Tuesday, March 3, 2009

How Debt Destroys Commerce: case study San Diego

Classic real life example of how a high-debt deflation wipes out the economy. Unfortunately, the reporter in the newspaper article does not grasp the root cause. Like everyone else, it is just assumed to be a force of nature, unstoppable.

In fact, if there was less debt at the root level, rents could be reduced, allowing these businesses to stay open. Instead, retailers are forced out of business by the land owners, who are struggling to maintain payments on their notes. It is entirely predictable, and easily solved: lower the debt on the underlying asset.

A mortgage Jubilee would allow marginal businesses to stay afloat instead of liquidating, which puts further pressure on the remaining retailers and real-estate owners, not to mention undermining the health of the overall economy.

It's the perplexing problem afflicting many shopping malls, strip malls and retail complexes across the United States: Owners of commercial properties are trying to preserve cash flow to maintain their mortgage obligations and make a profit. Retail tenants, hard-hit by the recession, are asking for rent reductions and in some cases are shuttering their businesses and leaving empty storefronts.

Merchants at the eclectic Seaport Village shopping complex are seeing something they've rarely seen amid the T-shirt shops and jewelry stores: empty storefronts and liquidation signs. There's the shop near the waterfront that once housed The Cabbage Tree. Its owners recently took the “midnight run” – emptying the gift store in the wee hours and disappearing, leaving landlord Terramar Retail Centers to try to collect on the lease obligation. Across the sidewalk, there's the “Closed for Inventory” sign hanging in the window of Whitt/Krauss Objects of Fine Art. The art gallery filed for Chapter 7 bankruptcy in January, owing creditors for everything from a $5,640 catering bill to about $250,000 in projected 2009 rent and maintenance fees. And a few steps away, the Big Dogs sportswear shop is holding a liquidation sale as the Santa Barbara chain prepares to close all of its 71 stores.

“In almost 25 years in business, I've not seen it this bad,” said Vince Brown, 71, owner of the Crystal Palace, a high-end gift shop at Seaport Village that has been in business since 1985. “Sales are so bad that I have to cover the rent out of my own pocket, but I don't have those kind of resources.” Like many retail tenants, Brown gave a personal guarantee on his lease and therefore is on the hook to pay the rent whether his shop remains in business or not. The only way to get out of the lease obligation, other than a settlement with the landlord, is to file for personal bankruptcy. Brown, who signed a five-year renewal on his lease in 2005 – at the height of the real estate boom, when landlords could command a premium – said he recently asked Terramar to reduce the $6,835 rent on his 980-square-foot shop. In addition to the rent, Brown also pays $2,900 in monthly fees to Terramar, which include so-called common area maintenance fees, money into the marketing pool and real estate taxes.

They said, 'We don't do reductions; if we give you a rent reduction, it reduces our income,'” Brown said. “I said I understand – but how many empty stores do you want?”

Many analysts predict that retail bankruptcies and shopping center vacancies will accelerate sharply this year if the economy continues to deteriorate and consumers remain on the spending sideline. And as stores close, landlords will have trouble repaying loans. While no one knows the ultimate price tag, as much as $1 trillion worth of U.S. commercial property could undergo foreclosure if the economy and the credit markets don't improve, according to Stanley Tate, president of Miami-based Tate Enterprises and an adviser to the Federal Reserve.

The real estate developer said landlords and tenants need to be negotiating now to work out new lease terms or other financial breaks that will allow stores to survive, and allow landlords to maintain some cash flow on properties that might otherwise be vacant. “It's going to get worse, not better, for at least another year, and the smart landlord will do their best to work with tenants to see what they can do to keep them in business,” said Tate, who a few months ago gave all his tenants in several commercial properties a 15 percent decrease in rent.

In some cases, tenants who had weak businesses to begin with or have products particularly hard-hit by the recession can't be salvaged, Tate said. And some landlords, particularly those who bought or developed properties in the boom years, have little wiggle room to renegotiate lease terms because of their own debt, he said.

Whether some way to provide rent or other financial relief is devised, it will come too late for art gallery owner Jack Krauss. Krauss said he approached Terramar in November about reducing his rent and fees to $15,000, with an upside for the landlord if sales improved. Krauss said he was told the company would take it under consideration, but he never got a formal response. “A rent reduction would have made a big difference; it would have given us a fighting chance,” said Krauss, 72, whose business filed for Chapter 7 bankruptcy. “I was fighting to the end, and they (Terramar) were aware of it.” “This took all my reserves, my savings and the money I'd put away for retirement, and I'll probably have to sell my home,” Krauss said. “I'll have to find a good doorway to live in.”


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