New Central Illinois Business episode, May 1, 2009, featuring Brian Bloom and Travis Alber

Central Illinois Business with Alex Ruggieri

Episode 41, May 2nd   Featuring...
Brian Bloom & Travis Alber

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Best Practices for Tough Economic Times

by Mike Henning
Henning Family Business Center
Phone: 217-342-3728
www.mikehenning.com

1. Focus on Cash Flow rather than Paper Profits
   Cash is king in business, and no company can survive for very long without a positive cash flow. Cash flow is defined as a company’s cash inflows minus its cash outflows over a given period of time. If a company cannot cash flow operations, consider alternatives. Yes, a company can stay in business while showing operating losses if they have strong cash flow.
2. Collect Accounts Receivable
   In order to protect your cash, you company, and your family business’ future, you have to be ruthless and tireless in collecting accounts receivable.
3. Focus on Lender Relations, and keep them Informed
   Bands do not like surprises. Whether you’re doing okay or whether you’re experiencing some recession difficulties, now is the time to invest a few hours in keeping your banker informed. Adhere to all your loan covenants.
4. Reduce Tax Payments
   Don’t always focus only on state and federal taxes alone, take a look at real property and personal property valuations to make sure you’re not overpaying.
5. Know Your Break Even Point
   This is the point at which a product or service stops costing you money to produce and sell and starts to generate a profit for your company.
6. Know Your Burn Rate
   Burn rate analysis can tell owners whether a company is self-sustaining going forward or if the signals indicate that there is a need for outside financing.
7. Forecast a rolling 13 week cash flow projection
   Protecting yourself in hard times means you must become intimately familiar with cash flow and must be able to predict it with stunning accuracy. A cash flow statement is a compressed corporate checkbook analysis. It helps avoid liquidity problems.
8. Invoice your Customers more Frequently
   As a general rule, by invoicing your customers more frequently means you’ll have opportunities to collect their payments sooner.
9. Drop those Pain-in-the-Neck customers
   In hard times, you need to be focused on core businesses and their highest pay off activities.
10. Sell underutilized assets and those not producing return on investment
    All too often is to observe vehicles or equipment which is idle.
11. Borrow money from the corporation’s Cash Value Life Insurance Policies
    Wonder if your cash flow analysis shows you will need cash in four months. Examine company paid insurance policies that have a cash value build-up, and if possible, borrow some of the cash for your business use.
12. Charge and enforce late fees.
    
13. Seek shareholder and family loans where possible.
    
14. Negotiate terms with vendors and suppliers.
    Now is the time to make every effort to reduce your overhead while maintaining sound business relationships with suppliers. Negotiating in good faith with vendors could save serious money in hard times.
15. Be ruthless and dispassionate about cost reduction
    Be diligent, thorough, and dispassionate about seeking belt tightening opportunities.
16. Utilize zero based budgeting.
    ZBB is a method of budgeting in which all expenses must be justified for each new period. (30 days, quarter, etc.)
17. Focus on executive duties instead of personal production.
    Experts estimate that most executives spend up to 50% of their time doing things that others could do as well or better and at lower costs. Focus like a laser beam on the highest payoff activities.
18. Communicate Openly to Your Employees
    Business leaders make sure you are communicating to the rest of the team what the plans for the future are. How will the company weather the current poor economy? What changes need to be made and will be made? Etc.
19. Communicate openly to Company Stakeholders
    Bankers and other advisors do not like surprises. Being proactive increases your chances for working out a win-win solution.
20. Careful Not to Lose Focus on Your Core Business
    Define what it is that constitutes your core business and stick to it! Never say never to entrepreneurial opportunities, but make sure the goose that lays golden eggs remains healthy in order to lay golden eggs after the current recession is over.
21. Developing a Marketing Plan with Accountability
    A good marketing plan is based on formal or informal customer research. Customers, suppliers and advisors my have insightful things to tell you that may surprise you about your business and your core competencies.
22. Protect Customer Relationships
    Make sure you are devoting sufficient tender loving care to your existing customers.
23. Establish internal best practices and knowledge sharing
    In slower times we generally speaking have more time to work on internal systems and processes. One of the highest payoff areas is to put your people together so that they can learn from one another and share knowledge.
24. Don’t try to do too much too fast
    Change is necessary in hard times. However, when making changes, it’s best to make one at a time, digest them a bit, then move on to the next.
25. Don’t do too little too slowly
    Not having a track record to run on can be an issue, and some companies run the risk of not taking action swiftly enough to stave off disaster. Once the need for change becomes obvious, move decisively.
26. Focus on product or service margins rather than top line sales
    It’s easy in hard times to take almost any new business that comes in your door. However, taking any business in order to keep your employees busy can be a fateful mistake.
27. When time is of the essence, develop Decision Making Criteria
    Tough times require that business make swift, sure decisions on strategy and direction. There maybe windows of opportunity which are even now closing, and slow decision-making or making no decision at all, are the worst things you can do in tough times.
28. Buy distressed assets or competitors
    If there is a fire sale going on that involves equipment, property, HR talent, or even an operating business, there are a lot of people hurting and are willing to give-up.
29. Join a Peer Review or Performance Roundtable Group
    Yes, it is lonely at the top. Seek out non-competing peers to bring questions and concern to. In some cases it would be prudent to begin an advisory board of risk-taking peers for your own operation. These groups address such topics as financial, investments, direction, top management, etc.

Directions: Upon returning to your business, sit down with your top managers and go over the topics you have marked or highlighted during our presentation. Remember, getting a good idea to help support your company’s success is worth nothing unless you take action.

Suggestions Follow...

1. You must have an active R&D effort consisting of market study, reading, researching, testing services, products, communications and thoughts of diversification.
2. You will need a dynamic sales and marketing effort.
3. Invest in infrastructure every year to remain current in such areas as facilities, computers, building renovations, equipment, etc.
4. Be willing to engage top talent or outsource for what we lack in expertise.
5. Our operational piece of the business must include purchasing, inventory control, job flow chart controls, billing guidelines and collection policy.
6. We must develop a fiscal discipline regarding the big sales/revenue month or quarter that we retain a healthy percentage of this cash to give us the “life blood” of any organization—cash flow.
7. We must be flexible but not forget our “core” focus or expertise.
8. We need the best possible support network we can find. For example, our staff of employees, family, friends, National and Regional Associations.
9. In truly tough business times, we can use a lot of spiritual support.
10. The ole saying, “take your work seriously but not yourselves.”

Income Tax Strategies for Real Property

By William L. Exeter
President and Chief Executive Officer
Exeter 1031 Exchange Services, LLC
www.exeter1031.com
william.exeter@exeterco.com

The sale of real property, whether it’s commercial or investment real estate or your primary residence or a vacation home, generally means that you will realize ordinary income, depreciation recapture and/or capital gain taxes.

Tax deferral and exclusion strategies can easily and effectively help you reposition your real estate portfolio in order to accomplish any number of investment objectives while deferring or excluding income taxes.

It is important for you to be familiar with the various tax deferral and tax exclusion strategies that are available to you. And, you should always consult with your legal, tax and financial advisors to ensure you select the most appropriate income tax strategy under your circumstances.

This article is the first in a series of articles on Income Tax Strategies for Real Property, and will introduce you to the various strategies available to you when selling real property. We will delve into greater detail on these strategies throughout this series.

Here is a brief summary of some of the Income Tax Strategies for Real Property:

1031 Exchange (Investment Property)
Section 1031 of the Internal Revenue Code allows you to exchange real or personal property that was held for rental or investment purposes, or that was used in your trade or business (relinquished property), for like-kind real or personal property that will be held for rental or investment purposes, or that will be used in your trade or business (replacement property), so that you can defer your capital gain and depreciation recapture income tax liabilities.

1033 Exchange (Involuntary Conversion)
Section 1033 of the Internal Revenue Code provides that real or personal property subject to an involuntary conversion, either from an Eminent Domain proceeding (condemnation by the government) or destruction by a natural disaster, such as an earthquake, hurricane or fire, can be exchanged on a tax-deferred basis for like-kind real or personal property that is similar or related in service or use.

1034 Exchange (Repealed in 1997)
Section 1034 of the Internal Revenue Code was repealed and replaced by Section 121 (see following) in 1997. The 1034 exchange allowed you to sell your primary residence and defer or roll over your capital gain by acquiring another primary residence of equal or greater value.

121 Exclusion (Primary Residence)
The Taxpayer Relief Act of 1997 repealed and replaced the tax deferral rollover provisions of Section 1034 with the tax-free exclusion provision under Section 121 of the Internal Revenue Code. Generally, you can sell your primary residence and exclude from gross income up to $250,000 in capital gains ($250,000 per taxpayer, $500,000 for a married couple). You must have owned and lived in the property as your primary residence for at least 24 of the last 60 months.

453 Installment Sale Treatment (Seller Carry Back Note)
Section 453 of the Internal Revenue Code allows you to sell real property and help your buyer finance the purchase of your property by carrying back an installment note (seller carry-back financing) while deferring the recognition and payment of your capital gain income tax liability until you receive principal payments. Depreciation recapture income tax liabilities can not be deferred under Section 453 and are due and payable in the year in which you sold your relinquished property. You can also accomplish this through a Deferred Sales Trust™.

721 Exchange (upREIT or 1031/721)
Section 721 of the Internal Revenue Code allows you to exchange investment real estate for an interest in a Real Estate Investment Trust (REIT). This is also referred to as an upREIT, or 1031/721 exchange.

The majority of investors will end up using the 1031 exchange to defer the payment of their capital gain and depreciation recapture taxes upon the sale of relinquished property and the subsequent acquisition of replacement property, so our series on Income Tax Strategies for Real Property will spend quite a bit of time discussing the 1031 exchange.

Market Report, Monday, April 6, 2009

Welcome to the 2nd issue (Volume 1, Issue 2) of the Sperry Van Ness | Better Capital Partners-Capital Market and Interest Rate Update Newsletter. For those readers that missed the inaugural issue, each week we will provide our readers with an overview of the following: National commercial real estate interest rates and underwriting for the major property types, marketplace conditions and how they affect various property types nationwide, insightful capital market analysis with a personal viewpoint and focused subject matter in every newsletter. You will notice that national interest rates are located on page (1) of this newsletter, and are broken down into two categories (multi-family and commercial) and provide a sample of our national, regional and local commercial real estate financing programs. These rates are derived from portfolio lenders, life companies, credit unions, agency and exclusive national correspondent relationships. Many of our lenders and exclusive correspondent relationships have the ability to lower these interest rates by 15-30 basis points if a borrower is interested in establishing a business or personal banking relationship.

Major Property Types:
Let's begin by taking a closer look at the major commercial real estate property types: multi-family, office, industrial, and retail.

Multi-Family: This property type covers residential, senior and student apartments, assisted and independent living and mobile home parks. Nonrecourse adjustable financing programs are still aggressively priced starting at 4.35%. Loan-to-values (LTV's) can still underwrite as high as 80% and underwriting debt service coverage ratios (DSCR) can go as low as a 1.00 breakeven.

Non-recourse fixed 5, 7 and 10 year terms are starting at 4.93%. Loan-tovalues (LTV's) are as high as 80% and DSCR's are starting at 1.20 for our correspondent small loan permanentprograms and 1.25 for our regular permanent programs. Please note that Sperry Van Ness | Better Capital Partners offers a Small Loan correspondent program with a fast track option. This program does not require tax returns and can close within 45 days. We also offer non-recourse multi-family financing programs that do not have any origination fees other than third party expenses (appraisal, environmental etc.) and closing costs.

Be aware that intel at a very high level has informed us the Fannie, Freddie and HUD financing programs may be tightening their underwriting guidelines again at the end of this month. This could further restrict some buyers from acquiring multi-family properties in this marketplace. However on a positive note, many of our local and regional lenders are stepping up to the plate and utilizing TARP money to portfolio lend on multi-family with the intention of selling the portfolio to Fannie Mae over the next 12-18 months. Construction lending is still available nationwide through our correspondent relationships at very aggressive terms. Qualified developers/borrowers of multifamily, healthcare and senior apartment projects can still qualify for a loan-tocost (LTC) up to 90% with an interest rate in the low 6% range with a 40 year fixed rate built into the construction package.

Office: The office market is expected to continue its downward decline throughout 2009. Each metro and submarket will ride out the recession in a slightly different manner and all will recover with their own timeline. The major risk facing the office market is lack of demand, oversupply is not an issue. Actually the distance between new supply and demand continues to expand. The office market is in a transition; we expect to see continued declines in demand and decreases in rent growth throughout 2009. This will push cap rates even higher. Core assets will be considered the most desired by investors, and only a small number of investors will take on a value-added office opportunity, especially, while there is still a large amount of shortterm leasing risk. The flow of capital for speculative new developments will more than likely decrease throughout the year. Lender underwriting for office properties are expected to continue to tighten and cap rates are estimated to increase another 50 basis points by the end of the year.

On the flip side, it appears that office medical buildings are still attracting buyers and selling quite well, offering very little vacancy and limited risk. Additionally, government leased office building also appear to be enticing buyers. Specifically those that don't offer short-term lease termination options.

Nationwide Interest rates are ranging from a low of 6% to a high of 7% for a 10 year term. On average a 5 year fixed is around 6.25-6.50% and may be lower. National lenders are offering the lowest fixed rates for 2 and 3 year term programs.

Industrial: The industrial sector is beginning to experience sizeable tenant vacancies, specifically in the warehouse and distribution centers nationwide. However, asking rents for new tenants and renewing tenants only saw modest declines. The shipping, freight, rail and trucking industries are taking the biggest hit with double digit declines. Industrial ports are also seeing sharp declines in shipping. The West coast ports in particular seem to be the most affected. On a positive note, tenants servicing the fast food, pharmaceutical, medical industries and the sector of the retail industry dealing in basic household consumables are doing well and may even grow in '09. LTV's can still underwrite as high as 80% and Small Business Administration (SBA) programs can underwrite as high as 90%. The SBA has recently eliminated or drastically reduced their origination fees to make an SBA loan that much more attractive for a borrower.

Nationwide, fixed 5, 7 and 10 year terms are starting at 5.75% for permanent owner-user programs and 6.25% to 6.75% for investment properties with 25 and 30 year amortization.

Retail: Retail properties can still be aggressively financed. Interest rates for retail are still ranging in the 6% to 7% range with 25 and 30 year amortizations and DSCR's in the 1.20-1.35+ range. If you're looking for aggressive retail financing, the name of the game is low leverage and strong sponsorship, and a swap program.

The current recession is posing a real challenge for many retailers. Vacancies are up nationwide and many businesses are closing underperforming locations. Single tenant transactions are also expected to be down year-to-year. The trend the past few years has been for multi-family owners to exchange into single tenant properties like quick service restaurants. However, the recession and liquidity crisis has made it difficult to sell many of these multifamily properties at capitalization rates that are acceptable to the owner. As a result, there will be an over-supply of this specific type of commercial real estate property and cash buyers will be on the prowl to acquire some of these distressed assets. Here is a snap shot of what we are seeing in the Single- Tenant Retail Market nationwide. Quick Service Restaurants: Starbucks is moving forward with its plans to close 600 stores and has cancelled its plan to launch 1000 new stores in 2009 and beyond. Icons like Mc Donald's and Wendy's are focused on inexpensive menu items with the intention of increasing customer traffic. Convenience Stores/Gas Stations: Higher gas prices have a dramatic effect on instore items that provide high profit margins for the owner. As gas prices continue to stabilize, we expect a significant increase in purchasing by consumers. Casual Dining: Families nationwide are tightening the purse strings and are eating out less frequently. Restaurant sales are down; many locations are shutting down and scaling back market expansion plans. Drugstores: It appears that CVS and Walgreens will continue to lead the market and are the preferred chains by most lenders. Rite Aid's still appear to be the most difficult to finance. However, they do offer some of the best capitalization rates in this category. Grocery Stores: The small local grocer is getting hit the hardest. The larger warehouses like Costco have cost efficiencies and can price very aggressively.

Interest rates for retail are still ranging in the 6% to 7% range with 25 and 30 year amortizations and DSCR's in the 1.20-1.35+ range.

Capital Markets Financing Shortfalls

Recently Foresight Analytics (FA), a locally based provider of national real estate analysis and projections produced some very interesting insight into the debt market. Below is my overview on their analysis:

FA's analysis utilized key data from the FDIC and focused on the increasing need for commercial real estate debt during this financial crisis. It is estimated that $814 billion in commercial and multifamily mortgages will mature during 2009 to 2011. This breaks down to approximately $594 billion in commercial mortgages and $220 billion in multi-family mortgages over the next three years. It is estimated that nearly $250 billion in combined commercial and multifamily mortgages will mature in 2009 and will increase to approximately $300 billion per year during 2011 to 2013. Maturing mortgages should settle back after 2013 but will still remain historically high exceeding $200 billion annually through 2017.

How did this happen? Taking an historical snapshot, the majority of the new debt growth occurred in 2005, 2006 and 2007, with more than $300 billion in net growth in each year. 2007 hit a high with $379 billion in net growth. Actually between 2000 and 2007 approximately $1.8 trillion in new debt for commercial and multifamily real estate was created.

In 2007 the issuance of commercial mortgage backed securities (CMBS) came to a standstill, created a major liquidity problem for commercial real estate borrowers nationwide. Banks and Thrifts have appeared to fill some of the void providing some recent net growth in the marketplace. Overall net volume is down dramatically, from around $33 billion per quarter in 2006 and 2007 to only $21 billion per quarter in the second half of 2008. Life companies still remain net contributors to growth in this market.

Life companies accounted for approximately $1.7 billion per quarter or 12% of the net growth during the second half of 2008. Their share is actually up from 2006 and 2007, but the dollar volume is down by about 50%.

CMBS itself has been contracting, due to defaults and foreclosure activity and loans being paid off. This is a substantial change from 2006 and 2007 when CMBS loans accounted for 41% of net inflows to the commercial mortgage marketplace. Today they account for net outflow to the marketplace.

It appears that serious financing shortfalls beyond the current environment could appear on the horizon shortly. Borrowers need to refinance and acquisitions need new debt as well. One of the biggest obstacles to refinancing a property today is the inability of these properties to qualify. Today properties have lower valuations, lower loan-to-value ratio's, and in most cases higher interest rates and shorter loan terms.

Some relief has been reported by the existing portfolio lenders and CMBS servicers. Many are providing temporary one-year extensions for maturing mortgages if a borrower or borrowing entity can't obtain or qualify for refinancing. This will ease those loans coming due in 2009 but add to the refinancing volume in 2010.

If current conditions like values and cash flows remain flat or negative beyond 2010, a significant portion of the $300 billion of maturing loans from 2011 to 2013 will be at risk. If the lending community can stabilize and obtain liquidity in the years ahead, a large number of defaults and foreclosures could be avoided.

As early as 2008, the lending community saw refinancing requests exceed new lending debt requirements. It is expected that this trend will continue over the next few years. If this assumed shortfall does develop, we may see minimal net growth in the commercial real estate financial market over the next ten years or so. Financing for acquisition and refinance. For a soft or hard quote, or to refer a client, please visit our corporate website at www.svnbcp.com or contact Eric Better for further information.