Investing In NEW Coin-Op Carwashes

reprinted from Fall/96

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Investing In NEW Coin-Op Carwashes All Politics? The indicators which control the rates on adjustable loans probably have as much to do with politics as anything else. The Federal Reserve Board sets those principal indicators. Under the direction of current chairman, Alan Greenspan, the "Fed" saw fit to raise rates 7 times within just 18 months ... jacking the Prime Rate indicator up and up and up. Or consider how Congress a few years ago doubled the tax rate "overnight" on capital gains and demonstrated how government whims can instantly change the value of an investment.

A prudent borrower, therefore, should be aware of risks involved in bor rowing at adjustable rates and consequences of governmental meddling in financial affairs. When candidates, politicians, and pundits tell us that low interest rates are "THE Secret" to a grow ing, healthy economy they are correct. And what I've tried to show is that at low rates a Return On Invest ment can be very handsome. But over time those rates can "go against you". And, as rates increase, other wise workable projects can become risky and perhaps even too much of a gamble.

The length of the loan period the term can help control the risk factor. A Loan's Life Span Just how long does the term of the loan have to be to make a proposed carwash investment work? In our theoretical model, the term of the loan was 10 years. I like carwash deals with 10 year terms. They work out pretty well. It's long enough to keep the debt service down and increase the probability of the NOI remaining sufficient to make the payments ... even if the adjustable rate goes up a fair amount. In 1994 I searched for a carwash loan with a 10 year term. I shopped lots of banks. I only wanted 60% of appraised value and I was willing to accept an adjust able rate and pay all the usual up front costs. I got several loan offers but none with a 10 year term.

Some of the offers really annoyed me. They only offered the pretense of a 10 year term. Actually more of a shell game with the term as the pea ... or should I say "balloon"? They offered to give me 10 years to pay and laid out a 10 year amortization schedule. But then they made the loan renewable at the end of 2 years a "balloon note". This means that at the end of 2 years the bank has the option to "call the loan" to demand full payment of the entire outstanding balance. Very risky business ... for the borrower, not the bank. At the end of the 2 years if the bank decides not to renew the loan then the borrower either has to pay off the loan, find another lender, or default. It is unlikely the bank would actually "call" the loan as long as the business was healthy and the payments were all made in full and on time. But if the project is only marginally successful, the bank may get nervous and decide to renew the loan only if the payments are raised ... death to a marginally profitable project. Or the lender might demand additional collateral be pledged by the borrower.

It's also possible the bank might ask for another appraisal plus another placement fee. At the very least, it puts the borrower at the mercy of the bank ... the "GBSH Syndrome" the ol' "gotcha by the short hairs". Renewable loans (those with balloon clauses) should make the borrower think twice. They make me very uncomfortable. And I religiously avoid discomfort ... especially when it comes to money. It's possible some bank will offer to make a carwash loan on a shorter term than our theoretical 10 years. Let's do the numbers assuming a loan term of only 5 years. The $300,000 borrowed at 2 points over current prime for 5 years has an annual debt ser vice of roughly $77,400. That's just too tight for me.

Technically, it would "work". With the NOI of $80K the wash would be self sustaining and it would be all paid for in a mere 5 years. But what if the NOI due to "out of the blue" competition and a run of poor weather drops to $60K? It's going to be a very long 5 years! This borrower will be subsidizing his wash to the tune of about $17,000 every year. And what if the rates went against this borrower on the adjustable loan? Then the needed subsidy gets even larger. Obviously that's a troubling scenario. In fact, such a wash would probably be belly up ... except for those few owners with real deep pockets and vast amounts of cash from other sources.

For a typical carwash loan a term of 5 years is probably too short. If the term is extended to 7 years, the annual debt service on a $300,000 loan at 2 points over current prime would be about $60K a year ... that seems workable. And if the adjustable rate increased at the same rate which it did over the last 2 year period then (depending on the outstanding balance at the time) the annual debt service could exceed $65K. What these examples suggest to me: 5 year term too short, too risky. A term of 7 years getting uncomfortably tight but still workable. A term of 10 years reasonable and prudent financial plan ning.

In analyzing the costs of borrowing there is another factor which bumps the quoted rated even higher the up front costs. These include fees for such things as the independent appraisal, environmental study, title insurance, application, recording, placement, and possibly other charges. Thousands of dollars are involved, which all add to the cost of borrowing. These costs typically push the quoted rate for the loan a point or so higher. Yes, thanks to those up front costs, that 10.5% loan you get will really cost you in excess of 11%. Dealing With Bankers Adjustable rates, terms too short, balloon notes, up front costs.

Does this all sound too critical of banks or other lenders? Are lenders the villains who keep carwash projects from becoming a profitable reality? No. Banks are in business to loan money. They do so in a competitive market. They should not take unnecessary chances with their depositor's money by making high risk loans. We all saw what happened when Reagan and Congress deregulated the lenders, doubled the tax on capital gains, and continued to insure the deposits. Some financial institutions played so fast and loose with depositors money that many went belly up and we tax payers got stuck with the "bail out" to the tune of hundreds of billions of dollars. It is the bank's job not to make loans which pose too high a risk to the bank's assets. And it is the borrower's "job" not to accept loans which impose too much risk to the borrower's assets.

Being turned down on a loan can be a service to the borrower. It's possible the banker has seen a flaw in the loan proposal which the borrower did not see ... ultimately saving the borrower's keister. A turned down loan proposal can offer the borrower an opportunity to reevaluate the proposed package. At the same time, it's clear to me that some banks are guilty of two practices for which they do deserve criticism. The first of these practices is "redlining" the refusal to loan money on projects in certain, "trouble some" areas. Technically it is illegal. But some banks have mastered the art and do so with impunity. Such banks will question the adequacy of the collateral and avoid any mention of the race or income levels of the potential carwash customers, let alone the geographic location. Why make urban core loans when it's safer to loan money in the "burbs"? So long as banks can get away with redlining, the deterioration of the urban cores all across America is sure to grow steadily worse.

Owner's of washes in urban cores can easily be victims of such "unofficial" policies. It seriously damages their value. Not only are loans for possible expansion apt to be denied, worse yet, the sales of redlined urban core washes are limited to cash buyers. Redlining is dirty, despicable business with devastating economic and social consequences. The other practice of some banks which I really detest is the routine practice of over-collateralizing carwash loans. Specifically, a bank requesting a carwash borrower give the bank a second mortgage on his home in addition to the collateral of the carwash itself ... even though washes have a failure rate well below other small businesses. That's just not an option for me. I'm even offended by the request. Ask, if you must, for an even fatter, "fail safe" down payment, but don't demand that a guy put his family home on the line.

....Pt. 2 Pg. 4

Pt. 2 Pg. 6....

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