CORONAVIRUS UPDATE FOR COMMERCIAL TENANTS

Articles Posted in Business Trends

In today’s San Diego commercial leasing market, some business owners are taking advantage of increased bargaining power when negotiating lease terms. Others see an opportunity to purchase property as the commercial real estate market continues to decline in value. The primary advantage of buying commercial space over leasing is the generation of equity over time via market appreciation. There can be no doubt that there are some real bargains in San Diego today, and the potential for equity growth is strong. However, the decision to buy commercial property instead of leasing requires thoughtful consideration.

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One of the most important considerations is the balancing of a growing business’ cash flow against the 20% down payment generally required for the purchase of commercial property. If a down payment depletes needed cash flow from a new or growing business, it’s likely not the time for a risky real estate investment. If a business has excess cash in its coffers for capital investment, there may never be a more obvious time than now to snap up a great value. Most businesses, however, are somewhere in the middle and will want to prepare a detailed evaluation of both options analyzing net present value cash flow (taking into account the anticipated appreciation of purchased property versus anticipated rental increases, interest rates, costs associated with lease expiration and other expenses over the term of the lease), the value of the respective locations to the business, growth considerations, cash flow needs and opportunity costs (potential economic gains from the alternative use of cash). Moreover, in many cases commercial properties have multiple units adding to the complexity of the decision. With multiple units comes the potential for additional income, but also additional responsibility and the risk of unleased space. These considerations are especially difficult for start up businesses which require greater flexibility. Start up businesses will want to attach greater weight to its cash flow needs.

The idea to purchase commercial property instead of lease is often an accident. Businesses stumble across property for sale as they search for suitable leasing space and see an opportunity they hadn’t previously considered. Whatever the reason, the benefits of ownership are appealing. It allows for complete control over the property, equity growth (especially in the long term), long-term customer relationships and permanent visibility in the community. The benefits are even greater in today’s real estate market where bargains are plentiful. Consult a commercial lease attorney and/or a commercial real estate professional for assistance.

Credit card companies’ decisions to unilaterally lower credit limits can have a severe impact on start up San Diego businesses.  During recessions, high unemployment rates drive many to consider going out on their own.  As they contemplate the decision, young entrepreneurs often factor in their credit worthiness.  Start up costs and monthly expenses loom heavy.  In addition, the young business owner worries about personal expenses.  If possible, they set aside funding to help pay personal expenses six months out or more providing breathing room while the business has an opportunity to grow.  Credit worthiness provides comfort during these initial months and impacts a business’ future ability to obtain company credit.

Credit4.jpgToday, many young entrepreneurs with a history of responsible financial planning and credit management are unexpectedly finding themselves with lower credit scores despite exceptional credit histories.  Credit companies are reevaluating credit reports and lowering credit limits based on high balances on other revolving debt despite the fact that their customers have stellar records with them.  The negative impact is twofold: first, needed credit lines disappear; second, credit scores are lowered making it more difficult to look elsewhere for alternative credit lines particularly in the midst of this current credit crunch.  For the entrepreneur, this can be devastating.  

While many argue the practice is legal, there can be little doubt that there is something inherently wrong with it.  There are alternative ways for credit card companies to reduce their risk profile – namely higher standards for new applicants.  Penalizing good customers is a tough model to stand behind while maintaining even a modicum of goodwill.  More importantly, credit customers rely on the good faith of the companies they decide to pay interest to.  They had other options at the time they selected which card to apply for and use.  They cannot go backward and elect a different company (one of the many credit card companies today that are not engaged in the practice of lowering limits).  And worse, their current options are limited because of the lower credit score.  Other creditors are raising interest rates instead.  While not very pleasant for customers, it is far less impacting than reducing lines of credit and lowering credit scores.
 
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San Diego businesses should be asking themselves how the “billable hour” law firm culture affects their bottom line. A recent article about a patent holder’s defense of a patent infringement action focused on the business’s desire not to cave into the demands of what it believed was a patent pirate despite the knowledge in advance that the legal fees would exceed the $400,000 licensing fee sought. Although the battle itself was inspiring, one can’t help but be awed by the last paragraph telling the story of the corporation’s victory and it’s new battle to recover over one million dollars in attorneys’ fees.

One million dollars in attorneys’ fees! Presumably, this is independent of costs necessary to defend the case. A sole practitioner has to shake his head at the staggering amount. Even experienced litigators prosecuting or defending multimillion dollar cases involving multiple parties and hundreds of attorney hours have to wonder. Law firms will undoubtedly counter that their rates are competitive and that a patent infringement case can easily reach into the 1000 hour range or higher. This is is not unheard of.  Five weeks of deposition, five weeks in a document review, law and motion practice, other discovery and a six week trial can easily exceed 1000 hours.  A six week trial with multiple attorneys working on the case could alone involve more than 500 attorney hours.  Undoubtedly, the stakes are high and corporations are willing to pay big dollars for the right legal representation.  Some may feel there is no substitute for the big firm experience.  But one million dollars?

Billable 1.jpgEach case is different of course and will have varying levels of complexity.  At the heart of this discussion rests two key components: efficiency and incentive.  The two components are interdependent.  Law firms typically hire young associates who are first and foremost expected to bill a minimum number of hours per year (billable hours).  The “billable hour” is the benchmark by which their performance is rated.  They are most often raw inexperienced  practitioners with little or no practical understanding of the complexities of the cases assigned to them, the procedural time lines important to litigation or the ultimate evidentiary effect of their decisions.  Combine this inexperience with the “billable hour” and you have a recipe for inefficiency.  Inexperience or not, minimizing attorneys’ fees for the client and maximizing billable hours in the real world are mutually exclusive.
 
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Whether San Diego small business can survive the current credit crunch may depend more on each business’s determination and grit than on the Obama administration’s attempts to ease credit. Some established businesses with excellent credit may not feel the impact of the current credit crises, but new businesses, start-ups and other businesses struggling in this current recession have to find ways to stay in business. Typically, new and struggling businesses fund themselves through difficult times with loans and credit cards. When credit dries up, businesses are left to fend off failure by cutting costs in whatever creative ways they can dream up, including sometimes laying off employees.

Unfortunately, there doesn’t appear to be any immediate relief in sight. President Obama’s administration is struggling to ease the credit crunch as part of his recovery plan but so far with little practical effect. Recent announcements regarding TALF (the Term Asset-Backed Securities Loan Facility act) reflect a promise to cure some of the TARP deficiencies. TARP (the Troubled Asset Relief Program) was the centerpiece of President Bush’s Emergency Economic Stabilization Act. However, it appears that most lending institutions cannot or are not participating in TALF, at least not so far.  This is not to say that President Obama’s overall plan has failed or will fail. At this stage, it is simply too early to tell.  There are some promising signs for small business.  For instance, the Small Business Administration has temporarily raised its size requirements making more businesses eligible for small business loans (Reuters “U.S. makes more businesses eligible for loans”).  The only thing certain for now is that credit to business remains tight.    

Credit crunch 2.jpgThe solution for small business today – ride out the recession and credit crunch.  This is easier said than done of course particularly as struggling businesses typically turn to credit during recessions. Nonetheless, American entrepreneurs are resilient and often exhibit their greatest potential during tough times.  First, businesses shouldn’t assume that the credit crunch means there are absolutely no loans.  Businesses should exhaust all potential sources before giving up.  The San Diego Daily Transcript, a good resource generally for small businesses in San Diego, offers some financing tips.  Small business owners can also use their personal credit card lines, and if necessary look to family and friends for short term loans.  More importantly, smart business owners will look for creative ways to cut costs and strive to maximize an efficient use of business resources. 

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