Credit For Small Business May Be Tightening

April 28, 2008
| By Pete Daly |
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Real estate sale/leaseback arrangements are growing in popularity, perhaps due to increasing difficulty of small businesses in Michigan to find loans for expansion.

Michael Rogers of the Small Business Association of Michigan said that something is going on regarding the credit available to small businesses— "and it's really accelerated in the last year."

Rogers, vice president of communications for SBAM, said an annual SBAM survey of 200 small businesses always asks the respondents to give a positive, negative or neutral rating to their accessibility to credit for expanding their businesses. Sixty-three percent of SBAM members have from five to 50 employees. In the 2007 survey, the “negative” ratings on credit accessibility were the highest since the survey began in 1993, Rogers said.

"It's very startling to us to see how bad things have gotten in the last year."

He said the perceived tighter access to credit for small business is partly a reflection of the weak economy in Michigan. But he added that SBAM staff have "also heard from companies and people in the financial industry that it is a consequence of the sub-prime mess just trickling down through the financial industry."

Real estate sale/leaseback financing is when a business sells its commercial property to a real estate investor and immediately leases it back on a long-term basis from the new owner. The sale contract is built around the terms of the lease.

With a lease, the company can deduct the full payment each month; with a loan, however, only the interest portion of the repayment may be deducted, said Patrick Mohney, an investment broker at NAI West Michigan.

"The other benefit is that you can sell the property on your timeframe and terms," said Mohney.

Real estate sale/leasebacks are not new, said Mohney.

"Some of the bigger businesses have been doing these for years," he said. "Some of the real reasons why these things are going on now is, business needs to focus that capital on business operations.

"Every year, business gets more and more competitive. The days of having capital in a business that isn't doing anything to further the business objectives are over," he added.

Professional real estate investors typically have better access to large amounts of capital at better interest rates than the average business owner, said Mohney.

A firm that wants to sell its building to a real estate investor and then lease it back must be in good financial condition, with good prospects for the future, because it will undergo a great deal of scrutiny by the buyer. That's because the buyer is paying well above the price that would be asked if the building were vacant. A building already occupied by a reliable tenant on a long-term lease makes that building a good income property.

"Usually, the underwriting of the lease is similar to applying for a commercial loan," said Mohney. "The better the tenant, the greater the value of the lease, and the purchase price will increase accordingly.

"West Michigan is seeing a lot of these sale leasebacks specifically because cap rates across the country are different."

It is possible to find higher cap rates here than, say, in New York or Los Angeles, where cap rates might typically be four or five.

"They can come to West Michigan and buy a similar investment at an eight or even a nine cap," said Mohney.

A capitalization rate is a measure of the ratio between the cash flow produced by an asset (usually real estate) and its capital cost — the price paid for the property or, alternatively, its current market value.

A building purchased for $1 million that produces $100,000 in net operating income in one year has a cap rate of 10 percent. A lower cap rate indicates a safer investment, which increases the price of that investment property. Capitalization rates are an indirect measure of how long it takes for a real estate investment to pay for itself in net cash flows.

The health of the company leasing the building, the health of the industries the companies are involved in, the length of the lease and other details all help determine the cap rate. A qualified investment real estate broker spends a great deal of time "talking with a business and looking at numbers associated with that business," said Mohney. From that, he tries to determine the cap rate.

"A very high cap rate is highly speculative. There's a good chance the investor is going to be left with the real estate" unoccupied at some point, said Mohney. CQX

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