When business owners decide to borrow funds from a bank, one of their major decisions is whether to take a fixed rate or a variable rate of interest.
“There really is no correct answer, whether to choose a fixed rate or a variable rate when borrowing,” says Alfred DeFlaviis, chief lending officer and senior vice president and Gabe Makhlouf, first vice president of commercial lending, both at First State Bank.
Studies have found the borrower is likely to pay less interest overall with a variable rate loan versus a fixed rate loan. But, that doesn’t take into account that the longer the amortization period of a loan, the greater the impact a change in interest rates will have on payments. However, by asking a few questions, borrowers can make their final decision easier.
Smart Business spoke with DeFlaviis and Makhlouf about what you should take into account when deciding on a fixed or variable rate of interest.
What is the purpose of the loan?
Companies borrow for many different reasons, but the funds can be classified into two categories — short-term or long-term financing.
Short-term loans can be for, but are not limited to, payroll and accounts payables. Borrowers typically use a line of credit and repay the funds advanced as they collect their accounts receivable. Because you borrow the funds short term, borrowers typically elect a variable rate of interest. The variable rate is less than a fixed rate. Borrowers also repay the funds quickly so there’s a lower risk of interest rate fluctuations.
Examples of long-term borrowing could include equipment purchases, plant/office expansions, real estate purchases and business acquisitions. Borrowers typically need a loan term of three to 10 years or a real estate mortgage loan, usually amortized over 15 to 20 years. In this scenario, the funds are based on a longer repayment program, so you usually choose a fixed rate of interest. The repayment comes from cash flow generated from business operations. So, a fixed principal and interest payment amount factors into your company’s budget, and therefore is not subject to interest rate variations.
What is the current and projected interest rate environment?
When deciding between fixed and variable interest rates, you should take the current and projected interest rate environment into consideration.
For example, if interest rates are currently low and projected to stay that way for 12 to 24 months and you are considering a three- to five-year loan, a variable rate of interest could work. In this case, the fixed rate of interest offered will be higher initially so the variable rate option would be better. And should rates rise, if your cash flow allows, you can always accelerate the repayment by making additional principal payments to reduce the risk and the principal outstanding.
However, if interest rates are projected to rise, you might want to borrow on a fixed rate because you will have the security of a fixed monthly payment, whether rates rise or not.
Keep in mind that virtually all fixed rate loans come with a ‘prepayment penalty,’ which is enforced if the loan is paid off early.
What is your current financial position?
As with any obligation, borrowers must consider their ability to repay loans should interest rates rise dramatically, or even slightly.
If you have the financial ability to weather a spike in interest rates over the course of the loan, a variable rate might be the best option. Again, the initial rate of a variable interest rate will be less than a fixed rate and, therefore, the borrower will incur less interest cost.
If you have projected the repayment of the loan based on future revenues, rather than current, a fixed rate loan would be a better option. This reduces the risk of rates rising, which allows business owners to always know exactly what they will be billed monthly.
There really is no correct answer whether to choose a fixed rate or a variable rate when borrowing. The decision is based on so many variables that there is no fixed solution.
Alfred DeFlaviis is a chief lending officer and senior vice president at First State Bank. Reach him at (586) 775-5000 or Adeflaviis@thefsb.com.
Gabe Makhlouf is a first vice president, commercial lending, at First State Bank. Reach him at (586) 445-4856 or Gmakhlouf@thefsb.com.
Website: To compare business loans at First State Bank, visit www.thefsb.com/businessloans.
Insights Banking & Finance is brought to you by First State Bank
As a company weighs its options between signing a short-term and a long-term commercial lease, there are many things it must consider.
“Organizations need to weigh the benefits of locking in historically low lease rates long-term (seven to 10 years) or having the flexibility of a short-term lease,” says Steve Kim, a senior associate, Transaction Management, with Plante Moran CRESA. “Each comes with benefits and risks.”
Low real estate costs can help increase your competitive advantage. However, there are potential downsides to entering into a longer contract that need to be realized and hedged against to create maximum flexibility for your company.
Smart Business spoke with Kim about lease terms and how to negotiate the right conditions to suit your business needs, both today and in the future.
What crucial areas should a lessee consider when choosing real estate for a long-term lease?
When considering a long-term lease, a business should first determine whether the real estate is aligned with its strategic business plan. For example, does the space have room to accommodate your long-term growth plans? Does the building fit with your company’s image and brand? Conducting a space program is essential versus adding a percentage to your current square footage. This exercise will categorize and assign a square footage to all of your space, including conference rooms, executive offices, staff work spaces, common areas and storage, as well as account for future growth.
In addition, with building values at historic lows, purchasing real estate may be a viable option to consider, giving you the ability to lease out space until you need it.
What conditions would signal to a business whether a short- or long-term commercial lease is a more favorable option for a business?
Short-term leases offer a company the most flexibility, but they do have a downside. Lessees often don’t have as much room to negotiate terms and conditions in a short-term agreement as they do in a longer-term one. Also, landlords know all too well the cost of moving a business and could raise your rent at renewal, betting that you will not want to relocate. In addition to potential rate increases, there is no guarantee that you will be able to renew a short-term lease, especially if a large or long-term tenant needs your space.
Long-term leases will typically offer higher tenant improvement allowances, while short-term leases may require out-of-pocket costs by the tenant. But long-term leases also carry risks. Business conditions may change while you are locked into a long-term agreement, making it difficult to expand or contract your business based on a change in your strategic direction. However, an early termination option can be negotiated into a long-term lease to offer some flexibility while maintaining the security and extended savings.
What is an early termination option?
An early termination option allows you to opt out of your lease at a certain point in the contract, which reduces some of the risks that can come with being locked into a long-term agreement. It also offers an opportunity to renegotiate with your landlord midway through your agreement.
A company could work out an option to extend a short-term lease to hedge against losing the space or being hit with a rent increase, but the protections are not guaranteed, as those that accompany a long-term agreement would be.
When trying to negotiate a termination right in a lease, it is helpful to understand the landlord’s potential challenges in providing this option. The situation varies from building to building in regard to ownership structure and the debt situation, for example, and investigating these facts prior to the request is mission critical. Furthermore, the ability to terminate a lease may also be less advantageous if the termination fee is equaled to an amount that is perceivably unlikely to be paid.
Termination option fees requested by landlords are typically for the unamortized portion of the costs based on the market value of the transaction made when the lease was signed, along with an interest rate factor and a penalty equal to the value of rent for a few months. However, if the landlord receives adequate notice that a tenant is leaving, it should allow that tenant to lease the space and head off any loss of income. Termination fees require time to negotiate and ultimately should reward the landlord for offering additional concessions in exchange for extending the term.
What else can a company do to mitigate risk and reduce costs in a lease situation?
Another option to consider is subleasing, which can help a company recoup a portion of its rental expenses. However, expect to invest time and money on the front end to find a tenant and adapt the space.
If the necessary tenant improvements are financially viable for a company to pay upfront, the landlord has a greater ability to accept the termination option because the initial investment in the transaction has been reduced. Furthermore, a lease rate associated with an ‘as-is’ deal is usually below market and can protect tenants with renewal options going forward. Finally, some of the tenant improvements may be depreciated, ultimately lowering some of the company’s potential tax
liability for a given year.
Steve Kim is a senior associate, Transaction Management, with Plante Moran CRESA. Reach him at (248) 223-3494 or firstname.lastname@example.org.
Insights Real Estate is brought to you by Plante Moran CRESA
Establishing a good relationship with your banker is beneficial to your business because a bank can be a source of ideas to improve your company.
“Think of your banker as an extension of your team, just as your CPA or attorney is part of your advisory team,” says Susan D. Steiger, vice president, commercial loans for Lorain National Bank.
“When we come out to see you, we don’t have the meter running. It’s part of our job to spend good quality time with our clients. We don’t send you a bill at the end of a meeting, so it’s something you should take advantage of,” she says.
And if your banker understands your business, he or she can bring you ideas that make your life easier.
Smart Business spoke with Steiger about how to establish a better working relationship with your lending partner.
How should business owners get their bank involved as they consider making investments?
Get your banker involved early when you’re weighing any kind of investment. Ideally, we’d like to be the first call when you have a major strategic move to consider. Whether an acquisition, buying out a partner or making a capital investment, it’s always better to start the discussion sooner rather than later.
Use us as a sounding board, bounce ideas off of us. We may have advice on structuring the deal or may have seen similar situations with other clients, so use that experience to your advantage.
On the other hand, you may be a nonborrowing client who doesn’t anticipate a need to borrow; maybe you’re just using the bank’s treasury services. It still is wise to begin a regular dialogue with your banker; the relationship ideally should be established before you have a borrowing request. Invest the time to educate your banker about your business, your markets and your industry — it will pay dividends down the road.
What else should a business owner expect from a banking relationship?
You should expect to have access to multiple levels in the organization. Make sure your banker is introducing you to others, especially top management. Your banker is your primary point of contact, but he or she is only one person and no one person is calling all the shots. Others at the bank are part of your team too, and you’ll benefit from everyone’s experience. Interaction with all the bank’s decision makers will pay dividends when your next credit request goes before committee.
We can also connect you with other valuable advisors. It’s our responsibility to introduce you to others, both inside and outside the bank, who have relevant experience. It might be for treasury management, investments or estate planning solutions, or tax advice — we can give you access to those professionals.
When is it a good time to talk with your banker about problems?
From the get-go, be forthcoming with information, both good and bad. It just is not a good practice to surprise your banker. When something happens seemingly out of nowhere, it raises red flags. We need to know if you’ve just lost a major customer, your new product launch is delayed or you’re in danger of tripping a loan covenant.
It’s a banker’s job to understand your business, and we know things don’t always go as planned. It is much better to deal with it as soon as you know about it because then we can help plan and strategize the next steps. Remember, we’re your advocate inside our organization.
Positive news often requires advance planning, as well. So let us know if you have just landed a major contract or are in negotiations for the purchase of a new warehouse.
How often should you be talking with your bank?
Your banker should be scheduling annual reviews with you. If not, then ask for it. This annual review is part of keeping the lines of communication open, but it also serves as a more formal process to review your year-end financials and the outlook for the coming year as well as to discuss any other needs you might have. But certainly meet with your banker quarterly, if not more frequently, on a more informal basis.
Also, get the other key people at your company involved in these meetings. Banks like to see that you have bench strength on your team and that the whole business isn’t being carried on your shoulders alone.
How crucial is it to negotiate rates?
Price isn’t everything. It is not necessarily the best strategy to negotiate every rate and price down as low as you can go. In the long run, if your banker is forced into that kind of relationship, when things get tough, he or she may not have the staying power to maintain the relationship. The financial relationship has to be a win-win. If the company is doing all of these things to foster a good relationship, it is going to get competitive pricing over the long haul.
I think it’s often frustrating for owners or managers to deal with the bank. They just would rather not do it or would rather delegate it to someone else, perhaps their controller. But that interaction is too important to ignore. The success of any relationship — personal or professional — always comes down to communication; it is the most important variable.
We are people and we are in a people business. Communication over time builds trust, and mutual trust is at the core of any good relationship. Everyone pays lip service to it, but it really is the key.
Susan D. Steiger is vice president, commercial loans for Lorain National Bank. Reach her at (330) 655-1824 or email@example.com.
Insights Banking & Finance is brought to you by Lorain National Bank
Certificates of insurance play an important function in doing business. Companies need a certificate to get work. A contractor needs one to get onto a jobsite. A trucker needs one to be able to pull up to deliver a load of cargo. A real estate company needs a certificate of insurance to go to settlement to buy a new building.
“It is the lifeblood of industry from an insurance standpoint,” says Joyce Shefsky, vice president, client services at ECBM. “There are so many issues involved with certificates, it can be a time-consuming and difficult process to get them issued and accepted.”
For example, a bank or general contractor will thoroughly examine a certificate of insurance to make sure everything is in compliance with the contract requirements, she says. If it isn’t, the insured could be held in breach of contract, or business could be delayed while the certificates are amended.
Smart Business spoke with Shefsky about the role that certificates of insurance play in doing business and how to properly use them.
What is a certificate of insurance and what should be included on it?
A certificate of insurance is evidence that certain insurance coverage is in existence as of the date the certificate is issued. It shows the insurance carrier providing coverage, the effective and expiration dates, policy numbers and limits of insurance.
Certificates of insurance are usually issued in conjunction with a contractual relationship between a third party and the named insured on the insurance policy. The contract typically stipulates the coverage and limits required.
It should include:
- Current policy information (limits of insurance, policy term, etc.)
- Name of the insurance carrier and the NAIC number
- Signature of agent
- Correct name and mailing address of certificate holder
If additional insured status or waiver of subrogation is required, a copy of the endorsement to the policy should be included.
Certificates of insurances are very critical to the construction industry, although other industries depend on them, as well. Often, it is the last thing businesses deal with, and it can be very costly if the insurance requested is not what the named insured has purchased. For example, a company will bid on a construction contract and not bother looking at any of the insurance requirements. Then, when it gets a job, all of a sudden it has to purchase more coverage, and its profit decreases or it is held in breach of contract.
When employers receive certificates of insurance, how should they review them?
The contractually required insurance, amounts, types of coverage and endorsements should be compared to the certificate provided. A procedure also should be in place to verify receipt of renewal certificates when the policies expire. In addition, a system to manage storage of the certificates is crucial; at the time of a loss, it is critical that the insurance certificate be available.
When requested to provide a certificate:
- Verify that your current coverage meets or exceeds the required insurance; this must include all endorsements requested.
- Always have your insurance consultant review the insurance requirements prior to signing a contract.
- Realize that adding additional insured status means you are sharing your limits with the additional insured, and you may want to consider purchasing higher limits to protect yourself.
What incorrect assumptions do employers make about certificates of insurance?
Some business owners mistakenly assume that certificates of insurance are binding. They might wrongly believe that just because a certificate has been issued to them that they are covered for any loss. Finally, all additional insured endorsements are not the same. Each is issued for a specific purpose, and the preparer of the contract must be specific as to the form of additional insured required.
How do subcontractors and policy renewals play into certificates of insurance?
When you hire a subcontractor to do work for you, request that a certificate of insurance be provided prior to the start of work. It is very important that the contractual agreement contain all of the indemnity and insurance requirements that are required in your contract with the owner or general contractor.
For policy renewals, a system needs to be in place to follow up for renewal certificates. The certificates need to be reviewed for compliance with your contract.
How have states taken legislative and/or regulatory action to address issues pertaining to certificates of insurance?
Often, insurance agents are asked to amend the Acord certificate form. It is copyright infringement to change the wording on the form. The wording that is printed on the form cannot be amended. There is legislation in most states forbidding an insurance agent to amend coverage by issuing a certificate. The policy must be endorsed for coverage to apply.
No business owner wants to be held in breach of contract because of a problem with the certificate of insurance. It also can slow business down — a job may not start, cargo may not get off a truck or a building owner cannot go to settlement. Therefore, take the time to ensure that everything is in order and properly reviewed to keep your business moving.
Joyce Shefsky is a vice president, client services at ECBM. Reach her at (610) 664-8299, ext. 1205, or firstname.lastname@example.org.
Insights Risk Management is brought to you by ECBM Insurance Brokers and Consultants
The recent uptick in sales is like a breath of fresh air for beleaguered business owners — unless they don’t have enough cash to meet rising expenses while they wait out a typical invoicing cycle.
A conventional line of credit may seem like the prefect solution, but since an owner’s personal and business finances are intertwined, those who fell behind on mortgage payments or bills during the recession may not qualify.
“Owners need short-term funding to carry receivables and hire staff now that the economy is improving,” says Paul Herman, small business lending manager at California Bank & Trust. “Their best bet is a short-term line of credit (SLC) since bankers primarily focus on a company’s cash flow cycle during the underwriting process.”
Smart Business spoke with Herman about the opportunities to grow your business by tapping a short-term line of credit.
What is an SLC and when are they advantageous?
Essentially, an SLC is bridge financing. Savvy executives tap the line to pay expenses between the time revenue is generated and receivables are collected. For example, they may need cash to purchase supplies or inventory to handle seasonal spikes or new contracts before the goods are finished, delivered and paid for. Contractors frequently use an SLC to pay bonding and insurance premiums so they can bid on new projects, and veteran attorneys and doctors often use the funds for operating expenses when they launch a new practice.
You can draw on the line as needed and repay the funds at will as long as you meet the terms of your agreement and attend periodic reviews with your bank.
How does an SLC differ from other loans?
It’s assumed that owners will pay down a short-term line as cash is received, so bankers are primarily concerned with how quickly a company converts receivables into cash when they consider an SLC request.
Long-term debt is typically used to purchase equipment, buildings or other fixed assets, so bankers must consider depreciation as well as a company’s profitability to assess its ability to service the loan. In fact, stable but slow growth is often a key indicator of a company’s ability to service debt over the long term, while an SLC is the perfect solution for cash flow shortages resulting from a growth spurt.
Are there risks associated with an SLC?
No loan is risk free. However, prudent owners can avoid default or cash shortfalls by following these best practices:
- Accurate forecasting — Some owners are so afraid of taking on debt that they run out of cash because they don’t ask for a large enough line. This won’t happen if you accurately forecast your company’s growth and cash conversion cycle. In fact, it’s better to ask for the maximum limit since you have the option of drawing the funds as needed.
- Be disciplined — Only use the funds to close short-term cash flow gaps. Otherwise, you may run out of money and have to liquidate assets to pay bills or meet payroll.
- Be responsible — Bad debt, delinquent customers or risky business practices can leave well-intentioned owners holding the bag. Are you ready, willing and able to accept responsibility for managing your company’s credit, cash flow and an unmonitored credit line?
How can a business maintain the quality of its assets and increase borrowing capacity?
Owners often emphasize sales, but what good is top-line growth if the margins are bad or you can’t collect your hard-earned money? Even tenured customers may encounter a cash crunch as the economy rebounds, especially if they wait too long to secure short-term financing. Be disciplined about verifying a customer’s credit worthiness, keep an eye on receivables and don’t forget to make timely collections calls.
Finally, don’t ignore your balance sheet because a business can’t survive with high debt and little equity. Grow assets as well as revenue, and make sure your balance sheet reflects the norms for your industry.
What do bankers consider when evaluating a request for an SLC?
In addition to reviewing traditional underwriting criteria like business and personal credit scores, bankers want to know whether you have the means and ability to manage and repay a line of credit.
They’ll look at your industry experience, the viability and diversification of your customer base, along with the ebb and flow of your company’s cash flow during previous cycles. Will your customers pay on time? Can your business survive if one customer defaults? Do you have enough personal assets or sources of secondary support to pay your bills while you wait for an invoicing cycle to conclude?
Bankers may be able to use government guarantees to overcome minor risks, and you could qualify for a conventional line of credit down the road if you use an SLC as a stepping stone to build your credit score and your company.
Paul Herman is the small business lending manager at California Bank & Trust. Reach him at Paul.Herman@calbt.com.
Insights Banking & Finance is brought to you by California Bank & Trust
When a company gets into a position of missing payments on a loan, the loan originator could possibly sell your debt to a third party. Once your commercial loan is sold, the velocity of both money and information becomes critical.
“Don’t panic,” says Brian R. Forbes, a member with Dykema Gossett PLLC. Instead, he suggests being proactive.
“The more proactive and transparent you are, the more likely the asset manager responsible for your loan will internally advocate options that may allow opportunities for a mutually acceptable restructure,” he says.
As a borrower, you have the chance to start your lending relationship over because there is no previous history with your new lender. Forbes says there is a possibility that you can restructure your debt on terms more favorable than offered by your original lender.
Smart Business spoke with Forbes about how to handle your distressed debt after it changes hands.
How do you define distressed debt?
Distressed debt would be any debt or credit that has one or more missing payments, either partially or in whole, or is in imminent danger of missing one or more payments without the ability to cure. If you are a borrower who has reached this critical point, there is a possibility your debt will be sold to a third party.
At what point does debt get sold?
Distressed debt can be sold at any given time. The third party that buys debt often has a different objective than the original lender because they are seeking to maximize their investment returns in a shorter time frame. Since the distressed loan frequently is purchased at a discount, an opportunity exists to negotiate terms more favorable to the borrower. The new lender could potentially offer more creative workouts, such as allowing the borrower more time to refinance, extending payments, stretching amortization or allowing a discounted payoff. A new lender is not always negative for the borrower.
How would you know your debt has been sold?
Most loan sale agreements require a borrower be notified immediately upon the closing of the loan sale. The loan buyer will contact the borrower quickly to ensure all payments due under the loan are going to the buyer and not to the seller. If the debt is in distress and there is a default, a workout specialist or asset manager will contact the borrower for updated information. In the best-case scenario, the borrower’s financial statements are complete and easily reviewed and verified, which enables the asset manager to quickly assess the situation and recommend a course of action.
The anticipation from an asset manager’s perspective is that information flows between parties within a month of closing. If the debt involves real estate, such as an office or apartment building, the asset manager will want to see rent rolls, pro forma financial statements and detailed budgets. The less information the asset manager receives, the more difficulty the asset manager has evaluating the credit and recommending a mutually favorable solution.
What’s at risk once it has reached this point?
The velocity of money and information is critical to the third-party debt purchaser. The new lender is making a decision as to whether there is a workable solution between it and the borrower. Many third-party buyers prefer to work quickly to resolve the asset with the borrower in either a full or, if justifiable, discounted payoff. In order to do this, the asset manager needs accurate information quickly to pursue the most cost-efficient action.
The remedies third-party buyers often exercise if they are forced to operate without the requested information include foreclosure, but generally third-party buyers do not want to own the property. Third-party buyers can enforce other remedies under any guarantees of the loan and pursue their rights against the guarantors and the underlying collateral. Third-party buyers will pursue a general workout strategy if it makes sense for both parties.
What should a company do when its commercial loan gets sold to a third party?
If a third-party buyer purchases your debt, anticipate that the new lender will be proactive in exercising its remedies under the loan documents in an effort to resolve the credit and that you should provide the new lender such information required under the loan documents. Remember, many debt buyers contractually respond to investors and lenders in the same manner as the borrower responds to the lender under the loan documents. It is advisable to have your asset manager well informed of your credit and circumstances in order to facilitate the best solution. Without sufficient information, new lenders often immediately exercise remedies.
Be forthcoming. Obtain counsel and with his or her advice gather and give your accounting information to your new lender who can evaluate and understand your credit as quickly.
What are the best-case outcomes once a company has reached this point?
The best scenario is the borrower obtains the opportunity to keep its business going, resolves a current credit that by its size may be limiting opportunities for the borrower, obtains for any guarantor a release from his or her guaranty for consideration, and either purchases the debt or refinances the debt at a price discount that corresponds to the current fair-market value of the asset serving as collateral or the value of the business. Do not panic. Everyone is interested in finding the best solution, which often means the borrower refinancing the debt with another lender.
Should a borrower get counsel involved?
Retain an expert representing borrowers in this context immediately to determine whether restructuring is viable and the best option. Counsel can help structure the best solution given the facts and circumstances of the underlying credit, while identifying and minimizing potential adverse tax consequences.
Brian R. Forbes is a member with Dykema Gossett PLLC. Reach him at (214) 462-6403 or email@example.com.
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Recently, a company with 55 locations — a good solid credit tenant — was looking for space in Northeast Ohio. There were three potential locations, and in two of the cases, the landlord was not willing to spend money on tenant improvements. Therefore, the owner of the third property got the deal.
“Oftentimes, we see tenants and landlords butting heads on improvements, but really, at the end of the day, most deals get done with some sort of compromise between the parties,” says George J. Pofok, CCIM, SIOR, senior vice president at CRESCO Real Estate. “On the other hand, there also are times when landlords or tenants will kill the deal and decide financially it’s not worth pursuing.”
Smart Business spoke with Pofok about how tenant improvements are used as a negotiating tool for both landlords and tenants.
What types of tenant improvements are typically made and why?
From an industrial perspective, the typical tenant improvements are the movement of a wall or two or replacing paint and carpet, as these are things landlords have been conditioned to take care of. A couple of other considerations could be replacing any stained or damaged ceiling tiles and making sure all mechanicals are delivered in good working order. These kinds of improvements are usually done because they are low-cost items that are easy to complete and make a big impact. For instance, if you have a manufacturing operation, oftentimes guys in the shop walk over the carpet with their oily boots, which tends to wear it out quicker than it really should.
What is the difference between capital and tenant improvements?
Capital improvements are similar in nature to tenant improvements but usually are bigger building-type improvements such as replacing a roof, repaving a parking lot, or upgrading the heating and air conditioning system. Tenant improvements are often made to the interior and are more cosmetic. For example, there may be 10 private offices and the tenant moving in may only need five and an open bullpen area. An energy efficiency improvement might be replacing lighting fixtures, but if you’re going to waterless urinals, as an example, those are more capital intensive and it’s an added asset, in most people’s eyes, for the building rather than the tenant.
How should tenants negotiate to ensure the best rates on industrial leases?
If you’re an existing tenant, you have more flexibility because you have a past history with the landlord. Since being there, the roof is that much older, the parking lot is that much older and that means more leverage. When you’re a new tenant coming in, there’s less flexibility, especially for capital-intensive improvements. This, however, can depend on the credit of the tenants; obviously if you’re a Fortune 100 company the landlord knows your check is going to be good.
As a tenant, you should:
- Start the process early on. When you’re touring a property, take careful note of what the space looks like and have all your needs ready upfront first versus having to go back to a landlord again and again.
- Prioritize so you know what you’re willing to give up. For example, you might want carpet changed in all the offices, to add a couple of additional private offices and have the warehouse painted white. Maybe painting the warehouse isn’t as critical to you, but the other two items are; then one of them can be a gift back to the landlord to get what you really want.
- Know cost estimates of what you’re requesting. If you’re going to ask for too much, then the landlord may take a tougher stance from the very get-go.
Another tenant tool is to pay for improvement expenses upfront and have the landlord amortize it via free rent or reduce the base rent.
It’s important to be fair and reasonable as you’re negotiating because landlords want to feel that they get a victory. It can be something small, but as long as they feel like they won part of the battle, then they will be more receptive to working with you.
How are the current economy and market influencing negotiations?
With landlords still hungry for tenants, they want to show to their lender a higher base rate but could still spend money to keep the tenant happy with free rent or additional dollars for miscellaneous improvements. Therefore, if your landlord wants to keep a higher base rate, you can typically ask for more improvements.
Despite this, tenants need to be aware of how the market is starting to change. As manufacturing took a hit over the past few years, landlords needed to be creative to backfill spaces that hit the market as a result of the recession. Now, the market is getting to a point where it has recovered and certain product types are more difficult to find. It’s been a tenant market, but now it’s just as favorable to the landlord.
The vacancy rate has decreased significantly. Right now, it is hovering around 8.3 percent, which is extremely healthy for the overall Northeast Ohio/Cleveland market. A year ago, the vacancy rate was 9.6 percent.
Leasing rates are not changing yet. Historically, they have remained very stable and consistent. The hope is as the vacancy rate declines, property owners will start seeing a slight increase in the flat values. This situation is semi-unique to the Cleveland market. When everyone had the big boom, our boom in the Cleveland market wasn’t significant so we don’t have as far to fall. The base rates are within 5 to 10 cents of where they have been over past five years.
George J. Pofok, CCIM, SIOR, is a senior vice president at CRESCO Real Estate. Reach him at (216) 525-1469 or firstname.lastname@example.org.
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The Akron/Canton area has seen a lot of commercial real estate activity recently. The area’s industrial vacancy rate has gone down slightly, from 8.7 percent last year to 8.5 percent this year. While that rate is slightly above the Cleveland market’s 8.2 percent, it is still well below the national average of 9.7 last year and 9.2 percent this quarter. The office vacancy rate sits at 10 percent this year, up from 9.3 percent last year but still below the national rate of 12.1 percent this year.
Some of the biggest news out of the Akron/Canton area includes the expansion of Struktol. The rubber and plastics supplier is expanding its operations in the area and recently leased 97,000 square foot in Stow, in addition to its existing space in that area. Also illustrating industrial growth in the area, The Timken Co. recently moved into 28,000 square feet of additional space to expand its operations.
Smart Business spoke with Terry Coyne, SIOR, CCIM, an executive vice president with Grubb & Ellis, about real estate trends in the Akron/Canton markets.
What are the factors behind the changes in the office vacancy rate in Akron/Canton this year?
Office space is typically a lagging indicator and industrial space is a leading indicator. The region is experiencing significant occupancy by new players in the oil and gas industry. Without them, the vacancy rate would rise.
While the vacancy rate for manufacturing has remained flat from the year prior, sizable companies such as Struktol and Timken are expanding.
The increase in the office vacancy rate seems to be correlated with an jump in total square footage in the region, which increased by 268,813 square feet in the second quarter. It therefore seems that the increased vacancy rate could be due to new construction that has not yet been filled, or from companies that have moved into newly constructed buildings and vacated their previous building.
What is the news beyond what the numbers reflect in manufacturing real estate?
A lot of vacancies have been bought up. Getting someone in the large Lockheed Martin building was fortunate, but there are also some emerging trends that are leading to these numbers. First, many manufacturing companies are reshoring, meaning they are moving production from abroad back to the U.S. Second, the oil and gas industry continues to attract business. Third, many existing manufacturing buildings are being razed, which is reducing the inventory and shrinking the market for existing properties. This causes vacancy to go down and rents to increase. Although the industrial numbers appear flat, the market is improving.
In the Akron/Canton market, existing buildings are filling up with tenants. What does that say about commercial construction in the area?
It’s really very hard to get financing for the speculative construction of office buildings. The area will continue to see rents increase and vacancies decline until banks decide they will provide the loans necessary for the construction of speculative office buildings. What will likely happen is that more businesses will begin building to suit themselves. But the interest rates that make this the best case scenario are not there yet, and many companies are hampered by the amount of equity they need to get a loan, which can be near 30 percent.
The area will likely not see a substantial pace of speculative office building construction for another two and a half years. While this might not be good for construction companies, it is good for landlords who will benefit from increased occupancy and the ability to charge more for rent as the market tightens.
How is the Akron/Canton area real estate market faring compared to the nation?
Net absorption rates in the Akron/Canton area in the second quarter were 651,525 square feet for industrial properties and 25,662 square feet of office space. This year, to date, absorption for industrial properties is at 1,447,517 square feet and office properties are at 111,678 square feet.
Conversely, the industrial vacancy rates in the Akron/Canton area have improved slightly, from 8.7 percent this past year to 8.5 percent this year. In comparison, the national vacancy rate was 9.7 this past year and has shrunk to 9.2 percent this quarter.
Looking at office vacancies, the Akron/Canton saw its rate of 9.3 percent last year, grow to 10 percent this year. This opposes the trend that is being experience across the U.S., which had office vacancy rates of 12.5 percent last year that tightened to 12.1 percent this year.
How do you expect the year to finish in both office and manufacturing real estate?
I expect that you will continue to see a decent pace of absorption on the office side, but industrial absorption will slow.
In terms of new construction, we’ve seen industrial slow down and office keep its pace. There haven’t been any sizeable properties shutting down recently and there’s not a lot of unsettled market right now. In that sense, the good news is that the bad news is over. In 2010, we hit bottom and all the negative noise that appeared every day of another building shutting down has stopped.
Getting rid of any dilapidated supply — when it holds more value as a commodity than as an underlying asset — helps underlying asset values. While it can be understood that razing existing buildings might hurt because it increases the price of existing properties, pricing in this area is still extremely low. If you are looking for office space, it’s tough to find a better deal than in the Akron/Canton area.
Terry Coyne, SIOR, CCIM, is an executive vice president with Grubb & Ellis. Reach him at (216) 453-3001 or email@example.com.
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There are many ways that small and medium-sized businesses can find themselves facing financial difficulties that lead to trouble in their commercial lending relationship. When this happens, many times business owners become paralyzed, shutting down and failing to communicate with their lender. While that is understandable, it is the wrong thing to do, says David M. Hunter, chair of the Real Estate Practice Group for Brouse McDowell.
“When a business anticipates that it is entering a period of financial challenge, one of the first things it should do is get competent legal counsel,” says Hunter.
Often, business owners only do this as a last resort. However, retaining knowledgeable counsel early on allows you to obtain practical pointers when there is often greater flexibility to negotiate an agreeable outcome, he says.
“Once a lawsuit is pending, things become much more difficult to negotiate, even with a lawyer involved,” he says.
Smart Business spoke with Hunter about how to work with your bank to preserve good relations during difficult financial times.
When a company realizes it may be headed for financial difficulties, what should it do first?
Small and medium-sized businesses typically have a large file that contains the underlying governing documentation when the business took out the credit facility. In the event that your business is slipping into financial turbulence, locate that file and review the terms and conditions of your loan.
However, most businesspeople are overwhelmed by the paperwork. This is a good reason to get counsel involved early. Your counsel will determine the secured or unsecured position of your lender. If your loan is secured, what are the assets that secure it and what are the current valuations of those assets? Is the loan in default? If not, what is the time period you project you could make the required payments and otherwise adhere to the terms of the loan agreement?
How can an attorney help?
A good attorney either has knowledge to assist a borrower facing a potential loan default or is with a firm with others who have knowledge of the federal bankruptcy law protections or other approaches that would aid a borrower facing an approaching problem.
Once you have secured counsel and discussed the issues, the next step is to contact your lender. Bankers appreciate knowing that a borrower is alert to the problem and wants to collaborate with the bank to address it or explore what remedial options are available.
Business owners often believe that banks want to seize a borrower’s property or shut down a borrower’s business. No bank really wants to do that. If it is reasonably achievable, banks want to rehabilitate nonperforming loans and transform them back into performing loans that pay as agreed. They want to lend money to borrowers that use loan proceeds effectively and to create an improved economic performance for the borrower, which will allow the borrower to repay the loan.
Are there risks in alerting a bank of a potential missed payment?
Some businesses, regardless of efforts taken to head off financial difficulties, can face a situation in which the next loan payment might be missed. No bank will think unkindly of a call from a borrower saying an upcoming payment might not be paid timely. Some borrowers might worry that if a bank finds out about a potential missed payment, an awful consequence will be triggered. But if that is the impulsive reaction you receive from the bank, you are likely dealing with the wrong bank.
However, after 90 days of delinquency, the loan will likely go into a nonaccrual status — a consequence which immediately and negatively impacts the bank’s earnings. This is a more serious situation. If you alert your bank early enough, it will likely work with you to find a solution. But it gets more difficult to take these steps the longer a borrower waits.
At what point does this become a legal issue?
There are legal issues every step of the way. But these become more acute when the evolving facts empower a lender to take steps that can disrupt a borrower’s business. Many loans contain a cognovit provision, a tool a bank can use if a loan is in default. This authorizes a bank to obtain an expedited judgment against a borrower. This expedited judgment can quickly empower the bank to attach the bank accounts or levy upon the assets of its debtor.
It’s important to communicate with your bank before such a provision is implemented in an effort to find a way to augment the terms and conditions of the loan to give the borrower a window of opportunity to make payments. This often leads to the creation of a forbearance agreement — a mutually agreeable written understanding between the bank and its borrower as to how the parties will treat this troubled loan. Forbearance agreements customarily provide that as long as the borrower adheres to the agreement, the bank will refrain from pursuing certain remedies, such as obtaining or enforcing a cognovit judgment.
Preservation of value should be paramount for both the borrower and the bank. Under potential default circumstances, borrowers and banks can do things that can negatively impact a business’s value, and banks know that. If a bank acts aggressively to prompt a forced sale of assets, often the value realized when the assets are sold will be reduced.
Before a borrower gets to that point, the borrower would be well advised to work with a lawyer and devise a strategy to deal with the situation. Often, the owner and lawyer can come up with a plan of payment and present it to the lender. If the plan is reasonable, many times the lender will be receptive.
What are some other potential resolutions?
There is often relief available in bankruptcy. But its practical effectiveness hinges on the size of the company, as the pursuit of such a remedy can often be cost prohibitive. Chapter 11 cases, for example, can come at a high cost and be labor intensive. But a Chapter 11 filing can make sense in certain circumstances.
David M. Hunter is chair of the Real Estate Practice Group for Brouse McDowell. Reach him at (330) 535-5711, ext. 262, or firstname.lastname@example.org.
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Finding the necessary financing to thrive — or just survive — can be difficult for small businesses. But there are resources available to help startups and entrepreneurs compete in this market.
“SBA loans are designed for borrowers that might not qualify for conventional financing due to a number of different reasons,” says Romona J. Davis, Vice President of SBA lending with FirstMerit Bank.
Smart Business spoke with Davis about how to determine whether an SBA loan could help your business, and how to get started with the process.
What are the differences between SBA loans and conventional loans?
The main difference is that SBA loans are backed by the United States government, which provides a guarantee to the bank. SBA loans are for borrowers that might not qualify for conventional financing due to a variety of reasons, such as:
- Insufficient collateral
- A startup business or one that’s only been in existence for a short period of time
- The company is looking for a longer term on its owner-occupied commercial real estate purchase
- The borrower is in a ‘high-risk’ industry
- The borrower only wants to inject a minimum down payment
- Impending or current ownership changes with the business
- Inconsistent financial performance over the past few years
How does a lender determine if an industry is high risk?
It varies by bank. Most banks consider the restaurant industry as one that has a lot of risk associated with it. Also, when the economy changed and building contractors were negatively impacted, they became high risk.
However, being part of a high-risk industry doesn’t mean a conventional loan is impossible.
What can SBA loans be used for?
SBA loans can be used to:
- Purchase owner-occupied commercial real estate
- Buy out a business partner
- Buy a business
- Purchase machinery and equipment
- Buy a franchise
- Construct a building (the business must occupy 60 percent of the space)
- Cover working capital needs
- Refinance existing business debt
What types of businesses are eligible for SBA loans?
To qualify for SBA financing, the entity must be designated ‘for-profit.’ In addition, the business must meet certain SBA size standards, demonstrate good character, have a positive payment history on previous federal debt (no prior defaults on federal debt), possess U.S. or Legal Permanent Resident status, and show reasonable expectation of repayment.
What are the required size standards?
The SBA has developed size standards for different types of industries. Companies must meet either a maximum number of employees, maximum revenue amount or an alternative size standard to qualify as a small business.
How is ‘good character’ determined?
First, the SBA looks at the company’s credit, tax liens and any prior delinquencies with the government.
Also, the SBA always wants to know if a borrower has any criminal background, has been under indictment, is currently on probation, has ever been on probation, or has ever been charged with or arrested for any criminal offense, other than a minor motor vehicle violation.
The two ways to assess character, from the SBA’s perspective, are through personal credit and personal background.
Why might a business opt for an SBA loan instead of a conventional loan?
Businesses might opt for an SBA loan versus a conventional loan if they:
- Want a longer term on their owner-occupied commercial real estate or equipment loan
- Want a straight term and amortization versus a balloon note
- Prefer a lower down payment on their transaction
- Have a collateral shortfall
- Want to consolidate business debt into one loan that could offer a longer repayment period
- Want to buy out their business partner with a minimum equity injection
- Want to purchase a business but there’s insufficient collateral
- Desire cash flow savings due to a longer term and amortization
How can businesses get started with the loan process?
If a business is interested in an SBA loan, the first step is to contact a bank that participates in the SBA program. The banker will need to make certain that the company is eligible as indicated above. Assuming the business is eligible, the borrower would need to provide a financing package to the bank for SBA consideration.
Disclosure: All opinions expressed in this article are that of the authors or sources and do not necessarily reflect the views of FirstMerit Bank or FirstMerit Corp.
Romona J. Davis is Vice President of SBA lending for FirstMerit Bank. Reach her at (330) 996-6242 or email@example.com.
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