Credit Crunch — The State of
Car Wash Financing
By Jeff Rauth

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 and the general market and finance options that are still available.

WHAT HAPPENED?

As most of the readers know, the global credit crisis started and has been perpetuated due to the residential subprime disaster. These loans, that were made to unqualified borrowers, were pooled together, securitized (in the form of bonds), and sold off on Wall Street to major investors like pension funds and foreign countries.

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 the 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 percent of all commercial mortgages were originated to be sold on the secondary market (often calledthe CMBS or Commercial Mortgage Backed Securities market). In 2008, that market was down 98 percent according to the Mortgage Bankers Association of America.

In a single year, over half of the market for commercial mortgages was 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 CAR 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 at a reasonable price. The buyer demand will be lower for special purpose properties when compared to 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 car wash.

Further — and this goes 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. For the most part, any special purpose properties, like car washes, restaurants, motels, gas stations, etc., have been ignored by the majority of lenders.

UNDERWRITING STANDARDS

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 and USDA B & I Loans. Take a look at the table below, to get a better idea:

Loan to value (LTV) is simply the ratio between the assets’ value compared to the loan amount. For example, if a car wash is worth $1,000,000 and the loan amount is $600,000 the loan to value is 60 percent. In general, this ratio has dropped considerably. In addition, values for car washes have dropped substantially in the last few years. So what we have here is “insult to injury,” i.e., declining property values from the market and tougher loan-to-value standards from lenders.

Debt Service Coverage Ratios (DSCR) is a way for underwriters to measure an operation’s available cash flow to pay for the proposed mortgage. Historically, the DSCR needed to be around 1.3 for car washes. Now, expect conventional banks to require 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 the net income is $200,000 (this is the gross sales minus all expenses, but before the proposed mortgage payment) and the total annual mortgage payments are $125,000, the 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 borrower’s personal and other businesses income and expenses and puts the same ratios as above to the test. So, even if the borrower’s car wash is doing great, but 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 were fairly relaxed two years ago; now they are very strict.

Amortization schedule refers to how long the loan payoff period is structured. Shorter amortization schedules mean quicker pay down of the loan balance, but higher monthly payments for the borrower. Shorter amortization periods are more conservative loans for the lender.

WHAT ARE YOUR FINANCE OPTIONS?

Finance options boil down to conventional bank loans, SBA, or USDA B & I loans.

Conventional
For the most part, conventional financing is currently on “life support” for car wash owners. “Conventional” refers to commercial banks (local or national) that fund loans and hold them in-house, i.e., on their balance sheets.

For conventional loan programs, borrowers should expect 50 percent loan-to-value financing (maximum), 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 is concerned, 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).

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 a highly liquid borrower, who has 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. In general, we do not recommend borrowers seek this type of financing, as it is currently a huge waste of time and money.

SBA Financing
As mentioned above, the SBA programs and especially the SBA 7a loan (for loan amounts below $2,000,000) are the most reliable form of financing in the market for car 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 percent of the total loan amount. The guarantee is normally set at 75 percent of the total loan amount.

Another positive regarding SBA 7a financing is that the secondary market for this particular loan is healthy. So 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.

SBA 7a Terms
Borrowers can expect 80 percent to 85 percent loan-to-value purchase financing and 75 percent to 80 percent 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 percent) and the margin that the lender charges is normally 2.75 percent, which is the maximum that the SBA allows. So, as of today, the “effective rate” would be 6 percent.

Ninety-nine percent of the banks structure the program on a quarterly adjusting rate. There are a few that will fix the rate for one year or three years, but this is very rare. The prepayment penalty on the loan is 5 percent in year one, 3 percent in year two, and 1 percent in year three, gone thereafter. So a lot of people justify the adjustable rate with the relatively cheap pre-payment penalty. That is, 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 1980s 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.

Terms
Most lenders structure the program similarly to the SBA 7a loan. It is tied to prime, with a margin between 2 percent and 3 percent. Most sources structure the rate to adjust quarterly. However, though rare, fixed rates for as long as seven years are available. Another major benefit is that amortization is usually on a 30-year schedule, which dramatically increases cash flow. Prepayment penalties are normally expensive. Five percent during the first five years is common, even on a quarterly adjusting rate. All in all, for the right situation we recommend this program as well.

SUMMARY

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-backed 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 runaround, they probably are.

Jeff Rauth is president of Commercial Finance Advisors Inc. in Birmingham, MI. They do commercial real estate loan across the nation, starting at $500,000. Visit SBA Business Loans on the web for more information.