Imagine a scenario where you have a small business in a building you purchased in 2001 for $1 million, and for which you have a loan of $850,000.

The property has gone up in value, and is now worth $1.5 million. You have inventory of $100,000 that needs to be paid, and a new order that needs an additional $100,000 for inventory. You would love to tap into the equity in the building to pay off that old inventory, fund the new, and lower your interest rate on the original loan. Your commercial bank has told you that your credit is great, and your cash flow is good, but that it will only loan 65% of the market value of the property. That’s only $975,000. You need $1,050,000. What can you do?

You call a Certified Development Company (CDC) and apply for an SBA 504 loan. CDCs are conduits for commercial banks and their borrowers to access Small Business Administration-guaranteed financing.

Mark Stebbins and Fernando Alvarez of California’s CDC Small Business Finance commented on the recently revised SBA 504 Debt Refinance loan program. Regulations were made substantially less restrictive Oct. 12, 2011.

“We think there are many commercial property owners who can benefit from this program, who have been shut out of refinancing programs in the past,” Stebbins said.

The SBA rules previously required that borrower’s provide historical records showing that each and every refinance of their commercial property resulted in at least 85% of the proceeds going towards the acquisition and or improvement of the real estate. That restriction is gone, replaced by the requirement that only the original loan satisfied the requirement that 85% of the loan proceeds were used for the acquisition and or improvement of the real estate. In addition, if the original purpose in acquiring the real estate was for investment purposes, but now the property is at least 51% owner occupied, the refinance of the original and all subsequent debt would be eligible.

Another huge obstacle that has been removed is the requirement that the commercial bank no longer has to finance 50% of the property’s value. That’s huge. CDC Small Business Finance’s Fernando Alvarez explained: “Under the recently revised 504 debt refinance program, the commercial bank and the SBA lender can each loan the same amount, as long as that isn’t more than 90% of the property’s value.”

A 90% LTV (loan-to-value) is an advantage to a commercial property owner, in and of itself. But the critical point is that the commercial bank doesn’t have to loan the first 50% LTV anymore.

Imagine if the owner in the scenario above wanted to refinance a total debt of $1,050,000. Under the old rules, the SBA 504 loan required the bank to loan the first $750,000 (50% of the value of the property). The SBA could then loan the difference for an additional $300,000. The old rules did not allow for cash out to cover inventory or any other business purpose.

Under the new rules, the commercial bank can lend the same amount as the SBA, not the first 50% of LTV. That means the commercial bank loan would only have to be $525,000 instead of $750,000 thereby saving the business owner increased interest expense for the additional $225,000 . The interest savings is derived from the SBA taking an equal share of the loan at rates historically below current commercial rates.

In the last couple of years of very depressing economic news, the changes to the SBA 504 debt refinance program is certainly a breath of fresh air and a step in the right direction.

According to data from the latest National Association of Realtors’ Commercial Real Estate Index, subleasing remains high and lenders are more lenient in allowing for extra time for tenants to make their lease payments.

CRE development remains stalled in all regions, but acquisitions are increasing and one CRE economist told HousingWire that, “the odds that it will transition to a self-sustaining expansion by 2011 remain better than 50%.”

The NAR CRE Index estimates that vacancy rates are expect to increase slightly from the second quarter this year to the second quarter of 2011, then begin a slow decline in the second half of next year.

Currently, retail vacancy rates remain largely flat, but industrial vacancy rates continue to grow.

The AIA says that, even with modest improvements in the economy, poor CRE construction conditions persist because of oversupply, weak demand, a continued decline in commercial property values and a tight credit market.

When things do begin to turn around, the retail and hotel sectors are expected to see the strongest growth, according to AIA Chief Economist Kermit Baker, PhD.

For 2010, the AIA says that hotel construction will be down over 43 percent, office construction will lag 29 percent, retail will be down 25 percent and industrial space construction will be off by 21 percent. All categories except industrial are expected to see single-digit growth by the end of 2011.

For the full AIA press release, go here.

In the last month, there have been an estimated $5 billion in CRE loans generated on eight issues of commercial mortgage-backed securities. But lenders are still being choosy, with high occupancy, premier properties in major metro areas attracting lenders while smaller markets still struggle to find loans.

A senior managing director of CB Richard Ellis was quoted in a New York Times article as saying, “It really is a tale of two markets. There are those assets that have strong cash flow and there are those that don’t. Those that do will find a home in today’s market and have a robust relationship with lenders, insurance companies and conduits. And those that don’t, it’s almost as if you’re seeing them fall off a cliff.”

Leading issuers include JP Morgan Chase and the Royal Bank of Scotland; Citigroup said it is also poised to re-enter the commercial mortgage-backed market as investor response has exceeded supply.

The Moody’s/REAL Commercial Property Price Index rose 1.7% from March; however, prices declined 16% from April of 2009 and are down 41% from the Index’s October 2007 high.

From a Bloomberg report:

Economic growth in the second half of 2009 and first quarter of this year have helped lift prices for offices, warehouses and stores from an October low. Property sales jumped 50 percent in the first quarter from a year earlier to $15.4 billion, Real Capital Analytics Inc., a commercial real estate research company in New York, said April 22.

“What we have is a bottom in the market,” Christopher Cornell, an economist at Moody’s Economy.com in West Chester, Pennsylvania, said in a telephone interview. “We have seen essentially a flat trend in commercial property prices in the last several months.”

A Wall Street Journal article outlined the key findings:

–Capital has returned to commercial real estate. “But optimism should be tempered, because national price indices are misleading when transactions are limited and fail to reflect the significant uncertainty around property valuations,” the report said.

–The transfer of commercial real estate risk out of the banking system may take longer than previous cycles, and as a result, prices won’t return to 2007 levels only toward the end of this decade.

–Macroeconomic factors such as unemployment will affect the outlook for rents, vacancies and capitalization rates.

Pimco suggests there are opportunities for patient investors as the deleveraging continues. Some of the options include dispositions of the assets of banks taken over by the Federal Deposit Insurance Corp., restructuring of large commercial loans and buying discounted subordinate positions in commercial mortgage-backed securities.

The report noted that there is a lot of commercial real estate investment money on the sidelines awaiting bargains that just haven’t materialized because lenders have been extending loans.

When attractive buildings become available, bidders are showing up. The Wilshire-Bundy Plaza, a preeminent Brentwood office building, drew 40 bidders and fetched $111 million. One CRE broker called that “an incredible price”.

The article also noted:

If the commercial real estate market continues to gain strength it would represent a significant shift in economic risk because many experts had feared that mass defaults by landlords on their loans could cripple banks and drive the country deeper into recession.

“It’s true that thousands of commercial loans must be worked out and some of these properties will enter the market in 2010,” investment banker David Rifkind said. But “federal policy has been accommodating to banks and they are not being forced to realize losses.”

“There is so much money sitting on the sidelines that when distressed assets or even small pools of loans come to market, there is a flood” of interest, said Rifkind, managing partner of George Smith Partners.

“That became palpable to us in the first quarter,” he said. “Money can’t stay on the sidelines for long periods of time. It has to retool and be put to use.”

Shenzhen New World Group, a Chinese real estate development company, purchased the Los Angeles Marriott Downtown in a foreclosure sale in March for $60 million, a bargain price from its 2007 purchase price of $110 million.

The San Francisco W Hotel was sold last July to a Hong Kong investment firm for $90 million, down from $212 million just two years prior.

From the Chronicle article:

As the state’s hotel industry continues to suffer from the loss of corporate and family travel spending, observers believe that the infusion of foreign capital into the California hotel industry will help stabilize the market and preserve jobs and tax revenue.

While other analysts agree that foreign investment will be part of the next wave of real estate buying, they doubt it will dominate the market. Domestic investment funds and real estate investment trusts have been inactive for two years now as real estate values have plummeted. And many are gearing up to start purchasing property again, said Tom Callahan, CEO of PKF Consulting, a hospitality research firm in Atlanta.

“Domestic investors are cautious about the stock market and the yield on bonds is very low, so they are trying to figure out where to put their money,” Callahan said. “The real estate market is so beat down, so that’s a place they are looking.”

The hotel business in California is particularly distressed. As of March, more than 400 California hotels were in foreclosure, including 79 that had been taken back by lenders since January.

According to an article in the Contra Costa Times, Sethi executive J.P. Sethi said the purchase price “was 30 percent below what you would have seen in normal times.”

Distressed hotel properties litter the landscape of northern California commercial real estate. According to the Times article:

The value of the Bay Area hotels in arrears on their property loans totaled $1.1 billion in 2009, according to a report by Real Capital Analytics.

That’s 12 times the $90 million in delinquent loans for Bay Area hotels in 2008, Real Capital estimated.

More hotels will become mired in foreclosures as the economy sours further, warned Alan Reay, president of Atlas Hospitality, which tracks the California hotel market.

“In California alone, we have 67 hotels being foreclosed on, and 320 in default,” Reay said. Both numbers are about five times the totals from a year ago, he estimated. “The number of hotel defaults is growing exponentially.”

Prices have melted down for hotels, he said.

“From the 2007 peak in values, prices for hotels have fallen 50 to 80 percent,” Reay said.

As lenders dangle foreclosed hotels before investors, the buyers have found some choice morsels.

“Investors are starting to feel we have reached or gotten near the bottom,” said Bose. “Prices are stable enough that you can see a good future with these investments.”

Here’s where investment dollars can make long-term cash. If you have staying power.

A Wall Street Journal article last week reported on the Mortgage Bankers Association’s sale of its headquarters building in Washington, DC to CoStar Group for $41.3 million – about $38 million less than what it paid for the building three years ago, and also way below the $75 million the MBA received from a group of banks to finance the purchase.

So is the MBA taking a walk on their underwater HQ? They aren’t saying.

In the WSJ piece, MBA CEO John Courson said, “We’re not going to discuss the financing.”

Which is a different tune than he was singing a few months ago, saying those who owed more than their property is worth should continue paying, even if it didn’t make economic sense. “What about the message they will send to their family and their kids and their friends?” Courson asked.

Yeah, about that message….we got it loud and clear: it’s the smart thing to do!