Investing In NEW Coin-Op Carwashes

reprinted from Fall/96

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The fixed rate is the first stumbling block to a desirable, predictable loan obligation ... and Rate Of Return. It was not too many years ago that banks which had made long term fixed rate loans found themselves "upside down" in the loans. That is, banks were paying depositors a higher rate to attract deposits than they were charging on some of their still out standing fixed rate loans made earlier. That situation has made banks very reluctant to make such loans again.

The banks became painfully aware of how tricky it is to predict future rates. So, in order to be assured of profitable "spreads", banks much prefer to now make "adjustable" (or "variable") rate loans. I know it seems strange that fixed rate loans can be obtained on homes, even loans with terms as long as 30 years. Not so for businesses like carwashes.

Here's the difference: Real estate loans are fairly low risk. In the event of a default, the collateral is worth enough to cover the outstanding balance of the loan. That's even true of some commercial real estate. It tends not to be as true with carwashes. In most cases, the value of a carwash business is well in excess of the value of the real estate associ ated with the carwash. Carwashes are "operational businesses". As such, their true value depends far more on how much profit they produce than on the value of the real estate associated with them. Real estate consists of land and buildings.

Whereas, carwashes consist of land, buildings, equipment and "goodwill" . Every carwash business I've ever owned was worth a good bit more than just the value of the land and build ing. My professional reputation, name recognition, loyal customer base, and higher than average per bay income all validate the extra value of the goodwill at tached to my washes. Moreover, carwash buildings are considered "single purpose" structures. That means they are not easily converted to uses other than carwashing. That implies in a default situation the value of the real estate may very well not be adequate to pay off the loan balance.

For some commercial real estate fixed rates loans may be available. Do not assume you'll be able to get one for a carwash project. I don't even bother to ask for them anymore. Isn't It Ironic? At this time, let me offer a quick aside into one of the ironies of carwash values and appraisals. There can be surprising consequences on borrowing and taxes. Any carwash loan is going to require an independent appraisal of the property. You may find yourself dealing with an appraiser under the mistaken impression that carwash businesses have all their value in their real estate ... and not the equipment and goodwill. If so, it's possible that the banker will not catch this error in appraisal theory and treat the loan as if it were collateralized entirely by the real estate. And that mistake might result in a loan with a longer term, a lower rate, and possibly even a fixed rate.

But if the appraisal confuses the value of the real estate and the value of the business watch out when it comes time to pay real estate taxes. You'll end up paying taxes above and beyond just the real estate. You'll get nailed on the total value of an operational business ... including the equipment and goodwill. Two types of carwash appraisals are needed. One for the purpose of getting a business loan an evaluation of the total value of operational business. And another type of appraisal for tax purposes an evaluation of the value of the real estate alone.

That's pretty straightforward, logical, reason able and fair. The problem is that many appraisers pretend there's no difference. Why? Human nature a real estate-only appraisal is easier, faster, less compli cated. So if you want the right appraisal for the right purpose, more often than not, you'll have to pursue it. And that pursuit may very well involve "educating" both your banker and the appraiser.

Adjustable Risks On an Adjustable Rate loan the rate charged by the bank to the borrower can either go up or go down. Sometimes it can change quarterly (that's common) and sometimes it changes only once or twice a year. The amount of change (up or down) in the rate is often pegged to the so called "prime rate" (the best rate the big New York banks charge their biggest/best borrowers) or to some other index or indicator. Neither the borrower nor the lender has any control over the amount of change in the rate, the indicator controls the change. These indicators can change swiftly and dramatically. This volatility adds considerable risk for the borrower as some recent history will make perfectly clear. During the late 1970's these indicators rose so far and so fast that some businesses with adjustable rate loans found themselves paying rates in the 20% range. I'm sure that back when these borrowers got their loans they would have thought a 5% to 10% jump in rates a few years later impossible. Wrong. Now jump back to our $400,000 wash with the $300,000 loan and the annual NOI of $80,000. If you remember, the debt service took about $48K a year ... as long as the rate was at 10% and the term 10 years. Jack that rate up to the 20% (as paid in the late 70's) and the debt service jumps up to $78,000 a year. At that rate, it takes nearly every penny of NOI just to service the debt. If the NOI declines, the wash is in "Loss City". Of course, that kind of loss would not happen in an all cash transaction. Declining NOI lowers the Return On Assets on a paid for wash, but there are no actual losses and a need to subsidize the wash until operational expenses are greater than gross revenues. Leveraged deals (borrowed money) can be, therefore, riskier than all cash deals I'll grant I did pick a dramatic case. The wild changes in rates in the 70's may never ever happen again and probably seem like ancient history to those much under the age of 40. So let's take a look at some recent history ... In late 1995 (recent enough?) the prime rate was 8.25%, but less than 24 months earlier it was 6.25%. Fluctuations in interest rates on adjustable loans changed accordingly. The rate "only" went up by 2 points (each one percentage increase is called a "point"). But the actual percentage of change to the rate was 32%. Yes, a 32% increase! Let me illustrate ... Suppose you realize that you'll have to buy some new pumps soon. The supplier tells you the pump model you want will cost $625. You wait a couple months and go back to your supplier and price the same pump. It's now $825. By what percent has the price of the pump gone up? That $200 increase in the price is an increase of 32% 200 ÷ 625 x 100. So it is when the prime moves from 6.25% to 8.25% ...a 32% increase. You cannot minimized such an increase and say it's "only 2 points". If prices for all goods rose by 32% in 18 months that would translate to an annual infla tion rate of about 20%. To put that in another perspec tive do you recall why Nixon imposed drastic (some might say "Socialistic") wage and price controls in the 70's? Well, he and his advisors were very fearful that the inflation rate might rise as "high" as 5%!!! So, anyway you cut it, a 32% hike is certainly not small potatoes. On a $300,000 loan a 2 point (32%) jump would increase a monthly payment by $500 ... adding another $6,000 per year to debt service.

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Pt 2 Pg. 5....

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