A Perfect Storm

By Jeffrey Barman | Apr 15, 2009

There are three ways to get started in a new business: Buy, Build and Inherit. In this column, I will address how current economic conditions are likely to impact buyers and sellers of coin laundries in 2009, and what you should do about it.

While my son is currently enamored of the Inherit option, he is contemplating other options, including toy designer, paleontologist, astronaut and chef. I have sagely cautioned him that kindergarten is a tumultuous time to settle upon a career, so he has agreed to postpone making a final decision and turn his attention back to Handy Manny.

If you are more seriously considering undertaking a straight inheritance from your parents (rather than acting as a third-party buyer would) as an option to enter your family business, be it laundry or other, this would be a good time to do so, as I believe estate taxes will inevitably be raised during the new administration’s first term.

Succession planning for small family businesses is an analytical entity unto itself, requiring Big Business Thinking regardless of industry, so you do need to carefully consider the financial impact of taking over a failing business. Sometimes the best thing for both generations of a small and dying business is to actually let it fail, and close. This is especially true if you do not control the underlying real estate. If you do inherit a failing laundry with the building, at least you have the valuable option to become a landlord by leasing to an alternative tenant in the future.

The second entry point for a new business is to Build. While this would appear to be extremely popular based upon The Journal’s monthly store spotlight feature articles, in truth it is as hard a thing to do as you can imagine. The Build option for a cell phone retailer or a professional services provider is one thing, but creating a laundry building from scratch is quite another.

Location, acquisition or lease negotiation, layout, permitting, construction, utilities…I’m exhausted already, and I know what I’m doing. However, if your heart is set on becoming featured in a profile, 2009 would be a good time to start.

The cost of buying and leasing commercial real estate is declining, and I predict it will do so for some time. Commercial and business loans taken as a group are defaulting at a slower pace than residential loans. The majority of problematic bank loans to date consist of those made to construction-related entities.

As the recession goes longer, it will also become broader and deeper. Consumer spending reductions will result in, among many bad economic realities, a rash of retail store closings, especially in the first quarter. This means empty shopping centers and unhappy landlords. Indeed, overleveraged landlords of B and C centers are going to be defaulting on their acquisition and development loans at an accelerating rate.

According to Federal Reserve statistics, the delinquency rate for commercial loans nationally was one percent in the third quarter of 2006, doubled to two percent in the third quarter of 2007, and more than doubled again to nearly five percent in the third quarter of 2008. Meanwhile, the vacancy rate for shopping centers during the third quarter of this year was at its highest level since 1994, at over eight percent, according to the real estate analytical firm Reis, Inc. I predict that both these rates will rise in 2009.

To you, what all this means is simple: you should be able to negotiate lower rents for leasing and lower cap rates for buying. After choosing the right location, the cost of controlling the real estate is the single most important factor for your store’s long-term viability. 2009 will offer you the chance to do so at a discounted price as compared to the previous five-plus years. Additionally, the cost of construction and the availability of qualified personnel to build your store will both be working in your favor, down and up, respectively.

Door number three to enter a new industry is to Buy, which I posit is the path chosen by 90% of first time laundry owners. There are two ways to react to scary times as a buyer; you can be scared, or you can be excited.

There’s good reason to be fearful. Have you noticed that most of the residential foreclosures in your neighborhood have been from the most recent buyers? They were the ones who were most likely to have taken advantage of cheap financing with low (or no) down payments to buy an asset at the peak of its pricing cycle. Now their mortgage rates have reset at the same time they lose an income stream (such as their jobs), and they have negative equity in their asset. The result is foreclosure. This is the Last In, First Out (LIFO) inventory principle at work.

What’s happening in the hardest hit areas is that the declining values and lack of a thriving resale market due to a paucity of buyers is trickling down to plenty of older buyers, who are suffering due to the economy and not due to excess leverage. They, too, are losing their homes. LIFO is expanding within the asset class, moving from the most recent to the less recent buyers.

So do you want as a buyer to try to catch a falling knife? There is absolutely nothing wrong with your answer being a resounding “no.” It’s far more important that you time your purchase to coincide with your highest level of emotional happiness than with the vagaries of the marketplace. If you buy a business today, the financial impacts will be hitting you just as hard as they did the previous owner.

Sure, you can be a better operator, refresh the interior, buy new equipment, start marketing, refine your pricing strategy, and all of the rest best practices that you’re supposed to do anytime you buy a business. Remember, recession-resistant does not mean recession-proof. Thomas Covenant easily burnt, but he couldn’t feel it through his leprosy.

To the thousands of recently unemployed professionals who are considering buying a laundry rather than rejoining the workforce, I say, welcome to our fantastic industry, but be sure you are ready to be a buyer in today’s economy. When things get worse, will you be prepared financially, operationally and personally as a first-time buyer to correctly deal with and resolve all such issues? Your new investment could easily become a LIFO casualty. You have been warned.

The consequence of the destruction in the past year of untold trillions dollars of home equity, plus the loss of five trillion dollars of stock market equity from just those companies that make up the S&P 500, is a profound lack of qualified buyers. With little to no equity left in homes, twenty and thirty percent declines in the value of 401(k) accounts, and over 1.25 million jobs lost in this past fall, the pool of buyers for all kinds of businesses, including laundries, has sharply contracted.

With all that news, we have yet to address the single most pressing question. Where is the money going to come from to purchase the business?

Without new equipment purchases, the manufacturers aren’t going to be interested, and even then most of them won’t help finance a brokerage transaction. Small Business Administration (SBA) financing has always been an iffy proposition for the coin laundry industry, primarily due to its paperwork requirements from both sides of the transaction.

Nonetheless, SBA loans are an excellent indicator of the general confidence level of small business buyers. After five consecutive years of record performance, the number of approved loans under the SBA’s popular 7(a) program fell by 30% in the twelve month period that ended in October. I suspect that this winter’s declines will be no less significant.

You could always try getting a loan from your local bank. First, figure out which of the five remaining national lending institutions has taken over your local bank. Second, recall that they have already cancelled your home equity line of credit. Third, recognize that even if you manage to secure an appointment with George Bailey, Mr. Potter is highly likely to refuse to even consider your application. Small business lending is, for now, dead for most of us, and will be especially so for first-time business buyers without strong tangible assets and a reliable outside income source.

There were at least 23 bank failures in 2008; only 24 banks failed in the previous six years combined. Note that this does not include the recent massive forced sales of such major banks as Wachovia, Washington Mutual and National City. Non-performing loans reached a 15 year high in the third quarter of 2008, at over $180 billion; charge-offs hit a 17 year high. The number of “problem” banks hit a 14 year high, with 171 banks with over $115 billion of assets on the FDIC’s anonymous watch list.

So we have many less buyers and they have no access to capital. What does this mean for the laundry brokerage marketplace for 2009? If you are a seller, simply put, don’t try to sell. The majority of stores on the market will be forced sales due to loan, lease, cash flow or personal reasons that can’t be avoided or put off any longer by such stores’ owners.

As time goes on with few buyers, much less buyers who are financially qualified, prices and multiples are going to have to fall to produce trades. I predict that stores will sell in 2009 for a full multiple point less than they would have a year earlier, which imputes an eighteen to twenty-five percent price drop for most of the country.

Buyers are going to be extra picky, driving the hardest bargain they can. They will be prepared to walk away, knowing there will be another store around the corner, sometimes literally so. I believe that there will be a reemergence of what used to be the norm of seller financing, with sellers carrying a three to five year note from the buyer for up to half of the sales price. If you can avoid being a seller during such market conditions, you should do so.

Still not convinced? Having had your request to enter our business be rejected three times, you return a fourth time, sure of your conviction? Fantastic, me too! For us, it’s time to start picking some targets and close a deal. There are going to be lots of blue light specials out there. The best time to buy is when nobody else wants to. For the contrarian minded investor, you will look back five or more years from now and be glad you were smart and lucky enough to be a buyer in 2009.

The trick is to make sure you are buying a good store from a troubled owner, and not a troubled store from a good or troubled owner. As you conduct your due diligence, always keep in mind the message I convey to my wife on her way to the mall (with a vacancy rate over six percent, before January’s closings): Just because it’s on sale doesn’t mean it’s a bargain.

My resolutions for 2009 are to buy at least one new store and to make more money in my stores regardless of the economic conditions outside (don’t worry, I spent a lot of time with my family in 2008). I wish for you the same. Happy New Year!