The car wash financing sector has been hit hard by the credit crisis. Yet not all of the news is negative. Below is an overview of what caused the credit crisis, the general market and finance options that are still available.
As most of the readers know, the global credit crisis started off and has been perpetuated due to the residential subprime disaster. These loans, that were made to low credit/low income borrowers, were pooled together, securitized (in the form of bonds), and sold off to major investors like pension funds, foreign countries on Wall Street.
Due to their poor performance, or high default rates of these loans, the buyers on the secondary market have lost a tremendous amount of money and their faith in this system. This mistrust has spread throughout all asset classes i.e. on both residential and commercial loans resulting in a severe drop in investor demand. For example in 2007, approximately 52% of all commercial mortgages, where originated to be sold on the secondary market (This is often called the CMBS market or the Commercial Mortgage Backed Securities). In 2008, that market was down 98%… according to the Mortgage Bankers Association of America.
In a single year, over half of the market for commercial mortgages were whipped out. The rest of the market, including conventional banks, credit unions, and the government guaranteed lenders (USDA B & I and SBA) were the players left standing, to fill the void.
Additional Challenge For Cash Wash Owners
The added challenge for owners or prospective owners of car washes is that this asset class (building type) is considered “special purpose”. What this really boils down to, from the lenders perspective, is that in case of borrower default, it will be more difficult for the lender to sell the property and at a reasonable price. The buyer demand will be lower for special purpose properties when compared to a more general purpose properties like office, retail or industrial. For example, there are hundreds of different types of businesses that could occupy an office building, but only one that can occupy and use a car wash – a cash wash.
Further and going back to my earlier point about the current death of the commercial secondary market, there is much less competition between banks that are still funding commercial loans. They are in a position to sit back and “Cherry Pick” the best loans that cross their desks. And for the most part, any special purpose properties, like car washes, restaurants, motels, gas stations, etc have been ignored by the majority of lenders.
Bottom line, underwriting standards have tightened considerably across the board, and especially so with conventional banks (see below). By far the most viable loan programs for car washes include SBA Business Loans and USDA B & I Loans. Take a look at the graph below, to get a better idea:
Loan Program LTV Purchase LTV Refinance Debt Coverage Ratio Amortization Schedule Conventional 55- 60% 50 -55% 1.5 10 – 15 years SBA 7a Loan 80- 85% 75- 80% 1.3 25 year USDA B & I 75- 80% 75- 80% 1.3 30 years
Loan to value is simply the ratio between the assets value compared to the loan amount. For example, if your car wash is worth, $1,000,000 and your loan amount is $600,000 your loan to value is 60%. In general this ratio has dropped considerably. In addition, values for car washes have dropped substantially as well in the last few years. So what we have here is “insult to injury”, i.e. declining property values, from the market and lower Loan To Value standards by lenders.
Debt Service Coverage Ratios (DSCR) is a way for underwriters to measure an operations available cash flow to pay for the proposed mortgage. Historically, the DSCR needs to be around a 1.3 for car washes. Now, expect conventional banks to want to see a 1.5 or most likely higher. On SBA or USDA loans, there is more flexibility, and the ratio can be as low as a 1.3.
DSCR is calculated by measuring the total available net cash flow of an operation (often referred to as the Net Operating Income), divided by the proposed annual mortgage payments. So if your net income is $200,000 (this is your Gross Sales minus all expenses, but before the proposed mortgage payment) and your total annual mortgage payments are $125,000 your DSCR is 1.6. ($200,000/$125,000 =1.6).
Global Income, which takes the DSCR analysis to the next level, calculates ALL of the borrowers personal and other businesses income and expenses and puts the same ratios as above, to the test. So, even if the a borrowers car wash is doing great, but if he has an excessive amount of personal debt and or another business that is doing poorly, the bank will most likely pass on the transaction as his Global Income is showing signs of stress. They are concerned that the other business(s) could cause a default on their loan. Underwriting standards on Global Income where fairly relaxed 2 years ago, now it is very strict.
Amortization schedule refers to how long the loan payoff period is structure. Shorter amortization schedules mean quicker pay down of the loan balance, but higher monthly payments for the borrower. Shorter amortization periods are a more conservative loan for the lender.
What Are Your Finance Options?
Finance options boils down to Conventional bank loans, SBA or USDA B & I loans.
For the most part, conventional financing is currently on “life support” for car wash owners. By conventional we’re referring to commercial banks (local or national), that fund loans and hold them in house, i.e. on their balance sheets.
For conventional loan programs that are available, borrowers should expect 50% loan to value financing (max), with 15 year amortization schedules. Rates would most likely be in the mid 6%’s. Borrowers themselves will need to be financially strong. Liquidity and cash flow are critical. As far as cash, conventional banks will most likely want to see at least 12 months of reserves. Meaning, if your expenses are $10,000 per month, a conventional lender will likely want to see $120,000 in cash (after the loan closes).
So the point here is that conventional financing is reserved for only the strongest of borrowers. There is almost always a story behind why one of these loans gets funded in this market. It’s normally a combination of highly liquid borrower, that has a significant deposits with the bank and or he owns another business that is doing very well and the funding bank is trying to get involved with that business as well, etc. In general, we do not recommend borrowers seeking this type of financing, as it is currently a huge waste of time and money.
As mentioned above, the SBA programs and especially the SBA 7a loan (for loan amount below $2,000,000) are the most reliable form of financing in the market for cash washes. This is a result of the loan guarantee that the government provides the funding banks, which acts as an insurance policy for the lender. Due to the Stimulus Package the guarantee is currently at 90% of the total loan amount. The guarantee is normally set at 75% of the total loan amount.
Another positive here on SBA 7a financing is that the secondary market for this particular loan is healthy. So SBA Lenders can still sell these loans onto the secondary market and make a substantial profit. This helps them with their liquidity and has kept the entire market moving. On the SBA 504 program, which is generally used on loan amounts over $2,000,000 (and for purchases only), the secondary market is in trouble. As a result, the 504 program is a less reliable form of financing.
Terms SBA 7a
Borrowers can expect 80- 85% loan to value purchase financing and 75% – 80% financing on refinances (considerably higher than the conventional financing discussed above). Amortization schedules are almost always at 25 years, with no balloons. The rate is normally tied to The Prime Rate (which is currently at 3.25%) and the margin that the lender charges is normally 2.75%, which is the max that the SBA allows. So as of today the “Effective Rate” would be 6%.
99% of the banks out there structure the program on a quarterly adjusting rate. There are a few that will fixed the rate for 1 year or 3 years but this is very rare. The prepayment penalty on the loan is 5% in year one, 3% in year two and 1% in year three, gone thereafter. So a lot of people justify the adjustable rate with the relatively cheap pre payment penalty. I.e. that they can refinance the debt in a few years. For the most part, we recommend the SBA 7a program.
USDA Business & Industry Loan
This is a relatively unknown program that was organized in the 1980’s by the United States Department of Agriculture to help create and retain jobs in rural communities. The loan process is a little more cumbersome than SBA or conventional, so you should only consider it if your loan amount is above $1,000,000. Also, a major qualifying parameter is that the property has to be in a town, with a population less than 50,000.
Most lenders structure the program similar to the SBA 7a loan. It is tied to Prime, with a margin between 2% – 3% over and most sources structure the rate to adjust quarterly. However, though rare, fixed rates for as long as 7 years are available. Another major benefit is that the amortization schedule is usually on a 30 year schedule which dramatically increases cash flow. Pre payment penalties are normally expensive. 5% for 5 years is common, even on a quarterly adjusting rate. All in all, for the right situation we recommend this program as well.
If you are trying to refinance a car wash and or are thinking of buying one, you’re going to want to make sure you’re prepared to deal with the new market realities. Think government back programs first and be prepared to talk to many potential lenders. Move on until you find one that is enthusiastic about your project. Don’t let the bank drag you out or try to convince them to take you on. If your gut is telling you that they are giving you the run around, they probably are.
About the Author
Jeff Rauth is President of Commercial Finance Advisors, Inc. out of Birmingham, Michigan. He specializes in Commercial Real Estate Loans between $400,000 – $5,000,000. Offering unique loan programs such as Commercial Second Mortgages, Commercial 30 Year Fixed and 90% non SBA financing, and Commercial Equity Lines. 248 885-8797