out.

Yesterday I posted about the SF Chronicle article that argued in favor of gaming the system to get lower payments on your mortgage.

I realized as I was at home and with friends that from the title of the post, it may have seemed that I was advocating not paying your mortgage.

This was not my intention at all.

I've written before about the government's unintended consequences.

Today we read:

As we mentioned yesterday, a bit of a fight has broken out over whether it is irresponsible for journalists and others to advise homeowners about the options that the government's bailout programs are opening up to them. But the fact is for a lot of homeowners it makes perfect sense to stop payments on mortgages...and it may even pay to stop any overtime work or have one of the earners in your household quit.

You Might Want To Think About Stopping Your Mortgage Payments and Reducing Your Income.

(HT:Tom Vanderwall)