Why Alstry is All or None
June 20, 2008
– Comments (6)
This logic doesn't apply to all, but does apply to many individuals, businesses, and municipalities.
After revenues decline to a certain point, whether 10%, 20%, or 30%, there is a certain point where the revenues reach a level that the entity can no longer sustain itself and defaults. Whether you call it fixed costs or monthly nut, the semantics really don't matter.
Right now, a number of people, businesses and municipalities below, at, or near that point.
Let me provide an easy example for illustrative purposes only:
A shopping center generating $1 million dollars per year in gross rents. The taxes and maintenance are $100K and debt service is about $700K per year. ($10 million at 7%). At 10% vacancy rates, income is cut in half but all is OK. At 20% the shopping center is break even and at 30% it is losing $100K per year.
Different centers have different leverage. In the go go years, many loans were written at much higher leverage rates than described above so just a slight decline in revenues creates a default situation.
The same approach can be applied to an individual or municipality. There is only so far expenses can be cut before total default.
It is my belief we have 25-40% of excess commercial space in America to support a less leveraged society. At those kinds of vacancies, most commercial projects fail and trillions in loans are in jeopordy of default.
We probably have 20-25% more workers than we need in an unleveraged economy. Salary reductions can assist as well.
The effect of deleveraging will be devasting for our cities and states. Just take the fact that car sales in June are about 2/3 pace of last year....carry that forward and just in sales taxes alone....billions will be lost. Many dealerships will go out of business impacting property taxes and income taxes....and we could go on.
When an entity goes bankrupt, as an investor, it is a total failure because as a stock holder you are totally wiped out. Right now I see a lot of bankruptcies on the horizon as the slowing continues.
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