My office is located in a office / manufacturing park. There are probably 30-40 buildings clustered. Recently, I couldn’t help but notice many For Sale signs. I drive past about twelve buildings on my way to my office, and there were recently six for sale.
On the For Sale sign for every building, there was a common item. They each indicated that the business was moving to a bigger location.
That’s a lot of growth. It got me wondering, is this anything to worry about?
For Sale Signs Are Good, Right?
Many would argue that for sale signs are good in this context. After all, the businesses are all moving. That means they’re growing. Ten years ago, we saw a large number of For Sale signs, but for a different reason. During those times, businesses were folding or shrinking.
Growth means many positive things.
It usually means more employees. This puts more people on the payroll and keeps money flowing into pockets. Money is then spent on groceries, cars, household items, vacations, clothes, and more. All of this spending continues to accelerate the economy.
Not only do employees benefit, but other companies benefit. Companies buy more items. They employ people to build out their new and bigger space. New business opportunities may be created. Additional space and capacity may allow companies to take on work that they couldn’t in the past.
Communities and Government
The more money companies make, then the better that it is for the community. More employees may move nearby to work. Higher revenues can lead to higher profits, which means more tax revenue. These allow communities to spend more on improvements for their residents. New parks, increased services and even fixing up those long neglected roads often come along with growth.
The Risks Of Commercial Real Estate Growth
So if growth is such a good thing, then what’s the problem? Why worry, right?
Well, I couldn’t help but worry a little bit when I saw all these signs. I even looked up a couple of the companies that were leaving for bigger places. In each case, they had announced an expansion. Each one was a significant upgrade in space and production. However, each one also had a significant cost. One company was doubling their space and it was costing them over $10 million to do so. That’s a lot of money, and there are risks involved. Here’s how.
Most growth is financed by debt. I hardly believe that the company that was spending $10 million to move had that amount of money sitting in the bank. Most private companies have costs involved with their operations, and would fuel such growth by taking out a loan.
Right away, that loan creates additional costs for the company. That loan has to be paid out each month on top of whatever other costs they had prior. This is no problem as long as the expected growth follows.
But what if the growth doesn’t take place? What if a company projects that their additional costs will allow them to double their output? That would be awesome, but what if growth is only 50%? Or what if they’re not growing at all?
Suddenly, a company is then saddled with extra costs and no extra income. Depending on how aggressive the loan is, that could erase most if not all profits. In some cases, that could be devastating to the business.
We’ve been in a very good economic cycle for over ten years now. Things haven’t slowed down. Will they? Probably. What happens then? Many times, companies will actually see the expected growth in sales and the debt I mentioned above looks like a great move. Until one day it doesn’t because the economy slows down. Companies have no control over the economic cycle. More debt, though, exposes them to that. The companies that survive recessions typically stay lean even in good times.
If a recession hit in the next year or two, companies that just went through the high cost of growing may not have had enough time to recoup even a portion of their costs.
Companies that grow often are the first to close. That’s not a coincidence.
All in all, the For Sale signs around the areas are exciting but also make me nervous. I don’t claim to know the finances of even one of the companies involved. Still, I think it’s a safe bet that a lot of debt was taken on in the collective growth of these companies. Growing can lead to exciting opportunities, but it also adds a lot of risk.
It’ll be interesting to see how these companies fare a year, or three years, or five years out. Do you think they’ll all be around and thriving? I wonder.