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.

More Than You Wanted to Know About Fungibility

This past Friday afternoon, I was visiting with a broker friend and three industrial developers over a beer when the subject changed to Kroger, Knoxville’s currently reigning real estate villain. As you may know, Kroger purchased a parcel of land adjacent to their existing Marketplace store on Kingston Pike near Cedar Bluff with the intention of building a new store (presumably abandoning the one they are operating now).

According to one of the developers, it is a scandal that Kroger would pave another greenfield site when there are so many vacant “big boxes” they could renovate and expand, if necessary. Besides, the Marketplace store is perfectly adequate, he opined.

 I am not able to comment on the adequacy of the store or the internal operations of Kroger; however, my friend, the developer of industrial buildings, had completely overlooked the idea of fungibility. Subject to zoning restrictions, site functionality, transportation considerations etc., an industrial building can be sited anywhere. Kroger, on the other hand, must evaluate the additional requirements of visibility, traffic patterns, demographics and others to identify a successful location. Simply put, the location of a Kroger is non-fungible; the average industrial building is much less so.

Besides, I am firmly convinced that Kroger’s decision to purchase/ develop this property and move its store is largely a stratagem to safeguard market share by denying one of their competitors the opportunity to out position them. Kroger has long been the dominant grocer in Knoxville, but the expansion of Food City, Walmart, Target, Fresh Market. EarthFare and Aldi, and the rumored entry of Publix, Costco and Trader  Joe’s, threatens their share of the grocery dollar.