I am sure you are hearing a lot of negative things in the financial world today, but if you think about it carefully, it is of no surprise that we find ourselves in this financial debacle! I recall a few years ago sitting in my office hearing for the first time that mortgages are being offered with interest only (no amortization), high LTV’s, and oh yea, by the way, interest rates are now at a 50 year low! In other words, people with a pulse found it extremely easy to borrow money. I wonder how difficult it would have been for your pet dog to borrow money during this time.

The key thing I recall saying to myself is what will happen when this “blows up” and the “money pot” stops pouring out cash? We are living the answer to this question today! If you proceeded forward with one of these deals, chances are things may not end up so nice and picture perfect as one would have imagined. Yes, there are exceptions; one being the disciplined investor who not only purchased an interest-only loan, but also decided to make extra payments to lower the principal debt amount borrowed, which would have helped offset a potential disaster. Of course, this is not the case for the majority of people who found themselves as borrowers of these types of loans. These same people should have been praying that nothing would ever change in the world between the time of loan origination and when the loan comes due although this is neither a likely story nor reality.

I recall a few years ago when a Client sold an industrial building for $3 million cash and he wanted to do a 1031 exchange to avoid paying the government the taxes that would have become due since he had such a low basis in the property. He wanted to diversify his funds into three different transactions, knowing he would be passing his assets down to his children when he passes. For purposes of this message, I want to focus on one of the deals he proceeded to move forward with. He took $1 million cash equity and invested in a multi-million dollar A Class Retail Center in Ft. Meyers, FL. It seemed like a great idea at first because you had AAA Credit Tenants operating in this fully occupied power center. The problem with an interest-only loan does not surface in a deal like this until it is time to refinance and you know the interest on the debt will NOT be as low. Recall in the previous paragraph the buzz word of a debt environment with the lowest interest rates in almost 50 years!! What people fail to realize is that the leases are all pre-negotiated and rental increases for the initial term (and perhaps the option(s)) are fixed while the cost to borrow money in the future when the balloon payment is due is unknown, and just maybe it is possible that the rate increase on the new loan will have to placed at a rate that puts the project under water from day one. Can you imagine what can happen to the $1 million equity invested when there is not enough cash flow to pay the debt?

I don’t want leave you with a dark, grim picture of the world even though today it seems like we have gotten ourselves in a financial pinch that we feel we may not crawl out of so quickly, however, we always have and always will! In fact, I believe that there are good opportunities that are beginning to unveil themselves in the coming months. Over the past several years, I kept telling Clients that wanted to purchase commercial property that could not find affordable deals to hang on tight to their cash because one day the tables will turn and it will become a Buyer’s market while over the past 15 years, it has clearly been a Seller’s market. Several of my clients continued to bust my chops and said they simply don’t see that happening. Today, I am confident to say, “I told you so!” The only thing I could not have predicted is exactly when things were going to change. And of course, it did not take a genius to figure out that had you purchased commercial property back in the mid-1990s, held them for a few years, you could have sold and made money. Unfortunately, the party may be over for making money the easy way!

Today, the capital crunch is making everyone go back to basics. As the financial world gets back on track, underwriting standards and procedures are becoming more stringent; more equity is being required to invest in commercial ventures (30% to 40% is what I hear) and/or the cost for the mezzanine piece of debt (typically to bring a property from about 60% LTV up to 80% depending on a number of factors, of course that goes beyond the scope of this “lecture”) is rising substantially. And days of non-recourse financing are not as prevalent as they were in recent years. What does all this mean for investment opportunities? I believe the answer is lower purchase prices and higher cap rates!! I am already beginning to see these things take effect and the savvy folks who still have cash in their pocket will once again take advantage of these opportunities. Who was it again that originally said “Cash is King”? They could not have been more accurate!

I hope you found the information somewhat interesting and perhaps useful. I welcome the continued “conversation” with anyone that would like to reach out to me and discuss this (or any topic) in more detail. I look forward to servicing all your Commercial Real Estate needs!

Next Month’s Topic: Medical Investing in Medical Office Properties

Favorite Contact of the Month: E LANGAN Engineering & Environmental Services. For all your Engineering needs and Environmental Services, please contact Richard R. Steiner at (201) 794-6900 or email him at rsteiner@langan.com.