[Market Watch] And the Walls Come Tumbling Down....Again?

With the residential housing market barely breathing the last few years, many pest management professionals have found shelter in commercial work.

It’s a segment that’s grown $1 billion in the past eight years, with 2008 revenue topping out at $2.29 billion, according to Specialty Products Consultant President Gary Curl, who annually surveys the industry. (Data for last year is yet to be released.) In 2007, commercial pest control revenue was $2.13 billion, up from $1.97 billion the year prior.

This safe haven, however, may be coming to an end. According to a report by the Congressional Oversight Panel formed to oversee Treasury actions following the bank bailout, a wave of commercial real estate loan failures during the next few years could threaten America’s already-weakened financial system.

Loans totaling $1.4 trillion for retail properties, office space, industrial facilities, hotels and apartments will require refinancing in 2011 through 2014, said the report. With property values falling more than 40 percent since the beginning of 2007, nearly half of the loans are "underwater," meaning the borrower owes more on the loan than the property is worth.

An April report by Real Capital Analytics found $7.4 billion in commercial properties fell into default, foreclosure or bankruptcy in February, for a total of $160 billion of outstanding distressed properties.

Not helping the situation, said the Congressional Oversight Panel, are increasing vacancy rates — from eight percent for multifamily housing to 18 percent for office buildings — and declining rents, down 40 percent for office space and 33 percent for retail space.

Stacy O’Reilly, president of Plunkett’s Pest Control in Minneapolis, hasn’t seen signs of a commercial real estate crisis but "we know it’s a possibility." The company services companies that go in and out of business all the time: One restaurant closes and another fills the space two months later, she explained. "The commercial market seems to be a little more resilient than the home market."

It’s also business as usual for Sprague Pest Solutions in Tacoma, Wash., despite "vacancies in a number of the buildings" it services, said President Alfie Treleven. "We haven’t yet seen people any further behind on receivables than we’ve seen in the past."

But for Phil McCloud, CEO of McCloud Services in Hoffman Estates, Ill., the number of clients going bankrupt has increased. "We’ve had probably a record year for that."

Crane Pest Control CEO Harold Stein in San Francisco also has noticed a growing number of smaller restaurants, cafes and bars going belly up. "They all are running very short in terms of liquid cash."

Maybe a commercial real estate crash is coming and maybe not. But if you believe the pundits, how should PMPs prepare for the next four years?

STAY CURRENT. Without a doubt, staying current with receivables is the No. 1 priority — and good business practice in any economy.

Don’t get more than a month or two out on distressed properties because "if they do go upside-down, they’ll go upside-down fast," said Trevelen.

O’Reilly agreed. "When they go into bankruptcy, you will be the last person paid." PMPs worried about clients’ fiscal health should offer a hefty discount for an annual prepay "so if they go under you won’t be stuck." Professionals might have to repay funds if the company goes bankrupt before the term expires, but this is a much better position to be in, she explained.

Stein admits over the years "our credit policy has been a little too much of ‘loving hands at home.’" The company carried customers too long and wasn’t disciplined. "We are going through the process of changing that," Stein said. "We have to be more disciplined, for the customer’s sake as well as ours."

Open Your eyes AND Ears. Now is not the time to stick your head in the sand, cautioned Deni Naumann, president of Copesan Services, a cooperative of pest management firms providing local service to national accounts.

"Work, work and work" with clients to get a better idea of their current needs. These conversations can be stressful because financials often are involved, but they’ll help professionals find ways to address client concerns and identify future opportunities.

Naumann also urged managers to ask technicians what they sense about the client. Front-line employees often have a "gut feeling" about a client because they see things and hear conversations, both good news and bad.

Day-to-day market intelligence gives you a better feel for how to work with that client, said Naumann.

Expect to Go Out for Bid. Distressed commercial properties still need pest control, even if new property management firms, banks or finance groups take ownership. Tenants now have more choices when it comes to renting space, so sanitation is a factor, McCloud said, meaning the industry’s pest management services will continue to be in demand.

It is who pays that might shift, said Treleven. And "it just might get more competitive for our industry" because contracts may go out for bid.

This is disheartening especially when you’ve put time in to solve challenges, but "there’s nothing you can do about it," admitted O’Reilly. Companies that pride themselves on quality service have to "ride out the low priced guys because you can’t go bottom-feeding with them." Clients who experiment with low-price leaders eventually may realize they need to shop for value not price, she said.

Stein agreed. Most Crane clients that have gone through the process of trying less-expensive companies have returned and are "not that quick" to go out to bid again.

Get Creative. The industry, scolded McCloud, needs to "start getting creative," like reducing service frequency or the amount of equipment to be serviced, and not cut price to remain competitive. Lowering price lowers profit, which can cause quality issues down the road, he reminded. "Protect your margin at all cost."

Professionals have a lot of technology behind them to make better service decisions, he said. If the data shows, for example, no rodents have been caught on 10 of 100 pieces of equipment in the last three years, "why would I continue to service that as frequently?"

McCloud said he can save an average customer 15 to 20 percent by eliminating eight of 52 services. Perhaps outdoor traps buried in snow don’t need checking in December, or weekly visits can be pushed to every eight or nine days.

Some customers, he admitted, have the mindset that frequency of service is one of the only ways to measure success and are slow to embrace other approaches. They must be educated there are viable alternatives, McCloud said.

Crane Pest Control will work with clients, particularly those seeking help to reduce pest control expenses, as long as lower frequencies don’t under-protect the client or the public. It’s a "difficult choice," said Stein.

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WITHOUT A DOUBT, STAYING CURRENT WITH RECEIVABLES IS THE No. 1 PRIORITY, AND A GOOD BUSINESS PRACTICE IN ANY ECONOMY. Don’t get more than a month or two out on distressed properties because "IF THEY DO GO UPSIDE-DOWN, THEY’LL GO UPSIDE-DOWN FAST," sAYS PCO Alfie TRELEVEN.

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VETERAN PCO PHIL MCCLOUD says the industry NEEDS TO "start getting creative," LIKE REDUCING SERVICE FREQUENCY OR THE AMOUNT OF EQUIPMENT BEING SERVICED, AND NOT CUT PRICE. LOWERING PRICE LOWERS PROFIT, WHICH CAN CAUSE QUALITY ISSUES DOWN THE ROAD. "PROTECT YOUR MARGIN AT ALL COST," he said.

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Monitor Public Health Risks. With the exception of food-service businesses, commercial properties usually can get by with lower service frequencies for nuisance pests, said Stein. Yet he is "worried and pessimistic" that the looming commercial real estate bust will spawn public health issues in port cities.

Ships from around the world come into San Francisco, which has a documented history of plague, he said. "We have to be so much on guard as far as rodents are concerned." He said Crane Pest Control would rather lose an account before performing rodent work less than once a month.

Stein experienced what out-of-control rodent populations can cause first-hand. Years ago he inspected an unused pool house on a large estate. He stepped into the building, noticed mouse droppings everywhere, and immediately was covered with fleas. Stein got out fast, but days later he had a 103-degree fever and ultimately was diagnosed at Stanford hospital with a mouse-borne virus.

"What goes on in an empty building where there’s been no control?" What if someone — a child, even — walks in on that, he asked.

*****

Cautiously
Concerned...

How concerned are PMPs about the negative impact of a possible commercial real estate "bubble"?

19%

Very Concerned

41%

Concerned

32%

Not Very Concerned

8%

Not Concerned
At All

*****

...Although PMPs
remain Bullish

What are the prospects for your company’s commercial pest control business in 2010?

12%

I expect it to grow dramatically

44%

I expect it to grow modestly

33%

I expect it to be flat

5%

I expect it to decline modestly

0%

I expect it to decline dramatically

4%

We don’t offer commercial
pest control services

2%

I don’t know

*****

THE CLOCK IS TICKING. Only time will prove whether a commercial real estate bust comes to pass or not. If it does, Treleven expects it will be similar to the crash in Seattle and Portland in the 1980s. Back then, Bank of America took over from developers and paid Sprague until it brought in other property managers or was able to sell off the buildings. It took five or six years to work through the inventory before new buildings started to come on the market, recalled Treleven. But in that crash, "the vacancy rate was higher than it is today."

And bed bugs hadn’t made a comeback. In fact, bed bug work may be masking the fallout of a commercial real estate crisis since most of it takes place in commercial properties, said Curl. "It would not surprise me if bed bug revenue topped $300 million in 2009." Curl expects to release his 2009 report this month.

Even in hard-hit markets like Cleveland, Ohio, where business foreclosures are a growing problem, pest control companies have seen a steady uptick in bed bug business. "Almost every day or every other day there’s a new building becoming infested," observes John L. Gedeon, staff entomologist, General Pest Control. "It’s no longer just a pocket of bed bugs here or there."

Government intervention may be playing a role, too. According to Real Capital Analytics, lenders "greatly stepped up the pace of workouts" in the first quarter of 2010, resolving $1 billion of outstanding distressed properties. This is a "significant milestone," though a small dent in the total amount of outstanding and unresolved distressed properties.

O’Reilly, however, has yet to find a good deal. She had hoped to purchase some buildings in her markets but was disappointed in the still-high prices. For now, she’s "waiting on the sidelines" for prices to drop and is positioning Plunkett’s Pest Control for the next 10 years. "Everything about pest control for me is long-term," said O’Reilly. There’s no point rushing into anything…or panicking, she advised.

The author is a frequent contributor to PCT magazine. She can be reached at anagro@giemedia.com.