Handling Fluctuating Market Values
There have been some strange goings-on with asset values recently.
In August, world stock markets shuddered over the US debt ceiling stalemate and the sovereign debt crises of certain European countries added to the global jitters. Daily, the newspapers seemed to be running the same story: ‘Stock markets tumble – investors lose billions overnight’.
eople started selling off assets for two main reasons: concern about the direction the market was heading or they needed the money. But it was only the people who sold who actually lost money. Lower share prices are losses only on paper; it’s only when you sell that the losses become real.
The same thing is currently happening in management rights.
The heady days are gone: Gone are the heady days of 2006 and 2007 when it seemed as if nearly anyone could buy a complex, then sit back and watch the money roll in 18 months later when they on-sold, recovered their costs and made a windfall. The focus back then was all about quick capital gain.
Reducing values get attention for the wrong reasons: The triple threat to the industry of downward real estate prices, lower net profits and reduced multipliers has made its mark over the past couple of years, with the latter two making the most impact.
For example, if a business purchase price was $1.2 million (net profit $200,000 with a multiplier of 6), a reduction in net profit of $25,000 and a market only willing to pay a multiplier of 5 would see this business now have a value of $875,000 or a fall of $325,000.
If the manager’s unit was bought for $500,000 and held its value, the overall impact is a drop of almost 20%. Where the unit has also lost value, the situation gets even uglier. If forced to sell, the owner’s loss on paper would become a real loss.
These sorts of numbers start to get the attention of prospective buyers, your accountant and bank manager. If the owners were keen to sell and wanted their $1.2 million back they would need to find a buyer willing to pay a multiplier of 6.85 times (impossible!) or bring their net profit up to $240,000 (a lot of hard work that would take time).
Understand your gearing level: At the height of the boom, gearing levels of up to 75% were not uncommon, depending on the bank’s risk appetite. Some lenders would lend on three-year interest-only terms – with neither bank nor borrower expecting any repayment of principal. After all, the business would be sold within two years and the debt would disappear. However, many of the owners who did not sell would now be looking at gearing levels as high as 85% to 90% of current market value.
Take the time to work through the sums and know your likely gearing level. Take action on any result above 75%. Plan for the conversation with your bank manager and have a strategy to bring this number down.
Quick remedies: Most banks will work with customers to reduce gearing. The quickest solution is to provide additional assets, such as real estate, as further security, although this option is not open to many. The smart owner may be able to comply with a request from the bank to make a lump sum payment if they have set aside funds that otherwise would have been used for principal repayments.
If paying down a large repayment is not immediately feasible, it may be more achievable to pay a smaller amount every few months, with the aim of reaching the desired gearing level within a particular timeframe.
Another request a bank is likely to make is to start principal and interest payments, if these have not already commenced. This may not bring gearing levels to below the bank’s required level immediately but, if the result is only a few percentage points above the limit, most banks will accept this position.
Play the waiting game: If you are uncertain about the current value of your assets, specialist sales agents can give you information about market trends.
Remember that in a downward market, the most drastic option is to sell the complex to clear your debts. Despite popular perception, this is not generally an action a bank recommends and should be the absolute last resort (pardon the pun) after all other efforts have failed. Why crystallise a loss that could take years for you to recoup?
Hang on for the upturn I reckon!
Sheryl Mahoney
Suncorp
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