S.E.C. Real Estate Observer

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WHERE THERE ARE REAL ESTATE OWNERSHIP BENEFIT PROBLEMS OR OBJECTIVES TO BE ADDRESSED, THE EQUITY MARKETING PROFESSIONAL HAS THE TOOLS TO BE SUCCESSFUL.

Equity Marketers do not have the kind of tool box that a plumber or carpenter would but we do have a tool box just the same. I contend that some of the most important tools in our Equity Marketing tool box are FORMULAS. Their importance is going to be magnified during the current and immediate future real estate market conditions. In addition to the many formulas to help structure equity transfer transactions, there are formulas to help rent/lease vacant building space and solve financing and cash NEED problems. A few examples are cited below.

Whether we go over the political and economic “fiscal cliff” in January 2013 or not, the macro-trends strongly indicate that our government debt excesses and our private debt excesses in America will have the imbalances corrected. It will happen in an organized manner over some time or it will be corrected in some more chaotic and/or catastrophic manner in the near future. Japan has been able to “kick the spending/debt can” down the road for nearly 22 years by borrowing 50% of what the government spends every year, building a national debt that is 230% of GDP. Most of the rest of the world economies have increasingly joined in this budget deficit and borrowing binge over the past decade. Every day that passes, the ability for governments and central banks around the world and in the USA to put off and deal with debt excesses is becoming more difficult and potentially with higher risk of causing more harm than good. No matter what one’s political label or leaning might be, the numbers, facts and the math cannot ultimately be papered over (pardon the pun.)

The short-term past does not look too bad for real estate. The headlines are positive. According to the CoStar Group November 2012 report, commercial real estate prices as a whole on a national basis are up significantly in all segments except retail. In some locations and market segments, prices are heading back towards their halcyon days of 2007. Even “user” land prices are rising in some locations. New home construction has recently shown large percentage increases (Check the actual numbers for a more realistic picture). According to the National Association of REALTORS, resale homes are also showing signs of increased sale volume and some increased prices on a percentage basis. The actual numbers are not as impressive in a headline as the percentage increases. The problem with these numbers and short-term trends is that they are historical. Because there are so many conflicting trends and possible negative economic and political factors, it is possible that the positive short-term numbers are not at all indicative of the trends forward for the next six month to three years. It is possible that U.S. and International political and business leaders will begin to resolve the economic headwinds and that our business recovery will be back on track in an orderly manner. If that is what happens, the real estate industry will go into an orderly recovery and our business future will continue to brighten as some of the market numbers in the third quarter of 2012 indicate.

What if U.S. and International political and business leaders do NOT begin to resolve our many economic problems in an orderly manner and maybe even take actions that make the economic recovery more difficult? What do we do in real estate in the next six months to three years if there is no orderly recovery but a further downturn?

• FIRST, prepare to operate and close transactions with far fewer purchasers with cash and much more difficulty in obtaining financing at any loan-to-value ratio.
• SECOND, prepare to have to counsel more thoroughly and effectively because a large portion of principals in the market are going to have to settle for what they NEED in a transaction rather than what they WANT. I suggest the even buyers with cash will be less able to acquire quality properties at the deeply discounted prices they WANT.
• THIRD, expect that the ability to close transactions to meet the NEEDS of principals will potentially depend more on multi-property transactions with small amounts of cash and low levels of financing available.

When the sale market it limited (or maybe non-existent), financing resources are very hard to obtain and investors are either on the sidelines or have become vultures, what can be done when the principal NEEDS to make a change in an ownership situation? I predict that it will take some time for principals and their advisors to acknowledge the “real” market conditions. I also predict that there will be a growing number of principals who both NEED and recognize/understand that they NEED to take some action to change their ownership situation.

Enter the Equity Marketer with a full formula tool kit. Every situation is different but there are common elements that might fit one or more formulas to achieve the desired result for the principal. Let’s consider a few example situations to get your creative thinking ginned up:

• MORTGAGE BALLOON: Suppose we have a retail center (could be office building, industrial building, etc.) with enough vacancy and market comparables to result in a significant appraisal value decrease. The problem is that the existing mortgage has a balloon in six months. Even though we are current on the mortgage payments and there is a small positive cash flow after debt service, the current mortgage balance is just about the amount a current appraisal will show. The lender might renew the loan but not at 100% LTV. A really simple formula that would apply is “ADDITIONAL COLLATERAL.” If the principal has additional property or other assets that could be pledged to reduce the loan-to-value ratio, the lender might renew the loan without a principal reduction. In some cases the lender might rather have your restored vintage collectable show car or some business accounts receivable than other real estate as the additional collateral. Also, don’t forget the coin or stamp collection of significant value. What if the principal does not have any other property or asset that is acceptable to the lender? Maybe we could “rent” the needed collateral from a third party for payments. Maybe we can acquire the needed additional collateral with some minority ownership in the refinanced property or a combination of payments and ownership. This formula will only work if the action is taken to pro-actively go out into the market and initiate WRITTEN offers to obtain the needed collateral.
• NEED A QUALITY TENANT: We have a vacant industrial property that needs substantial tenant improvements to be able to obtain a quality tenant. The owner does not have the funding resources needed for the improvements. An assumption in this case is that the value of the building will be greatly increased (over and above the cost of the needed tenant improvements) when the tenant improvements are completed and it is occupied by a quality tenant(s). This might be a situation for an “EQUITY PARTICIPATION LEASE.” Let’s suppose we can find a quality tenant that would be a good fit for the space but they are not even thinking about relocating. Besides, even if they are looking for space, why should they relocate to the subject building? In simple terms, we are going to “sweeten” the deal by offering the tenant a minority ownership in the building for “$10.00 and other good and valuable consideration” if the business will relocate to the subject building on lease terms sufficiently favorable to the landlord that the value of the building will be substantially increased. With the quality lease in hand, it becomes more possible to finance the needed tenant improvements. In some cases, the tenant might provide their own tenant improvements at their cost in exchange for a larger portion of ownership in the building or might become the lender to provide the tenant improvement funding. The effectiveness of this formula is in the extent to which the original principal owner of the building has an ownership value equal to or greater than the original vacant building value after delivering a minority ownership to the tenant.
• PRINCIPAL NEEDS CASH: An owner of a valuable investment property NEEDS CASH for a purpose that can only be satisfied with cash. The subject investment property is a solid and marketable income-producing asset. However, a current quick sale would probably require a discount to the real long-term value of the property to the current owner. In addition, the principal’s cash need does not even require all of the current discounted price equity in the property. This situation fits the “’DISCOUNTED SALE OPTION BUY BACK” formula. The property could be sold at a discounted value sufficient to provide the NEEDED cash with the Seller taking back an option to repurchase the property with an investment profit return to the buyer over some period of time. The Seller might also lease back and operate the property to protect their asset.

An alternative in this situation might be to go back to the “ADDITIONAL COLLATERAL” formula. Suppose the owner has additional collateral or can obtain it from a third party. It might be possible to obtain a new first mortgage or second mortgage on the subject property to obtain the NEEDED cash. It might be possible to use the subject asset as additional collateral to obtain financing on some other property in the owner’s portfolio.

We could go on for many more pages of examples. My point is that we, Equity Marketers, have some amazing formula tools to meet the NEEDS of principals even in crisis down-cycle real estate market conditions. If you have taken a formulas course(s) or accumulated materials on Equity Marketing formulas, go back and review them. If you have not taken any classes or accumulated the available formulas materials, DO SO as soon as possible. If you are a real estate principal or an advisor (attorney, CPA, investment advisor) and you have not been introduced to the many formula tools and the use of multi-property transactions available to you and/or your clients, contact the Society of Exchange Counselors to find out when and where such education is available. The Society has some published materials available and can provide a list of Society Member Equity Marketers across the U.S. and in Canada.