Shelley L. Bennett’s Blog

Hello all!  I hope this finds your offices having a busy week of summer buyers and sellers.  We have a great new listing this week for lease: 

Premium, downtown Pullman, WA space.  Office space upstairs and 2000 +/- s.f. retail frontage that opens up to the plaza and has immediate access to the Pullman trail system.  Perfect for a retail shop or restaurant.  Just in time for the  WSU students to return!

Here’s a great article my one of my agents passed along to me on financing basics….get your calculators out and enjoy!

Commercial Real Estate Financing Basics

Published on Tuesday, December 9, 2008, 12:55 PM Last Update: 1 year(s) ago by Howard Dutra

Category: All Articles » Commercial

Getting a loan for your investment property has become a real challenge. During the last six months, we have watched as lending criteria have morphed and Lenders are scrutinizing loan applications with missionary zeal.

Multi-family buildings with greater than four rentable units are treated as commercial properties. So are office buildings, commercial/industrial properties and retail space. The lending process is somewhat different.

1. Banks will usually not finance more than 75% of the appraised value of the property.  Frequently that number can be as low as 65% of the appraised value.

2. Properties must show sufficient debt-repayment ability by way of a ratio of 1:20X or higher. (See last months newsletter for a discussion of this topic).

3.  In case that the property financed is occupied by a sole tenant (commercial warehouse) the lender might want to take a look at the financial strength of the tenant.

4. Owners will need to provide an updated rent roll to the lender, which might require this drill every year.

5. The term of the loans are shorter, generally 20 to 25 years.

6.  If the property is not residential in nature, the lender might require an environmental audit (phase-I) to find out any possible contamination of the site.

Analyzing the debt Repayment ability of Income Producing Property

In order to give you an idea of the analysis that Banks do for Income Producing Property, take a look at the following cash flow analysis for a 2nd Mortgage request that I prepared a while back, (Names have been changed to protect the innocent)

Cash Flow Analysis for the Utopian Apartment Building

located at 1234 Main St. Anytown, FL.

This analysis retains the 1st Mortgage as per borrowers request

Debt Repayment Ratio: 0.79X (Insufficient)

As you can see the property could not pay the debt. The most important number in the above analysis is the Debt Repayment Ratio ( Net Operating Income / Total Annual Debt Burden ). A smart borrower will know what kind of a debt repayment his property can carry in order to obtain the most money from the Bank. To calculate the maximum loan amount you need to know the answers to the following questions.

1. Your Net Operating Income?

2. The interest rate that the Bank will charge?

3. The lowest debt-repayment ratio that the institution will accept (this is usually 1:20X)

4. What kind of an amortization schedule is used for this type of facility.

a) The bank charges Prime + 1% for this type of facilities when it is secured by a first mortgage, and Prime + 2% when it is secured by a second mortgage.

b) The Bank tries to approve loans with a debt repayment of ratio of 1:25X, but the credit policy states that the lowest is 1:20X.

c) The Bank uses various amortization schedules but the most favorable ones for this type of facility are based on a twenty-five (25) year amortization with a seven (7) year balloon.

Armed with that information you do some math:

$92,455 / 1.20 = 77,045 <==== Maximum Debt Burden.

Finding out the Market Value of Income Producing Property

Obtaining a loan without an appraisal is very difficult, expect to have to pay for one (most commercial appraisals are at least $1,000 with the average being $1,500) A professionally prepared appraisal will use all three methods to come up with an estimated value for the property.

There are three methods of estimating a market value for a property.

1. The Cost Approach: This approach adds the cost of constructing the building, deducts the depreciation, adds the value of the land, and adds the value of the improvements. It is used mostly for newer buildings since there would be very little depreciation.

Ex:

2. The Sales Comparison approach: Self-explanatory! The appraiser will go around looking for comparable sales, it will assign a certain modifier to each in accordance to how much they resemble the property to be appraise and come up with an average.

3. The Income Capitalization approach: which is the one that concerns you as an investor of Commercial Real Estate is calculated the following way:

9.5% X .75% = 7.13

10% X .25% = 2.50

Cap. Rate 7.13 + 2.50 = 9.63%

Then it is a simple matter of dividing your Net Operating Income by your capitalization rate:

$92,455 divided by 9.63% = $960,072

This is the value of the building, and it is the most you should pay for it in order to obtain a 10% rate of return on your investment.

Big news!  In May, I kicked off the Palouse’s only real estate company tailored for Moscow’s and Pullman’s commercial needs…Palouse Commercial Real Estate.  We began with over 25 listings, and I’m pleased to say that business has been brisk.  Despite recent challenges the economy has presented, sellers have resigned to lower their pricing, which has translated into some great deals for buyers.  Land sales have been particularly good. 

On the financing front, we are still waiting for the banks to start lending again. Then things will really be looking up. All you local banks that continue to lend to our buyers….thank you. 

The attached article notes the benefits of taking advantage of the great interest rates available now.  Read and enjoy!  Until next time…call our office at (208) 882-3800 or email me at  sbennett@palousecommercial.com if we can assist your business.    

Low interest rates heighten appeal of buying a building for your business

by IBR Contributor
Published: July 12,2010
Time posted: 5:00 pm
Tags: Commercial Real Estate, financing

Danny Lawson
Dolan Newswire

With interest rates down to a level not seen in years, businesses interested in financing or refinancing an owner-occupied facility may be able to save thousands of dollars a year on their largest fixed cost.

Owner-occupied professional offices, medical buildings, and retail/industrial warehouses are typical examples of properties that will benefit the most from today’s lower rates.

While most qualifying facilities are used entirely by the borrower, “owner-occupied” doesn’t mean the door must be closed to other occupants. Banks usually allow an owner to lease as much as 49 percent of the premises to a paying tenant.

Why buy?
If your business is currently leasing facilities, ownership could reduce your costs. Mortgage interest is generally deductible as a business expense, but check with your tax advisor to make sure this applies in your situation.

As your own landlord, you’ll also have more flexibility and independence in making decisions. Perhaps most satisfying of all, you’ll have the freedom to buy or build exactly what you need.

Choosing a loan that suits your cash flow
Financing on newly purchased or constructed owner-occupied real estate is typically based on a maximum 80 percent loan-to-value ratio.

Owner-occupied real estate loans generally fall into two categories: full-term amortization, or balloon financing. Either one can give you interest-rate protection for as long as seven years.

Full-term loans are often based on 15-year amortization. Many owners choose rate adjustment every five years, but protection for one, three, or seven years is also available. At these intervals, the rate resets to a certain margin over the current yield on comparable Treasury securities.

Balloon loans typically have a fixed rate for five or seven years, with amortizations up to 20 years. A balloon payment is due at the end of the rate-protected term. At that time, the owners can apply to renew the loan at a new fixed rate and term.

If you’ve been thinking about buying, building, or refinancing business facilities, today’s low interest rates could make this the perfect time to act.
***
 

It’s been a long time folks! It is my goal to give you the most accurate up-to-date information on the commercial real estate market. In order for that to occur the information needs to up-to date by the time it reaches me. As you are aware the market has changed significantly over the past months. It seems we were getting different information on a daily basis.

As the dust starts to settle we are beginning to see new legislation proposed to try to help prevent future collapses of the real estate market.  Published in the ICSC news letter Friday, December 18, 2009 issue is the following that may be of particular interest to most commercial real estate owners and business persons:

Will Congress Let the Estate Tax Expire?

As of this writing, all indications suggest that Congressional tax writing committees will allow the Federal estate tax to expire on January 1, 2010.  Senate Democrats have said they will try early next year to pass retroactive legislation to ensure no lapse in the estate tax.  If Congress succeeds in reinstating the tax retroactively, court challenges are likely against the Internal Revenue Service (IRS) with opponents alleging that the tax violates the Constitutional ban against ex post facto laws.  The Supreme Court, however, ruled in a 1994 case (U.S. v. Carlton) that the ex post facto ban did not apply to tax laws.
If the Federal estate tax disappears it will be replaced by a capital-gains tax paid when heirs sell inherited assets. In 2011, unless Congress acts, the estate tax will return to tax estates above $1 million, or $2 million for couples, at a 55% rate.
Current law provides a basis tax break for inherited property.  Heirs can “step up” the basis of any property they receive to its fair market value on the day that the original owner died.  If the estate tax disappears is or repealed heirs must carry over the departed’s basis in the property and this has significant capital gains ramifications for property that has greatly appreciated over the years.

Credit Help for Small Business

Year end legislation currently being considered by Congress contains an extension of funds for the Small Business Administration’s (SBA) 90% guarantee rate for 7(a) loans and to continue fee waivers for borrowers through the end of February 2010.  The “Jobs Bill” that the House passed this week also contains an extension of funds for these SBA programs through Sept. 30, 2010.  The Senate is expected to have final passage this weekend on the spending bill, but it is unlikely the Senate will be able to address any “Jobs Bill” measures until January.  Funding for the SBA loan programs was exhausted on Nov. 23 and since that time many small business owners are waiting for loan approvals - while many others wait on the sidelines to see what action Congress takes.

Carried Interest Legislation Delayed

Earlier this month, the House of Representatives passed tax legislation to significantly increase taxes on real estate partnerships.  The original targets of this tax increase were private equity and hedge fund managers who often utilize a “carried interest.”  In real estate this practice is commonly referred to as a “promoted interest,” “promote,” or a “carry.”  The carried interest is a financial interest in the future appreciation of a real estate development project often negotiated between limited partners (LPs) and the general partner (GP) in the venture. In real estate the carried interest, which has traditionally been treated as a capital gain and taxed at 15%, aligns the interest of the GP with the LPs and recognizes the entrepreneurial risk and liability that the general partner takes on for the partnership.  This stake is often hard to value as it is not guaranteed income to the GP.  Under the proposed tax increase, the carried interest would be treated as ordinary income at the 35% rate and would also be subject to self-employment taxes, representing approximately a 150% tax increase on real estate partnerships.   

Further consideration of this tax legislation by the U.S. Senate is unlikely before the end of the year thanks to significant grassroots opposition from ICSC members and others.  It is our understanding that the U.S. Senate does not intend to increase the taxes on carried interest due to the potential unintended consequences associated with it.  ICSC believes, however, that additional consideration will be given to the proposal next year in conjunction with a larger tax reform debate. 

 As the current down cycle continues to grip the nation many are concerned about whether their business will make it through.  According to Peter Hobbs, managing director of RREEF, the Asset Management Division of Duetsche Bank (as quoted in the May issue of Urban Land Magazine) “the good companies are getting their balance sheets in order so that they can go out and exploit the cycle in that countercyclical way” and the downturn will be “awful, deep and long.” This is not to say that all areas of the country will be as impacted. In fact, according to msnbc.com and Moody’s Economy.com Idaho and Washington are among the five states to recover first. 

Smaller areas that were in trouble before the downturn will be hardest hit. Cities, such as Moscow and Pullman, where creative people live will fair the cycle much better, perhaps even coming out on top. As residents of the Palouse Region we should all be aware of what makes our area so great. We have activities such as the Moscow Farmer’s Market on Saturday’s, Pullman’s Wednesday Farmer’s Market, Art Walk, Rendezvous in the Park Concert Series, Lentil Festival just to name a few.  As the time gets closer to some of these events I would encourage all residents of the area to pick up a visitors guide from their local Chamber of Commerce, get more information about the area you live in and become more involved in your community.

The economy of Moscow/Pullman has been stable thanks to companies such as Schweitzer Engineering Laboratories, Gritman Medical Center, Washington State University and University of Idaho. The creativity in the Palouse Region combined with our stability will help our region. Our residents need to keep in mind as they continue to hear of all the troubles in other parts of the country that we don’t feel the harsh swings. We never get too high and we never get too low. With so much focus on what is going wrong with the economy in the country now may be the time for us to focus on our economy at home. Together we can all help make the Palouse the best it can be.

If you rely on sales headlines you could be being misled. According to John Burns Real Estate Consulting sales volumes have not bottomed out. John Burns Real Estate Consulting specializes in collecting and analyzing real estate data. Sales have risen in the West (west of the Rockies) while continuing to decline elsewhere, although at a slower rate more recently.

Reporters have been trained to use Seasonally Adjusted (SA) data, which can be misleading. While there is merit to the SA numbers they can fluctuate based on sample size, weather, or any number of other issues. The issues affecting the numbers are usually addressed in the body of the story but most people will not read the entire article for the details. For more information go to; http://www.realestateconsulting.com/Newsletters.aspx?quicklaunch=true&newsletter=US/us200904

The Pullman Planning commission held a public forum on April 29, 2009 to discuss its proposed urban growth area. Part of the proposed area the City of Pullman would like to grow into is along Kitzmiller Road. This area of the county is zoned as cluster housing which allows for 20 acre parcels to be divided into smaller lots of not less than one acre. The residents of this area as well as the residents of cluster housing along Country Club Road, to the south of town, were very vocal in their opposition to the cities future plans of annexation. The proposed plan calls for the area along Kitzmiller Rd, after future annexation, to be zoned as High Density Residential, a drastic change from the county zoning currently in place. This type of zoning stipulates no less than seven dwelling units per acre be built. Current Kitzmiller residents were very upset with the possibility of their rural neighborhood being developed with apartment complexes.

Other areas of concern among the attendees were:

The proposed south by-pass (to get the large trucks out of downtown) which would run nearly parallel to Bishop Blvd and meet up with Hwy 270 near Airport Rd. A few residents along this route were in attendance and opposed the route of the bypass.

One property owner, Gary Kopf, was in attendance as a representative of his family. He requested of the Commission that nearly 80 acres of his families land be annexed into the city and have services provided to the area in order to attract larger retail businesses as well as hotels.

At the end of the evening the Planning Commission stated it will take into consideration all public input. Ultimately, however, they will to make a decision that will benefit the most people. While there are still many details to be determined as to the actual growth area, it was clear that the city will not be able to make everyone happy.

Since CoStar Group, a commercial real estate information company, began tracking retail trends in 2000 the retail market has posted a negative net absorption for the first time First Quarter 2009. Retail leasing has dropped off by 9 million square feet creating 24 million square feet of negative absorption and a vacancy rate of 7 %. Landlords are beginning to respond to the downturn in the market by lowering their asking lease rates by an average of nearly 10%. (Information taken from CoStar Group Newsletter)

The Moscow retail real estate market, as you may already know, is not immune to the negative absorption seen around the country. Moscow currently has listed 151,000 +/- SF of commercial space available. This does not include the recently vacated Karl Tyler space or the former James Toyota dealership space. This news is not all grim however.  It has been many years since Moscow has seen such opportunities. Property on the main strip through town previously thought to be unattainable is open. While the strip may be a highly coveted retail area landlords will need to be aware they will need to be flexible with their asking lease rates as well as tenant improvements. Remember Moscow is not immune to the market fluctuations.

As we begin to see some turnaround in our economy now is the time to start thinking green. If our situation is to truly change and we are to become independent of foreign energy sources then we must start to look at renewable energy.

The way we build needs to change. We cannot continue to simply build with no regard for the future. Our infrastructure must be sustainable, it must be efficient. In the past this type of thinking was on the fringe - that time has passed. The economy will comeback, things will get better. As this happens we have a chance to start changing the way we look at the world around us.

The builders of Moscow/Pullman real estate need to consider that younger; more eco-friendly consumers are coming into the market. This is not a fringe group. This is a generation raised on “reduce-reuse-recycle”, a generation that expects new building to be of high quality and built sustainably with minimal impact on the environment.

We are at cross-roads, as a country we can continue on the path we have been on for centuries or we can collectively choose the path that leads to a greener future for ourselves, our children and our grandchildren.

As the national economy continues to spiral downward the Moscow residential and commercial real estate markets can take heart. Latah County has not seen the drastic drop other areas of the state and country have seen. According to the Idaho Business Review in the month of February Latah County had just one filling for foreclosure. In Ada County the number is 1 in every 140 homes, Canyon County is at 1 in every 219 homes. This discrepancy can be attributed to the stability of our commercial markets. We have two major state universities and Schweitzer Engineering Laboratories (SEL) to help stabilize our area. Not only have we not seen the massive layoffs SEL continues to hire. We also have growing opportunities in the Moscow-Pullman Corridor with major developments still planned to break ground within the next year or two. Moscow also has unprecedented opportunities in its downtown area with the development of the URA district as well as opportunities in its main retail strip on Third Street.

When times are tough people will inevitably look for a good deal. This is true with commercial real estate as well, the Moscow Idaho Real Estate market is no exception. As a landlord you will need to be prepared to negotiate the terms of any lease. While you do not need to give in to every demand of every tenant you do need to be flexible. Every tenant and every situation in different, you will need to be prepared for tenants, current or prospective, to want to negotiate their lease. Reduced rates, improvement allowances and free rent are some of the most common concessions landlords are making to either get or keep tenants. Do not be surprised if a tenant asks for one or more of these things.