Lenders steer clear of dealership mortgages

Dealer Ralph Martinez's recent attempt to buy a $4 million Subaru dealership suddenly collapsed when the bank rejected the deal.

"It's not about equity," says Martinez, a multifranchise operator in Portland, Ore. "I was going to put down 66 percent. If that's not strong enough, how do you get a deal done?"

The reason: Dealership real estate values have crashed in the last three years.

Martinez learned the hard way that lenders have grown skittish about financing dealership properties. As balloon mortgages come due for renewal some lenders are telling dealers to look elsewhere for financing. Other lenders are requiring dealers to cough up six- or seven-figure amounts to boost their equity in the properties.

They're often raising mortgage rates and requiring dealers to guarantee the note with personal assets.

"Commercial real estate is the next Achilles' heel," says Nicholas Stanutz, senior executive vice president of dealer services for Huntington National Bank. He said dealers often don't have sufficient working capital to comfortably operate their business "or they burned through their capital over the last 15 months."

Jonathan Gengras, CFO and co-owner of Gengras Motor Cars Inc. in East Hartford, Conn., lost his mortgage lender when the bank stopped providing commercial loans to car dealers a year and a half ago.

"It was difficult to find banks willing to work with us," Gengras says. "Banks were unwilling to return our calls."

Some of the lenders who agreed to finance the dealerships required the owners to sign a personal guarantee allowing the banks to seize the owners' personal assets if the loan goes bad.

"Either you sign it or you don't get the loan," Gengras says.

In the last three years, lenders grew jittery as dealership values plunged. Plummeting new-vehicle sales, soaring commercial real estate foreclosures and automaker bankruptcies also fueled lender anxiety.

By the end of 2009, overall commercial property values had declined 41 percent from the peak in October 2007, reports Moody's Investors Service and Real Estate Analytics. Lenders say dealerships are a bigger worry than other real estate because the buildings have such limited uses.

"We have heard of real estate appraisals where the appraised value of the dealer property was zero -- that'll get your attention," says Ellsworth Clarke, president of dealer financial services for Bank of America.

"Appraisers look at a dealer property and the highest and best use is to bulldoze the building and sell the land."

Paul Taylor, chief economist for the National Automobile Dealers Association, says last year's record dealership closures took a toll on real estate.

"In 2009 we lost 1,772 rooftops. The net change -- after dealership openings -- is 1,550, which ties with 1980," he says.

In California, 260 dealerships have closed in the past two years. Many "are still vacant, which further depresses the dealership real estate market," says Peter Welch, president of the California Motor Car Dealers Association.

Charles Ognibene, a Boston lawyer who represents major lenders, says dealership values suffered steep declines because of the General Motors and Chrysler bankruptcies.

The automakers' uncertain future made GM and Chrysler dealers seem like bad risks, and hundreds of dealerships shut down.

Ognibene says a lot of dealer real estate is "under water" -- meaning the loan balance exceeds the property value. Banks "are not likely to continue a real estate loan that is under water," he says.

Falling property values have led banks to adjust the loan-to-value ratio they require. Three years ago, dealers could obtain financing for 80 or 90 percent of the property's appraised value, but now they're financed for 60 to 75 percent.

"An 80 percent loan-to-value ratio would be really aggressive," Stanutz says. "Dealerships are single-use buildings. The land might be valuable but the building is not. And as the loans come due, property values are down as much as 50 percent."

Most dealership mortgages are three- to five-year balloon notes, says dealer consultant Mark Johnson of Seattle. As mortgages come due, banks are asking dealers to pay down their principal before renewing the financing.

"They say they want another million dollars. Or they say they'll extend the loan for another year, but they want another $500,000," Johnson says.

"But even if dealers can't afford to pay down the principal, they should keep making their monthly payments. I've never seen a bank foreclose on a dealer who continued making payments."

Mortgage lenders also are raising their rates by as much as 3 percentage points, dealers say.

Johnson says current commercial mortgage rates range from 5 to 10 percent, though some captive finance companies offer rates as low as 4 percent.

And if dealers have to shop for another lender, they generally must pay their current lender extension fees to extend their financing temporarily.

Gengras paid an annual extension fee of 1 percent of the outstanding balance. On a $3 million note, a 120-day extension costs $10,000, he says.

It took extra time to shop for new lenders because he couldn't find one lender to assume all four dealership mortgages. The smaller local banks willing to provide financing wanted to keep the loans below a few million dollars to limit their exposure, Gengras says.

Dealers financing their real estate through an automaker's captive finance company are finding the captives easier to work with than banks, and they say they are obtaining favorable terms as their mortgages mature.

"The captive finance companies such as Toyota Financial Services and Mercedes-Benz Financial are being very supportive," says Tom Price, CEO of Price Family Dealerships in Larkspur, Calif.

Banks have tighter standards than captives, but "we have enough equity so it's not an issue," Price says. "The only area where banks have asked us for more money is for future property development. We were asked to reduce our outstanding [debt] a little bit."

Still, Martinez, the Oregon dealer whose acquisition deal fell through, is puzzled by the bank that killed his plan. The lender courted him for years, and he thought it would gladly finance his property.

"The bank was really excited at first," Martinez says. "But they got to the altar and they got cold feet."