Friday, May 17, 2019

Is a Commercial Building Worth More Vacant or Leased?

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As we’ve discussed - commercial real estate is owned by those who occupy it with a business or investors who rely upon the rent the property produces. Therefore - a slice of commercial real estate is valued according to its utility - in the instance of an occupant or to an investor - in its ability to produce income. Occasionally the lines cross - which I will cover in the last section.

Utility varies. Think about it this way. If you’re a company that tools aerospace parts - the electricity feeding a property is critical because you use it in your operation. Without the amperage - the parcel is worthless to you. A logistics company that stacks products in a warehouse relies upon the number of truck doors and inside ceiling height. Therefore - utility is found in a property with such upgrades. An easy way to consider utility? Generally, an occupant considering a selection of buildings will place a greater emphasis on utility or use in its decision. Said occupant is willing to pay more if the commercial real estate has the features he seeks.

Income production. Rent. How much? How certain? How long? Easy. Let’s assume a building has market rents and is leased to a Fortune 500 tenant for ten years. So, there is very little risk. The valuation is simple - an investor will buy the income stream for a price. His price? Easy math. Annual rent divided by his desired return - also knows as a capitalization or “cap” rate. Thus, an annual lease payment of $12.00 at a 6% return yields a value of $200 per square foot. Consequently - your 20,000 square foot building is worth $4,000,000.

If a building is vacant - is it of no value to an investor? If he is smart - certainly not! However, the analysis is more complex and the stars must align for the resulting price he can pay to compare to an occupant purchase. Here’s the way it works. Since an investor relies upon the income - rents - a property produces, he must calculate what those rents will be, how long it will take to achieve them, and at what cost. We refer to this as lease origination expense. If he’s looking at a vacant building and the seller wants $200 per square foot - the investor must factor in the origination expense. If an investor can pay the $200, absorb the origination expense, and still get his return - golden!

If a property is leased - is it worthless to an occupant? It depends. Keep in mind - an occupant looks at utility. And he must be able to occupy the building. So, if the PERFECT site - with all the bells and whistles - is available but leased for awhile - it might still work. Here is how. We recently represented a buyer. Obligated for two years in a lease - they wanted to pursue a purchase for their next move. So, if we located a building for sale with a short term lease in place - that was beneficial. We did! Plus. Because the lease on the building we bought was short term - the buyer got a better price. Because - most investors were turned off by the impending lease expiration and most occupants couldn’t wait two years to move. Boom!

When do the lines cross. We are seeing a fair number of investors buying vacant buildings these days. Recently - a high percentage of the structures in a new development in north Orange County were sold to investors - vacant! Their motivation? Money needed to be spent. Capital had to be deployed. It was costlier to wait than to buy vacant and incur the origination expense. A similar trend is occurring inland where new logistics boxes are trading without tenants in place. The reason? More occupants are seeking leases vs purchases. As an investor - if you can buy the right utility - your origination costs are reduced, you create the income, and the world is a happy place.


Friday, May 10, 2019

Commercial Real Estate is Still Local - Three Reasons


When I started plying my trade in the early eighties - our means of sourcing new business were the phone, a Rolodex, shiny shoes, and a big smile! My, my, how things have changed! If you were engaged to find someone a building or secured an agency to list a vacant property - your methods of getting the word out we’re limited to the U.S. mail, newspaper ads, calls, signs, and telling your fellow brokers. Area specialization was key. Because there were no multiple listing services - local knowledge was your value.

Flash forward. From our kitchen table - we now can access an ownership of any commercial property in the United States - and there are over 48,000,000 of them! Want to find a vacant building in Austin, Texas? No problem. Your client operates four hundred locations nationally? We are now equipped to manage his account through the technology at our fingertips. Competition for business is no longer local as everyone has access to the same information.

So with the advent of technology and the open doors we all share - has the local nature of commercial real estate been lost? Hardly!

Value is still local. One of my current assignments has taken me a bit out of my patch. I’ve been hired to locate a distribution center for an East Coast operator. Generating a list of available properties is a snap. Understanding the nuances - not so much. An example. We discovered the zoning of one of the buildings we liked would not allow our use. Hmmm. Had I been entrenched in that area daily - I would have saved some time. In SoCal, the farther east you look - the cheaper commercial real estate pricing becomes. However, distance from the port is greater - which adds a layer of cost. In some cases utilities are higher. Hmmm. Didn’t think about that.

Relationships rule. We recently competed against four different buyers for a building for sale. All four buyers had made asking price offers. Demonstrated by all was proof of funds and an ability to close quickly. We won the deal! Why? Because I had successfully closed several previous transactions with the owner’s broker. He had confidence in our ability. We see each other at the gym. We talk at open houses. We play golf together. I sat at his table at our recent SIOR event. This sort of familiarity is impossible if your practice spans many states.

It’s the market. I can look at a building on paper - let’s say in Tempe, Arizona. Certain boxes can be checked - size, amount of office, loading, warehouse clearance, price. I can jump on Southwest Airlines and see it in an hour. Great! What I can’t determine is recent sale and lease activity. How many properties - with similar features are currently available? What are the local value drivers - employment, population growth, attitudes of municipalities, housing? Sure. I can utilize the same database used for the avails but a true understanding of why the comps sold or leased can only be catalogued by someone there every day. That’s value!

Akin to a beat cop who walks the streets or patrols a neighborhood - commercial real estate is still a local business - and always will be.

Friday, May 3, 2019

Negotiations are Stuck! Now What? _ Suggestions

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Commercial real estate transactions require negotiation. Duh! But, candidly, the back and forth is my least favorite part of a deal. Many consider the volleying a sport - one that must be won or lost. Skillful negotiators realize - in order for there to be a successful outcome - both parties must win. I’ve witnessed sellers - down to their dying breath - decide they’d rather give the building back to the bank vs conclude a transaction with an over zealous buyer. 

Conversely - I’ve seen buyers - whose business growth depends upon buying a building walk away due to a minute tweak in the terms. The worst - however - is a stand-off. Akin to heads-of-state squared up in an intense disagreement - the mantra of “he who first blinks loses” is repeated. As commercial real estate professionals - we find ourselves between the warring factions - struggling to find common ground.

If your negotiations are mired - what can be done? Below are _ suggestions.

Why are you at an impasse. Price? Terms - such as the length of escrow or deposit structure? Maybe your issue is more esoteric - your seller has the impression the buyer can’t perform and therefore is holding firm. If the conversations have been many rounds - sometimes a party gets weary - enough already! Regardless - the solution is often contained in the reason for the roadblock.

What’s at stake. The owner I referenced above had to sell or the bank was going to foreclose. However, he had to salvage something - even if it was his dignity. Buyers came along sensing a fire sale! What the buyers failed to recognize? At a point - the seller would simply fold and allow the lender to take the premises - consequences be damned. Just when you believe a seller has no room to maneuver - in fact he does. Never underestimate a desperate seller.

What are your alternatives. Too often a buyer will confuse his operational goals with his purchase criteria. Early in the process - gain an understanding of the buyer’s motivation for the purchase. If the buy will allow him to hire more folks, generate more sales, carry more inventory, accommodate new machinery, or manufacture a new line of products - there is an economic motivation. If negotiations reach a standstill - we review the benefit and downside. Sometimes that difference in price becomes moot in light of the increase in business revenue - or loss if he doesn’t move forward.

Are there non-monetary solutions. Occasionally, parties will agree on price but stall for other reasons. Most common would be a closing date. You see, some sellers benefit from a quick conclusion while others would prefer to postpone the final bell. Sometimes a buyer requires a bit more time to process a loan or bridge a lease obligation. So hypothetically - a seller wants finality in 60 days but the buyer is adamant about 90. Maybe the buyer can beef up his deposit in return for the extra 30 days.

Time to say good bye. Once in a while - the best deal is the one you DON’T make. I’ve found if transactions are meant to be - motivations are aligned and transparent negotiations take place - a rhythm evolves between the parties. It’s a beautiful thing! However, if you find yourself working diligently to resolve minutiae - maybe the stars won’t align. Time to crank up that search for another building.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.

Friday, April 26, 2019

Is Price Important - 5 Reasons Why it’s Not!

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This could be the shortest column EVER! Of course price is important. End of story. But, because I have a bit more space - allow me to offer some arguments as to why price is not important. As we’ve discussed - buyers of commercial real estate either buy to occupy (owner occupant) or buy to collect the rents as income (investor). In the latter case - no relationship exists between the owner and the occupant - it’s strictly arm’s length. Counter with the former as an owner operated business will soon be housed.

With this as a backdrop - in what circumstances would price not matter?

Utility trumps. Currently, I’ve a client who leases a good sized space for his distribution business. His lease expires in a year and he wants to buy a building from which to operate. While understanding his motivation - he explained - the new footprint will allow him to triple his revenue. Sure. Owning a facility twice the size of his leased premises will cost him more - but not as much as the inability to expand his revenue. Plus, these are young businessmen. They see the bigger building accommodating their growth for many years. Does price matter? Not in the face of the alternative - stymying the sales pop!

Tax impact. Many times an investor will find himself in a pickle. You see, he sold a piece of commercial real estate and must now purchase another lest he pay a significant chunk of his equity to the government. I’ve seen extreme examples where the potential tax exceeds the sale proceeds. Does price matter? No! Just help me defer my tax obligation.

The hold horizon is longer. When I started my commercial real estate career - Wham! was together - the price of a 50,000 square foot industrial building was around $2,500,000. The same 50,000 square foot building today weighs in closer to $11,500,000. Wham is right! So that buyer in 1984 who had heartburn over a few thousand dollars is now kicking himself. Does price matter? No. Just don’t ever sell.

Financing is attractive. We have benefited from Eisenhower era interest rates for several years. The days of double digit borrowing costs we saw in the early 1980s have been usurped by rates in the low 4% range. If you can buy today - lock in financing at record low rates for 25 years - why not? Does price matter? Not when the payment is close to what you would pay in rent.

After-tax benefits. Owners of commercial real estate are afforded many ways to reduce their taxable income. Depreciation. Each year - as a property owner - you’re able to deduct a percentage of the structure’s value. Certain expenses related to the operation of the real estate are also deductible. The costs associated with re-tenanting should be considered. Mortgage interest? Yep. Does price matter? Not when you analyze the after-tax reality.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.

Friday, April 19, 2019

What is a Tenant Rep Broker?

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A commercial real estate professional’s work is generally divided between agency assignments - listings - wherein an owner is represented or tenant or buyer representations. In the former - an agency - needed is a buyer or tenant for a vacant building. So, we are hired to locate an occupant. The latter? Yep. We are engaged to source a spot for a buyer to by or a tenant to lease.

Today, I delve into the world of buyer and tenant representation also know as Tenant Rep. By the way - this genre of commercial real estate practice evolved in the mid eighties. Largely responsible was the legendary Dallas Cowboy quarterback Roger Staubach. Prior to that time most of us were generalists and even today most of us work both sides of the fence - owners and occupants.

When do you require a Tenant Rep Broker? Most typically a need arises. Such as - the current physical plant can no longer house the operation or the opposite - swimming in excess square footage is the company. A lease expiration portends a requirement as one of three decisions must be made - stay and extend the term, move, or stay month-to-month. Mergers and acquisitions can create a Brady Bunch of facilities with a consolidation warranted. Opening a location in a new market creates a search criteria. Sure. You could attempt to navigate the waters without help - but you recall what someone once said about the person who represents himself.

What is typical? Standard among most practitioners in this space is an engagement agreement whereby you - the occupant - “hire” the broker to conduct a search and market your requirement. Included in this marketing is a notification sent to cooperating professionals, solicitation of owners with buildings meeting the criteria, and a vetting of potential buildings submitted for consideration.

Who pays? The cool thing about engaging a Tenant Rep is the owner of the building pays him. You may be thinking - I know I must somehow pay more. In actuality, you don’t. Most market lease rates and sales prices contemplate a broker fee. If you forego representation - you pay more because you lose the benefit of her market knowledge - which leads to more favorable rates and terms.

Are other services included? In some instances - yes! Many Tenant Rep outfits employ project managers, space planners, architects, and move advisors. All are included with no cost to you.

How does the process work? Steps may vary. But generally - you engage the professional, your requirement is clearly defined, marketing collateral is created, your requirement is published to the brokerage community, submittals are received and vetted, buildings are previewed, alternatives are toured, requests for proposals are submitted, proposals are received and compared, negotiations commence, negotiations are finalized, a lease or purchase agreement is signed, the deal is closed, improvements to the space - if any - are completed, you move in. Whew! Now you understand why you shouldn’t try this untethered. It’s a complicated process with many steps.

Friday, April 12, 2019

A Week in the Life of a Commercial Broker

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As commercial real estate professionals we have two commodities - our time and our information - aka our market knowledge. Therefore - we must spend our time wisely - on profitable activities and share our knowledge with those who need our services. My philosophy is to be stingy with my time and generous with my knowledge.

So, just how do I spend my week to monetize activity and gain market knowledge? Today - I’ll share with you a formula that has served me well. The percentage of time spent on each category each week may vary according to tenure - but should include all of the components highlighted below.

Prospecting. Knocking on doors and calling on prospects on the phone. Sure. There may be a more high tech way to go about prospecting but I have found the old fashioned way of looking for new business still occupies a large part of my week.

Canvassing. This is quite different than prospecting although some use the term interchangeably. Canvassing is viewing the stock of inventory within your market. Whereas prospecting is about business development. My differentiation between canvassing and prospecting? Canvassing is gaining knowledge about the building and prospecting is gaining knowledge about the occupant or the owner of said building.

Networking. Chambers of Commerce, BNI, Society of Office in Industrial Realtors, National Association for Office and Industrial Parks, Provisors, Vistage, all provide great platforms from which to meet professionals who are complementary to your profession but not competitive. Remember, networking is not selling. Networking is creating strategic referral relationships. A successful referral relationship should work both ways - you should be willing to give in order to get.

Research. Conducting a search for a potential purchase or lease requirement, finding out members of a company who have a LinkedIn profile, reviewing quarterly reports of publicly traded companies, and updating your contact relationship manager fall into the category of research. Many companies have a research department whereas smaller brokerage houses conduct their research individually. Mine tends to be a combination of both.

Meetings. Our commercial real estate industry is a contact sport - meaning we must conduct face-to-face negotiations, building tours and prospect discovery meetings. I have used video conferencing to accomplish this when a face-to-face meeting is impractical.

Food and drink opportunities. Each work week contains at least three food and drink opportunities per day – breakfast, lunch, and dinner. Additional opportunities could be cocktails after work or a midday smoothie at the gym. Don’t eat alone! It will be your most expensive meal ever. I generally conduct these on a one to one basis with a strategic networking partner. I have found these in formal face-to-face meetings are a tremendous way to generate activity.

Transaction coordination. A certain amount of each day must be spent actually closing the business that you generate. I employee a full-time transaction coordinator who can deal with some of the nuts and bolts of the deal such as contract preparation, fielding inquiries and forwarding information, document circulation, tracking of key dates, and general closing conditions. However, if the deal hits a snag and additional negotiation is needed - I am always ready to re-engage.

Marketing. Digital, physical, and personal. The marketing of your services should include a good mix of digital - email marketing, social media marketing and content creation or curation. Mailed to potential prospects and referral partners should be newsworthy articles, gifts, market information, or success stories,. All of these mailed pieces increase your physical presence. You also must be known in your marketplace. Your personal presence – open house attendance, group functions, networking events, and other community activities will boost your personal presence immensely.

There you have it!

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.

Friday, April 5, 2019

Commercial Real Estate IBuyers - Will we See Them?

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I read with great interest Jeff Collin’s column entitled - Will Online IBuyers Upend Home Sales? If you missed the column - shame on you! But, allow me to provide you the abridged version. Currently, there is a trend in residential sales wherein on-line buyers purchase your house quickly and you avoid the hassle of the marketing steps - choosing an agent, pre-sale prep, repairs, staging, showing, negotiating and closing.

Akin to CarMax - you receive an offer on your house - with fees, closing costs, and repair concessions baked in. If you say yes - the deal is done without you ever having to V-dent a sofa pillow. Easy. So what’s the catch? Just this. IBuyers rely upon a motivation which eclipses most sellers. Simply - you MUST sell and can’t wait for the normal sales process to unfold. Remember - the IBuyer isn’t planning to live in your house. They’ll buy it, fix it and flip it to someone who will. Therefore, you walk away with less than a conventional arrangement. How much less? It depends on the condition of your house - repair offset plus the larger fees associated with an IBuyer.

So what’s this to do with commercial real estate? I pondered this question and my thoughts are outlined below.

Do commercial IBuyers exist currently. The short answer is no. Buyers of commercial real estate typically fall into two broad categories - occupants and investors. The difference? Occupants buy to house their business. Investors rely upon the rents paid by the tenants in the building. Residential IBuyers are investors with no desire to lease the house. Their play is to acquire it, prepare it for sale, and sell the home to a resident. Could such a strategy be employed commercially? Sure. Some value-add investors operate this way. But the price delta is enormous. Most commercial real estate sellers - when shown the amount a value-add investor will pay compared to an owner occupant - will opt for the latter.

Can commercial real estate be standardized. Another challenge confronting commercial IBuyers? No two commercial buildings are identical. You may say - gee, neither are there synonymous houses. However, tracts of cookie cutter domiciles dot our poppy filled hills. Very few differences exist within plan models sans owner changes. Not so with commercial real estate. So the challenge becomes just how to value a commercial offering. Layer in some special features such as upgraded offices, a fenced outdoor yard, or special power feed - and the challenge continues. Considered next would be the out sale price or expected lease rate less the cost to originate the lease - fees, concessions, down-time, etc. Kinda complex.

Will we see IBuyers. We’ve certainly encountered on-line selling platforms. What started as a way to liquidate distressed lender owned buildings under the umbrella Auction.com has morphed into Ten-X which relies upon one of three ways to create buyer pools for commercial assets - traditional auction, managed bid or offer select. I’ve used Ten-X successfully. With certain commercial offerings - it works quite well. But the lack of lender owned portfolios of problem properties has slowed their volume. Another drawback? The large buyer load - in addition to the fees paid by the seller to his broker. It’s quite expensive.

The takeaway. Yes. We will see IBuyers. When? Hard to say. Our industry is too huge and spans over 55,000,000 commercial properties nationwide. That’s an awful lot of semolians! Some well-heeled tech savvy group will figure it out and disrupt the commercial buying process. Just look at the way in which CoStar upended commercial real estate research and inventory. Stay tuned.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.