Cautionary Tale

Wall Street Journal

Small Investors Lost It All in Memphis

By LINGLING WEI

The commercial real-estate mess is clobbering lots of investors. Few of them are reeling as much as the 27 owners of 1023 Cherry Road in Memphis, Tenn.

The office complex about five miles east of downtown tumbled into foreclosure last fall because the owners couldn't refinance the $14 million loan used to buy the two glass-and-steel buildings in 2004. They also lost all $7.1 million they invested.

Cherry Road's collapse is an ominous sign for thousands of other commercial real-estate deals in which mom-and-pop investors pooled their money to get a tiny piece of the action. As unemployment and fallout from the credit crunch fuel rising vacancies and declining rents, a growing number of small investors are getting wiped out.

"We ended up all losing collectively $7 million of lifetime savings," says Lynn Rogoff, a New York artist who put $213,000 into the Cherry Road deal. Individual losses range from about $100,000 to $700,000, according to Cherry Road investors.

Many such deals were structured as so-called "tenant-in-common" ventures, known by the acronym TIC. Often, the TICs took out commercial mortgages that were packaged into commercial-mortgage-backed securities.

"Now, they're starting to experience problems on the property levels," says Marc Perusse, principal at RSS Advisors, a Denver firm that works with troubled TIC investors. "With the majority of TIC investments being syndicated from 2005 to 2007, the future of many of these assets is extremely bleak."

CMBS delinquencies climbed to about 6.5% this month, an all-time high, according to Trepp, a New York company that tracks the commercial property market. More trouble is looming for small-time property owners because much of the $223 billion of CMBS debt coming due between now and 2013 is in the form of mortgages of less than $50 million.

TICs surged in popularity after the Internal Revenue Service said in 2002 that they could be used by investors to defer capital-gains taxes from the sale of "like kind" properties. More than $14 billion in TIC equity is outstanding, according to Omni Real Estate Services, a TIC brokerage and research firm in Salt Lake City. Unlike deals where large developers overloaded acquisitions with debt, many of the mom-and-pop deals were conservatively underwritten. For example, the Cherry Road group put up a third of the purchase price in equity, and the buildings generated more than enough cash to service the debt.

If the $14 million mortgage had been held by a bank, it might have been refinanced or modified because the owners were current on their payments when it came due.

But the Cherry Road loan, made by KeyCorp, was sold off as CMBS to investors by Merrill Lynch & Co., now part of Bank of America Corp. When the loan matured in April, the owners couldn't refinance the debt, since the CMBS market has essentially been shut down for more than a year. The owners also reached out to about 40 banks, but were rejected by all of them because the property's value had declined.

One problem: The lone tenant, Harrah's Entertainment Inc., moved its back-office operations out of Cherry Road even though its two leases are in effect until 2012 and 2017 and the company has continued to pay rent. The move by the tenant has caused a significant drop in the property's value.

Cherry Road property's manager, TIC Properties Management LLC, contacted the "master servicer" about a loan extension, according to Paul Aiesi, the company's chief investment officer. But the servicer, KeyCorp, was only in charge of passing along interest payments to the CMBS investors every month. According to CMBS rules, a master servicer has no power to modify loans before they go into default. A KeyCorp representative declined to comment.

After the mortgage wasn't paid off when it came due in April 2009, it was transferred to a specialist in troubled loans.

"We put some strong proposals in front of the special servicer, but they showed very little willingness to negotiate at all and seemed content to foreclose and keep the property" in its real-estate-owned portfolio, Mr. Aiesi says.

A spokeswoman at the servicer, ING Clarion, declined to comment.

Mr. Aiesi says the servicer offered to extend the loan if the investors would contribute another $2 million in equity. He recommended against that move.

"The property is worth significantly less than the debt on it," he explains.

Cherry Road investors say they are innocent bystanders who are paying a painful price for the credit crunch.

"We're not going out to fancy dinners and we're not taking vacations or major trips," says Steve Harris, a retired television-advertising executive who lives in Valley Center, Calif. He declined to say how much he invested in the Cherry Road building.

When It's Time to Shutter Your Business

When It's Time to Shutter Your Business
By KAREN E. KLEIN, BUSINESSWEEK.COM
Posted: 2009-04-06 17:02:55
Filed Under: Small Business, Management

If your best offerings just haven't sold, the entrepreneurial excitement is gone, and you're not staring down problems, it might be time to move on.

"Six years ago I tried to start a fashion clothing company. I did all the things I was instructed to do and put in countless hours that led nowhere. Everyone I spoke to loved my idea and no one can understand why I haven't made any money. Can you give me any advice?" -- J.P., Los Angeles

Business lore is replete with stories of tenacious entrepreneurs who hit it big after years of trial and -- mostly -- error. But if your company is not making a profit, and doesn't seem likely to after six years, it is probably time to look for a new venture, says George Cloutier, a business turnaround expert with American Management Services in West Palm Beach, Fla.

"The capacity of small business owners to hang in and stick it out continuously amazes me, even after 25 years in this business," Cloutier says. "But when your financials are not working and you're losing money faster than you can bring it in, or find it from investors, that's a strong suggestion that your products are not being accepted."

What went wrong? It's impossible to tell without a professional evaluation of your business plan, product line, capitalization, sales efforts, and other details. But Cloutier says there are common mistakes that often doom startups: flawed business models, poor product introduction, undercapitalization (you need at least $100,000 to fund a new fashion line, he says) and bad timing. (See a previous interview with Cloutier for advice on setting up a business to profit from its inception.)

"Many entrepreneurs think that a nice Web site will make a business work. But especially in fashion, you have to be all over the industry, showing yourself, working directly with clients. Manufacturers' reps can't do the selling for you. And now that we're hitting the wall in the economy, and angel investors are not around anymore, the chances of turning this around are tough," he says.

Never Risk Losing Everything
The positive feedback you received about your idea is outweighed by the fact that customers are not buying, Cloutier says. "The positive feedback you need is products selling, especially in a do-or-die situation."

Robert Chell, an organizational psychologist who does small business consulting in Indian Wells, Calif., agrees: "In starting companies, friends often tell us what we want to hear, not what we need to hear. When we are heavily invested in an idea, we often distort what we hear or we do not effectively listen because we are too busy attempting to refute it," he says.

When should you think about quitting? Joe Kennedy, author of The Small Business Owner's Manual, says maybe it's time when you've already unleashed your best products and ideas into the market and they did not work out well. Other signs include not being excited or enthusiastic about your venture and losing touch with why your competitors are succeeding, or not.

"If you could lose everything if the business continues at the current rate," you should consider closing up shop. "Never put everything on the line," Kennedy says, particularly in a down economy when you suspect your company is too financially weak to survive.

Consider a Partner or an Advisory Board
If you're absolutely committed to your company and want to continue trying, evaluate your own strengths and weaknesses and consider hiring or partnering with someone who has the skills you lack, says Paul O'Reilly, a small business consultant with O'Reilly & Associates in Los Angeles.

"Since so many talented people have been laid off, there may be someone out there ready, willing, and able to invest their time and energy into your company. In other ways, these tough times may make finding anyone willing to take a risk a tough task," he says.

Get help creating a business plan, if you don't have one, through an entrepreneurship program at your local community college or university extension course. You might also consider creating a board of advisors, O'Reilly suggests, who could serve as a support system and sounding board. "Small businesses usually lack this kind of support and, thus, often feel isolated and unsure of whom they can ask for advice and feedback," he notes.

If you can increase your efforts toward achieving your goal, find a new goal, or find a new way to reach your goal, you're more likely to succeed eventually -- if you have a sound business model and desirable product line to begin with, Chell says. If you find yourself spinning your wheels with anxiety, leaning on defense mechanisms or rationalization, and using escapism rather than confronting your problems head on, it's probably time to move on.

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.

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