Whether You Lease or Own…

By Bob Nieman | May 26, 2010

The latest quarterly survey from Washington, D.C.-based Real Estate Roundtable suggests commercial real estate trends are “stabilizing.”

But that same study predicts a slow, uneven recovery.

The survey said 82 percent think market conditions today are better than they were a year ago, up from 73 percent in the first quarter, although only 17 percent characterized conditions as "much better." Its "current conditions index," which hit a low point of 17 in the fourth quarter of 2008, now stands at 74.

"Clearly, the sense of gloom that prevailed a year ago has eased, property values no longer seem to be in a free-fall and market participants are feeling more confident," said Roundtable CEO Jeffrey DeBoer. "Some are even saying we may finally be at or near the bottom of the commercial real estate downturn, which would mark the beginning of the road back to recovery."

The survey also notes refinancing remains difficult for many, and defaults are still rising.

Of the 65 percent who said debt capital is more available today than one year ago, 27 percent characterized availability as "much better."

"What's needed now is robust job creation, more equity and restoration of secondary market functioning so that banks can clear their balance sheets of toxic assets and begin bending again to credit-worthy borrowers," DeBoer said.

While the commercial real estate market may not have fully recovered yet, National Association of Realtors Chief Economist Lawrence Yun has identified some developing, positive trends in the market that could eventually lead to recovery.

"With the momentum of a broader economic expansion and the recent creation of jobs, the commercial market is showing slight signs of improvement," Yun said. "There will likely be weaker figures through 2010, but it's important to keep in mind that commercial real estate almost always lags the economy by a full year."

Yun said jobs only began increasing a couple of months ago and are still below peak. "We have turned a corner in terms of jobs, but we still have a long way to go."

The commercial market has seen a few improving trends in recent months. The market is experiencing an increase in transactions due to more distressed properties available, and prices are beginning to stabilize. Yun believes within the next year more lending will slowly become accessible to commercial property owners. Two commercial sectors showing the most promise are manufacturing and multifamily. Manufacturing activity and employment have risen recently and because household formation is also rising, the multifamily sector will likely fare the best during this economy.

Despite some of these promising trends, the commercial market is still experiencing high vacancy rates and rent concessions. "All real estate is local, but I expect to see vacancy rates bottoming out and rent rising by next year," said Yun.

Yun also warned against some of the possible risks commercial practitioners may experience in the future such as high interest rates and inflation, as well as increased taxes for commercial real estate investors.

"The commercial market may not be where we would like to see it right now, but it is trending up," said Diane Swonk of Mesirow Financial. "The economy is slowly stabilizing and jobs are steadily rising, but full recovery cannot happen without liquidity. Liquidity is the fuel for the engine in the commercial real estate market."

Laundry Industry Trends

“There are a lot of national companies that are downsizing or going out of business – Hollywood Video, Blockbuster and White Hen are just a few examples – and those spaces will make great potential laundry locations,” said Dion Marcionetti of Laundry Concepts in Addison, Ill. “There seems to be more aggressive advertising on spaces for rent.

“Cheap deals are available to those who have the cash to act quickly. You must have a specific purpose in mind to purchase property at this time. These are not good economic times to speculate.”

On the West Coast, the real estate market varies dramatically, according to Bryan Maxwell of Western State Design, headquartered in Hayward, Calif.

“Some pockets of the economy have been hurt more than others,” Maxwell offered. “The two determining factors impacting the West Coast real estate market are the recession and changes in demographics. The effects of the recession are obvious and, to varying degrees, have had an impact on the entire West Coast.
 
“Changes in demographics have been equally significant to the real estate market,” he continued. “The Hispanic population has decreased significantly in some areas of the West Coast. Employment opportunities in construction have decreased because of the real estate crisis and employment in agriculture has decreased due to California water shortages. Lastly, changes in immigration laws have reduced the Hispanic population.

For laundry owners who rent and are looking to renegotiate leases, Marcionetti believes that there many business owners “crying wolf” who are not being taken seriously by landlords.

“There are two different options that I have seen taken by landlords,” he said. “Number one, they will not negotiate any reductions in rents because they believe that, for a specific amount of time, they collect less rent and reducing the rent 10 percent to 20 percent will not make a failing business successful. Their experience is that the business normally doesn’t make it anyway. They believe that it just extends the time and the opportunity to rent that space at the going rental rate. The banks that carry the mortgages on these properties dictate the rental rates and the owners’ hands are tied.

“Number two, some landlords have been negotiating the terms of their leases both in longevity and with very short term reductions in rental rates, especially with properties that are slightly below par. Those properties need to fill their spaces so that the common area maintenance charges help pay for the work that needs to be done to bring the property up to a better standard to entice higher paying tenants. The old saying that nothing is free also holds true in lease negotiations.”

Maxwell has seen landlords’ reactions to the recession vary, based on the region and the particular situation.

“If there is a long-term lease in place, we have seen very little movement by landlords to renegotiate leases,” Maxwell stated. “Many clients have attempted to renegotiate more favorable leases, but if a long-term lease has been executed, landlords have not been willing to renegotiate.

“Regarding leases up for renewal, approximately 50 percent of the landlords recognize the existing market conditions and are looking for long-term security. This is the perfect situation the coin laundry owner. With these types of landlords, our clients have been able to secure very favorable, long-term leases that are 20 percent to 25 percent lower than agreements executed in 2006 and 2007.”

There's never a bad time to renegotiate a coin laundry lease, if you can, and the current distressed conditions certainly allow a higher likelihood of success, according to Jeffrey Barman of Wonder Wash Family Laundry Centers, based in Laguna Niguel, Calif.

“Your ability to gain traction on improved lease terms will be largely contingent on your landlord's personal outlook on the future of his rental income stream – it's much easier to negotiate with a pessimist. Additionally, a coin laundry leaseholder has less options than a cell-phone-store leaseholder; it's much harder to legitimately threaten that you will pack up and take your equipment, water meter and roof penetrations with you."
 
In addition, Maxwell has noticed a number of landlords looking to build and operate laundries of their own. “Having difficulties attracting retail clients, they have determined the self service laundry industry provides them with an excellent business opportunity,” he explained. “It’s an opportunity they can either keep and operate themselves or sell at some later date. Either way, they end up with a long-term tenant.”
 
As a laundry distributor and a landlord, Bill Gilbert, president of Service Laundry Machinery in Belton, S.C., views the current real estate market from both sides.

“I own some property on which we’ve got some laundries,” he said. “Some of the owners are coming back to me and saying, ‘Bill, my five-year option is up, is there an opportunity to keep the rent where it is because of the way things are going?’ And I’ll either lose a tenant or say yes.

“This is a perfect time for negotiating leases,” he added. “Look at shopping centers now and how many are vacant. We’ve got large grocery stores that are going out of business, declaring bankruptcy. They are the anchor tenants, so the owners who bought this investment property are doing whatever they can to keep someone in there.”

Keith Griffin of Super Suds Coin Laundries, based in Beebe, Ark., is currently working on lease for a new store, “and I think I will be it done for about 20 percent less than I could have done it 18 months ago.”

“The great thing now is that there are a lot of spaces to choose from, and you can ask for the moon,” Griffin added. “Cheaper, long-term tenants are better than none. I think this will be the environment for next three to five years. Now is a great time to expand.

“It’s a buyers’ market out there. I would recommend asking for more than they think they can get. After all, anyone who manages much property is aware of the market conditions and are very willing to work with current tenants, rather than seeking new ones.”

One of the keys to obtaining commercial real estate in today’s market is cultivating a solid networking system to alert you to deals that are available before they are known to others, according to Marcionetti.

“Having a good banking relationship to be able to act on a deal when it arises is critical,” Marcionetti explained. “The great deals go fast, and you have to be able to move quickly.”

“The biggest keys on your chain are your ability to access a distressed deal, having no financing contingencies, and offering a no-hassle closing schedule,” Barman added. “It is not likely that you have dozens of deals to choose from that specifically fit a laundry in your particular geographical sub-market, but there are some. The very best deals, the ones offering the magical discount to market that everyone wishes they could specialize in, are by their very nature going to go fast. To paraphrase the not-a-realtor Woody Allen, 80 percent of the battle for winning a great real estate deal in this market is showing up."

Investors Positive on ‘Triple-Net-Lease’ Deals

One segment of the commercial real estate market that doesn’t appear to be suffering as badly as the rest, accord to a Wall Street Journal report, are properties on “triple net leases” – a common type of lease for many self-service laundry owners.

Such ventures are "the best-performing sector of the commercial real estate marketplace," said David Bailin, head of global managed investments for Citi Private Bank, which serves ultra-high-net-worth clients. "It is the sector that lost the least value [during the recession] and rallied the quickest."

Triple-net-lease properties are usually freestanding buildings in which a tenant agrees to take responsibility for maintenance, taxes and insurance during a long lease.

Triple-net-lease properties are generating annual returns of as much as 12 percent these days, estimated Bernard Haddigan, managing director of Marcus & Millichap Real Estate Investment Services' National Retail Group.

Triple-net properties suffered during the recession, but less than other types of real estate. Whereas overall commercial prices fell by about 40 percent during 2007-09, prices for triple-net properties fell by about 15 percent, according to Haddigan.

Leasing vs. Buying

At some point, every potential laundry owner is faced with the dilemma of deciding whether to lease or buy his facility. What are the advantages and disadvantages of each? There are a few factors that should be taken into consideration when evaluating whether to buy or lease space.

Comparing the benefits of leasing versus buying from a cash standpoint is an important step, while looking at the business’ future needs. The long-term space requirements also are an important part of deciding whether to lease or buy.

Often, when beginning a business, leasing appears more appealing. Cash flow is the main reason. When purchasing space, it takes a larger portion of cash up front, typically a down payment between 10 percent and 20 percent of the purchase price, depending on the lender and credit, plus closing costs. What are the "opportunity costs" for those dollars if used in your laundry business? For most owners facing this decision for the first time, the thought of borrowing money to buy commercial property is as intimidating and overwhelming as it is for a first-time homebuyer. Ownership also can bring a separate set of headaches – being responsible for maintenance and operations can have a huge impact. After all, it represents time away from running the business.

But buying your building certainly has its advantages. Developing equity in a building can be a sensible way to grow your business, as well as your personal wealth portfolio.

When you buy, you control your destiny as far as the length of the lease and the amount of the increases. You’re buying some insurance that you won’t have to pay rent increases. Also, historically, there has been appreciation on almost all real estate in almost all areas. Instead of paying rent and throwing the money out the window, you’re going to be paying on the principle and, eventually, you wind up owning that building, which could be worth a substantial amount of money. And the business will help pay for that.

If you’ve got enough money and your credit is good and the opportunity to buy is available, that’s the path you should take. The problem is that, in the bigger cities, very little real estate is available and, typically, it’s a portion of a shopping center. So the real estate opportunity often isn’t readily available in the urban areas to most coin laundry owners.

However, don’t immediately walk away from a good deal just because it doesn’t have real estate; after all, your primary reason for getting involved in self-service laundries is to own the business, not the real estate.

Of course, before any decision is made, do the homework – know the pros and cons of both buying and leasing:

Leasing Advantages:

• Credit ratings are not quite as crucial, compared to buying.

• You don’t need to worry about selling if moving to a new location.

• Your monthly rent is a tax deduction as a business expense.

• You may, with landlord approval, have the freedom to sublet, assign the lease or move if need be at the expiration of the lease.

• No loss if owning in a bad market.

Leasing Disadvantages:

• Rental rates with annual escalations based on market conditions.

• Loss of the reversion or the value of the property at the end of the lease.

• No equity buildup.

• You may be forced to leave at the end of the lease.

It’s important to understand that, when you sign a lease, it’s a permanent contract, only escapable by bankruptcy. When you sign a lease, it’s usually forever – and that’s regardless of whether or not your business makes money. When signing a lease, use extra caution and make sure you understand what you’re on the hook for. You have to be very careful to watch the lease escalations in relation to the volume.

If you’re going to buy a laundromat, leasing the space, it would be wise to create a spreadsheet detailing your expected revenue for the life of the lease, as well as your maximum possible rent for the duration of the lease.

That simple exercise will reveal whether or not the rent-to-gross ratio is going to become problematic. By the way, coin laundry volumes rarely grow significantly once the business has been established. This simple analysis is probably the single most important analysis you can do in acquiring your self-service laundry.

Buying Advantages

• Interest on the mortgage loan is tax-deductible.

• Changes can be made to the building to accommodate your business.

• You can take annual depreciation deductions on taxes.

• No rent increases. You don’t have a landlord who can just automatically pick a number out of the sky and say, “This is what your new rent is going to be.” If that happens, your entire profit-and-loss statement could be out the window, and the next thing you know you’re not able to make it work financially.

• You can benefit if you sell when the market is good.

• If you end up with excess space, you can lease out the extra.

• No set hours of business.

• You can stay at that location as long as you wish.

Buying Disadvantages

• Usually requires more initial capital to secure financing.

• Property values may decline.

• Owning real estate subjects the owner to various legal and regulatory risks not associated with leasing.

• It requires the owner to invest time and energy into matters that are not directly business-related. For example, if you have a roof problem, you’re the landlord. You have to fix the roof. There are a lot of inherent issues that you have to deal with when you’re the landlord.

• Inexperienced owners may operate their real estate inefficiently and increase operating costs.

Beyond this are the additional questions – and possibilities – of building a new store versus buying an existing coin laundry location. One of the benefits of buying an existing store, naturally, is that all of the infrastructure is already in place. Therefore, there is no buildout cost involved. You are up and running tomorrow.

One of the main risk factors of building a new store is eliminated, because your customer base already exists. It’s a concrete number. It’s not something that’s abstract. It’s not a situation where you’re saying to yourself, “Let’s build it and then hope they will come.”

Then again, there also are solid reasons for those, who have the financial means, to choose to build new. You begin with a clean slate. You can put in all of the amenities – the tanning salon, the coffee bar, the restaurant and so on. And you don’t have to worry about making them fit into the pattern that you were given, had it been an existing store.

Certainly, these lease-versus-buy and existing-versus-new factors can only be decided by you. Then again, your financial situation may make the decision for you. Ask yourself just how much money you really have to invest in your coin laundry venture.

If you think that your tax return of $5,000 is going to put you into a brand new business, you’re probably not going to be a coin laundry owner.

“I believe interest rates, higher-than-normal vacancies and the constant threat of foreclosures are the driving force in the market today,” Marcionetti said. “The owners who are not over-financed are the ones who will survive and become much stronger when we go into an economic upturn.”