How the Real Estate Crisis Hurts Small Businesses

John Puffer, chairman and president of Pilot Bank, a community bank in Tampa, Fla., has had a ringside seat to the real estate crisis. Florida is one of the states hardest hit by the market crash, and Puffer has witnessed the economic devastation that foreclosures and declining prices have caused on businesses in his community.

"The weak housing sector continues to have a ripple effect throughout the entire nation and is putting severe stress on households and small businesses nationwide," he told the House Small Business Committee this week. "Restoring confidence in the housing market is vital to restoring economic growth."

The most immediate impact on small businesses is in credit markets. They have been severely damaged by the sharp decline in housing prices and the decline in collateral that real estate represents, said Puffer. Some 45 percent of outstanding small business loans are collateralized by some type of real estate asset. Small business owners, in particular, often rely on the equity in their homes and widely use home equity loans and lines of credit.

Beyond tapping their homes for financing, small businesses are closely tied to the housing market, even if they aren't directly involved in the construction or sale of homes. "The housing sector's weakness affects not only home builders, realtors, mortgage brokers, and others directly involved in home sales," but also related small businesses that provide such services as landscaping and home improvements as well as products such as furniture and appliances, said Rep. Steve Chabot, R-Ohio, ranking member on the House Small Business Committee.

In the first three months this year, for example, sales at auto dealers were down 2.5 percent compared with the same period of 2007. Sales at furniture dealers were down 5.9 percent, according to data compiled by the federal Commerce Department. Clothing store sales rose a weak 1.4 percent in the first three months of the year compared with a year earlier, according to a separate report by NDP Group, a provider of consumer and retail market research. The Commerce Department found that the downturn is being driven by factors that include the drop in home values, which is preventing people from borrowing money to keep consuming as the economy slows.

Consumer spending, which makes up 70 percent of economic activity and is the lifeblood for countless small businesses, is directly influenced by real estate. A Congressional Budget Office (CBO) study estimated that each dollar increase in housing wealth translates to two to seven cents of additional consumer spending. All else being equal, a $1,000 increase in the price of a home generates $20 to $70 of extra spending annually, the study noted. Conversely, the CBO estimated that a 10 percent decline in home prices could slash consumer spending by as much as $103 billion to $316 billion. That would slice between 0.7 percent and 2.2 percent from the nation's Gross Domestic Product (GDP).

Home values, the bedrock of all communities and the foundation for much of our consumer credit, continue to fall sharply. The S&P/Case-Shiller home price index, a key measure of national home prices, dropped 14.4 percent in March compared with a year ago. It was the biggest drop since the figures were first published in 1988, according to the Commerce Department.

Most small business owners then are unlikely to see a turnaround in their own bottom lines until the real estate market rebounds. But when that will happen is anyone's guess. During a recent series of hearings on Capitol Hill, experts laid out a grim picture of the downturn, the worst in a generation.

At the end of April, there was a ten-and-a-half month supply of nearly half a million unsold homes. During the first three months of this year, 650,000 properties nationwide were in default, facing an auction sale, or had been repossessed by a bank, according to RealtyTrack, which follows distressed real estate. That represented a 23 percent increase from the previous quarter and a 112 percent increase over the first three months last year. Sales of new homes in April were down 42 percent from one year ago, the largest year-over-year drop in nearly 27 years.

In Florida, Puffer's home state, one in every 97 households was in foreclosure in the first quarter, up 178 percent over a year ago. While Florida, California, Nevada, and Arizona were hardest hit, prices dropped in 43 states, according to the federal Office of Federal Housing Enterprise Oversight (OFHEO).

To help with this serious situation, the House committee is studying a number of tax incentives that benefit small firms caught up in the housing crisis, said Chabot. Among the initiatives being discussed is a Super SBA Small Business Loan Program. It would provide "low-doc," expedited SBA 7(a) loans of up to $250,000, with reduced lender and borrower fees. The government would guarantee 85 percent of the loan. The idea is to expedite loans to small businesses to help them expand and create jobs.

Another measure would grant immediate relief from the Alternative Minimum Tax (AMT) for the 2008 and 2009 tax years. The measure would increase after-tax income for small business owners by sending rebates directly to taxpayers.

According to a recent survey by infoUSAPoll.com, a provider of business and consumer databases for sales and mailing lists, 60 percent of the 1,000 small business owners surveyed said the real estate slowdown was affecting their business. It's safe to say small business owners are unlikely to see a turnaround in their own companies until the real estate market rebounds. That's why it's important to let Congress know that what's good for the real estate industry is good for small business, and the nation at large.