Monday, November 15, 2010

Gordon Food Service and the Dawn of a New Age

Some very close friends of mine who currently are shopping around for a loan. They own a large vacant office building which is arguably worth  about $3,000,000; it would require much more than that to replace it. The owners are looking for a $400,000 loan to replace some unfavorable, existing debt. That is all they owe on the building – something less than $400,000. Even with a very conservative appraisal of the property, a lender would be funding a very small percentage of the value. For instance, if the lender agreed that the building had a value of $2,000,000, their $400,000 would represent only a 20% loan to value. This is the very heart of how real estate lending is supposed to work. A borrower comes to a lender offering real estate as collateral for a loan. A commitment to lend is provided by the lender based on certain terms - rate, term, amortization, loan to value (LTV) and receipt of an arm’s length appraisal of the property. Done deal.

The problem is that over the last few years, property values have dropped. A loan that once carried a LTV of 75% in 2006 now may be a 90+% LTV. The value of the lender’s collateral has dropped in step with this trend. Borrowers are not the only ones who can find themselves underwater. Consequently, asset loans, loans based on the perceived value of something are a little hard to arrange. Or am I being too subtle? Among many lenders, asset loans are toxic.

That’s why the news of the Gordon Food Service purchase of 1 3/4 acres on Kingston Pike for $1,000,000 per acre is so positive. Finally, we are seeing signs of appreciation, or at least stabilization of prices of prime real estate. Over the past few years, values have been dropping and licensed appraisers have had to use those dropping property values as comparables to fix values for newly appraised properties. Please understand that appraisers are not villains here; they are bound by the data available to them.

But think for a minute. Gordon Food represents a new trend – prices stabilizing, even increasing. Now we have a new comparable. A few more, similar transactions start to make a trend. Appraisals will reflect this trend. Bankers may decide that the risk of holding real estate as collateral has diminished and allocate a larger percentage of their funds to real estate loans. Think of it. Developers and investors fully engaged in their work. Architects and contractors fully employed. The possibilities boggle the mind.

When Gordon Food Service opens for business, I think I’ll go in and thank them.

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