Friday, October 30, 2020

Commercial Real Estate Marketing Reports

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Some of you reading this own a company which occupies a building you also own. Others are involved in some facet of the commercial real estate profession - a broker, lender, architect, escrow holder, title officer, or contractor. Still others might own a strip center, office building, or small industrial condo from which you derive monthly rent to supplement your income - hi, Rudy. Regardless of your angle - you’ve been on the receiving end - or have prepared - a marketing report. You see, when a vacancy occurs, a broker is hired to find a tenant or buyer for said vacancy. This, of course, unless you choose to go it alone - which I strongly discourage - but I digress.

What information should expect from your broker in the report? That is the subject of today’s column. I generally like to update I three specific areas. Akin to a microscope zooming in - my reports start with the overall market conditions and zero in to specific recommendations for the assignment.

 Market Activity. The market in which your vacancy competes should be constantly reviewed by your commercial real estate professional. Let’s say you own an industrial building of 100,000 that is ten years old. How many spaces are available? What are the most recent comps? Speaking of comps - are they mainly sales or leases? What active requirements are circling? Based upon all of these data points - market conditions emerge from which decisions can be made. As an example - if you’re attempting to attract a tenant and the vast majority of recent activity is from buyers - you might consider altering your plan. Conversely, if your asking price eclipses the market sales - you better have some staying power to allow the pricing to catch up. But if you find yourself in a downward trending time - you may wait a very long time.

Active Interest. Who has inquired? Are they kicking tires or is there some motivation to their search? I try very hard to find out specifically which company is represented, what else they are considering, and why our building may or may not work.

Next Steps. Fresh coat of paint? Add an office or two? Freshen the landscape? Lower the pricing? Offer some owner carried financing? Offer something that others can’t - an option to buy as an example. All could appear in the recommendations to an owner of commercial real estate.

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.blogspot.com.

Friday, October 23, 2020

Can 2020 Get ANY Crazier? A Commercial Real Estate Metaphor

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Commercial real estate business as usual - no recessionary storm clouds massing on the horizon. Drought behind us - as we continued a relatively wet winter. Local sports teams finishing strong. The opening of Marvel Land - Avenger’s Campus at Disney’s California Adventure. Summer vacations, kids starting their spring semesters anticipating graduations. June weddings. Breaks in the work schedule to celebrate birthdays, anniversaries and National holidays. Yep. That was our view of things to come in January 2020.

 But, in the ensuing gestation period - 2020 has eclipsed any year in recorded history for weirdness! Pandemic, 208,000 deaths, worst economic recession since the 1930s, upheaval in the streets, absence of civility in our public discourse, hurricanes, wildfires...And just as we believed we’ve seen it all. BOOM! Our President and First Lady - and a host of close encounters - have been stricken by the hidden enemy - Covid-19. I’m not certain 2020 can get any crazier!

 So, is 2020 somehow metaphorical for commercial real estate transactions? Maybe! Indulge me while I develop the conversation a bit more.

 An unexpected turn to the charted plan. Purchasing commercial real estate for your business home remains a great way to build legacy wealth for your family. I speak to many closely held company owners who’ve created an entity to own their acquisition and then leased the purchased real estate to their corporate operation. Some boast, their locations are now worth more than the companies they host. Occasionally, I encounter the opposite - akin to the start of 2020 and what followed. Take, for instance, the aerospace manufacturing group that tooled parts for jetliners. Successfully operating from an owned location, things were peachy. Revenue was growing, the facility met their needs, commercial real estate was appreciating, many were employed, life was grand - until it wasn’t. You see, although the owner of the business and real estate were similar - they were not a mirror image. Upon the untimely death of the founding patriarch - all manner of chaos ensued. Unbeknownst to the business operator - son, title to their company site had been deeded to seven factions with disparate goals. Some wanted money, others needed money, while still others realized absent the building - where would operations continue? Things got very ugly. I’m pleased to report the aerospace firm is happily domiciled in a leased location and the building was sold. Oh that 2020 will end happily as well.

 It really boils down to risk. Our President contracted the virus. It presented - debatably how seriously. Many test positive yet are asymptomatic. Was it a blatant disregard of safety protocols - masks, distancing, sanitizing - by a purported germophobe or simply a random occurrence. The arguments on either side are as numerous as viruses in a petri culture. Suffice it to say - risks were taken. It may end badly. We pray not. Are there ways to minimize risk? Of course! Stay home, follow the guidelines, avoid human contact. Done. Sadly, many adopt a riskier approach - much like driving in and out of the fast lane on the 405 and exceeding the speed limit all while eschewing a safety belt - you’re increasing the odds of a catastrophic outcome. With a commercial real estate - to avoid ALL risk - “mask up” and do this. Buy a building - at a safe social distance, no less - at cheaper than market comparable sales - for cash - no loans. Plan to occupy it with your business. If you don’t own a company that can pay you rent - forget about buying commercial real estate. If you divest yourself of the company - sell the building as well. Pay the taxes. Bank the profit. Done! I’ve just described 3% of commercial real estate owners. The remaining 97% tend to take a bit more risk - albeit for a potentially greater return. Tantamount to playing Twister in a Tsunami - the risk doesn’t have to affect life, limb, or the pursuit of happiness - although some invest that way. Examples of “going without a mask” in commercial real estate might be; borrowing more than the property is worth, buying an unsustainable income stream, investing in a special purpose building. You may end up just fine. There again - you may have to quarantine for 14 days and hope for the best.

 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.blogspot.com.

 

Friday, October 16, 2020

Industrial Deals Soar Amidst the Pandemic?

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As the year of the pandemic 2020 dawned - many in our industry prepared for a continuation of the past nine years - robust leasing and buying from owners and occupants of commercial real estate. Derailed was the market as Covid-19 case positivity, hospitalizations, and death ravaged the globe. In March, commercial real estate largely hit the “pause button”. We collectively held our breath - albeit behind face coverings - awaiting the next wrinkle in our state’s lockdown and business hiatus. June brought encouragement as akin to Rip Van Winkle - our state awakened from its slumber - to a changed world indeed! Commercial real estate activity for manufacturing, logistics, and warehousing outfits returned with a vengeance! Currently, in Orange County, there are fewer buildings available than pre-virus. Amazing! By the way, and as previously noted, space geared for office and retail applications is not experiencing the same froth as industrial.

 So what is going on? Indulge me while I expand the discussion.

Essential businesses. Largely, manufacturing and logistics concerns were deemed essential to our economy. Simply, these businesses continued to operate. As a matter of fact, some never shuttered. Many conducted business as usual - as usual as a masked, sanitized, and temperature checked workforce can be. Construction, aerospace, packaging, food production, plastics, hardware, furniture, etc. all find their homes in industrial buildings. Demand for additional space soared as did revenues because many rely upon machinery to drive sales and complete orders. Additional real estate was needed.

No gray area. Unlike past economic slow downs, the pandemic of 2020 quickly picked it’s winners and losers. Absent from this downturn were companies that simply maintained. This blip found businesses thriving or bankrupt with very few in between. Take for example a group that places adhesive material on tape. With all of the on-line purchases and home delivery in boxes - tape is needed - a lot of tape! How about an operation manufacturing recreational vehicles? An inventory glut in early 2020 quickly evaporated into a shortage as folks sought different ways to vacation. Compare these to the poor guy who formerly catered conventions or provided stages to outdoor concerts. Point made.

Government assistance. The Small Business Administration - SBA, which is a primary loan originator for closely held business real estate purchases - responded to the slow down with two unique incentives. First, any existing Small Business Administration borrower was granted six months of payment forgiveness - not forebeafance, mind you - but forgiveness! New transactions - using SBA funding - that occurred prior to the end of September - received the same loan forgiveness. Spurred was a number of purchases. Remember the CARES act? Contained in the trillion dollar legislation was the Payroll Protection Plan - PPP. Afforded for those maintaining or re-hiring furloughed workers was 75 days of expenses - 60 days for wages and salaries and the balance for “other expenses” such as rent. Did I mention these loans are forgiven? “Ducks on a junebug” describe applicant attitudes toward the “free money”. Sorry! Occasionally my southern roots take hold. Ducks on a junebug is parlance - whenever someone is absolutely on and after something. One of the deals we completed in July was a direct result of PPP money. Received was a $300,000 forgivable loan. Our client used some of the money to defray moving expenses to a new facility. Boom!

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.blogspot.com.

 

Friday, October 9, 2020

What commercial real estate lease terms are normally negotiated?

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In any given year - as a commercial real estate professional - approximately 50 to 85% of our transnational volume is generated from lease originations and lease renewals. The balance occurs with sales. Certainly this is an industry average and the percentages vary based upon an agent’s specific expertise. Simply, if the niche is tenant representation - the deals completed each year will be all leases. Conversely, selling Single Tenant Net Leased (STNL) investments yields all sales. Today, I’d like to delve into some specific terms typically negotiated during a lease transaction. I’ll break these down into new leases and renewals - similar yet different deals.

New deals. As defined - a transaction which involves a relocation from point A to point B. These deals are about half of the lease transactions that occur in a market during a given year. Covered during most negotiations are the following points:

Term of lease. For leased premises fewer than 5000 square feet, we will see 2-3 year terms. As the square footages increase, so do the number of years. For a 100,000+ square foot building, we generally ask for a much longer term - maybe a five year minimum up to ten. The rationale for this is pretty straightforward. Bigger spaces can lay fallow for longer periods of time which is costly. Therefore, owners of large buildings want a secured term for a longer period of time.

Form of lease. Many are unaware that you can ask an owner for a specific form of lease. Standard forms include those produced by the AIR-CRE or the California Association of Realtors. As deal sizes increase we see a preponderance of owner generated leases.

Commencement of lease. The start date of the lease is an important part of any lease negotiations. We try to marry this with the expiration of the existing location. If successful, any sort of double rent payment is avoided.

Possession of the premises. In some cases tenants are given occupancy prior to the commencement of the lease. This is known as “Early Possession”. It’s not uncommon to see early possessions of 30 to 45 days prior to the commencement of the lease.

Lease rate. A critical component of any lease negotiation is the lease rate and monthly rent that will be paid throughout the term. Rent amounts may include the operating expenses - such as property taxes, property insurance, and common area maintenance - also known as an industrial gross lease or an office full service gross lease. An agreement net of these operating expenses which is known as a triple net lease.

Increases in rent. Standard in any multi year lease would be an increase in rent throughout the term. 2 to 3% annually would be found in today’s market place. Rarely do we see changes in lease rates as they occur in the consumer price index - the reason for this is the increases are too difficult to compute.

Tenant improvements. Any sort of office additions, power distribution, changes in the parking, or general cleanup and painting should be clearly outlined in the tenant improvement ask. Most leases provide a warranty for the systems within the building such as air-conditioning, roof, plumbing and other mechanical systems. However, it’s very important to specifically outline the condition with which the building should be left prior to occupancy.

Free or abated rent. In robust times like we’re seeing industrially - free or abated rent would encompass many fewer months than in more difficult economic times. As a landlord’s motivation increases so does the amount of free or abated rent he is willing to consider. Half to one month per year of the term is pretty standard.

Extension rights. What happens at the end of your lease? That question is answered via extension rights. Whether they are a Right of First Refusal to Extend, a Right of First Refusal to take additional space, a Right of First Offer for additional space or some sort of an Option to Extend or Purchase or an option to purchase arrangement - all can be found in the request for an extension right.

Miscellaneous. Many large corporate leases will have opt-out or termination clause within their leases. Some also might include an allowance for moving expenses, a must take provision whereby a tenant agrees to lease a smaller square footage today in return for an absolute agreement to expand into additional square footage in the future.

Lease renewals. The biggest difference between a lease renewal and the origination of a new lease is the tenant is currently in residence and desires to stay. Therefore many of the terms and conditions above or non-applicable. Things such as the miscellaneous category which includes termination rights are probably not included in a lease renewal. Many times free or abated rent are excluded. But the length of term, the lease rate, and in certain cases clean- up or a small allowance for carpet are included within at lease renewal. One word of caution with respect to your renewal - please don’t try this at home! Even if you have a wonderful relationship with your landlord, it’s always best to have representation by a commercial real estate professional who is familiar with market conditions and can advise you accordingly.

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.blogspot.com.

 

Friday, October 2, 2020

In-Box Purge!

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My inbox is full! Today, I will parse through the noise and attempt to make some sense of the questions I receive on a daily basis. Plus purging is good. From cleared clutter to sanitized sanity - here goes.

 Does the Presidential election slow commercial real estate activity? Certainly some small business owners take the political landscape into consideration before making a commitment to lease or purchase buildings. Specifically, how does the current administration deal with ownership? Are there tax breaks if you occupy your business home? What about borrowing costs? The vast majority of commercial real estate financing is originated through loans either made or guaranteed by the Small Business Administration. Frankly, in the year of the pandemic 2020 - most companies are concerned with their survival. What happens in November appears to be a distant outpost.

 Will office space ever be used as it was pre-virus? Prior to the lockdown - which sent workers scrambling home to find enough internet bandwidth and clear the guest bedroom - the trend in office space was toward more density. Meaning - doing away with fixed walls, creating a more collaborative work environment, fewer private offices, and more employees per square foot. Concepts such as WeWork - executive suites on steroids - became popular. For a small monthly fee, companies can pivot as their space needs morph. Add a few bodies? No problem. Lose a contract? Just downsize next month. The appeal of coding alongside several strangers advanced. Now, decision makers are re-imagining the way their spaces are occupied. Visit my office on a typical day and you’ll find four or five agents bouncing around a vacant suite. Many of us have found working from home advantageous, productive, and efficient. Will I return to the office on a daily basis? Maybe. But taking a work break and watching Frozen II with our two year old grandson has its advantages.

 Is there a “virus discount”? Simply. It depends. As aforementioned - office space is experiencing some uncertainty. Therefore, if you charge out into the leasing market - chances are you’ll find a deal. Retail? Who knows? We are actually witnessing a virus premium in industrial real estate. Our vacancy was historically low at the beginning of 2020. Even the catastrophic nature of a Covid-19 pause has had little impact. I suspect the bump is largely due to cheap borrowing rates.

 Are touring protocols in place - similar to residential? I read with great interest, Leslie Eskildsen’s column last week. Outlined were the hoops required to simply walk through a house prior to buying it. Good grief! No more open houses, safety gear, financial pre-qualifications prior to touring, handy wipes at the beckon, masks. Yet houses are leaving the market at a record pace! We can still tour without much hassle. Sure, masks are required. In the case of a new build - plan on safety vests and hard hats. But, these are a good idea whenever walking a construction site. I showed up at a building in shorts a couple of weeks ago - when the mercury surpassed my patience. You can imagine my embarrassment when my client perused the space alone - long pants required, sorry!

 How is 2021 shaping up? I’d only be guessing. However, I suspect the fourth quarter of this year will portend what’s next. If businesses reopen fully, a vaccine is discovered, and most importantly - confidence returns, we could see a bounce back like no other. Remember, not so long ago, folks were optimistic about a banner 2020. Man. That is SO 2019!

 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.blogspot.com.

 

Friday, September 25, 2020

Proposition 15 - Look into it, Please!

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 First, a bit of context and a brief history lesson. 

“Proposition 13 (officially named the People's Initiative to Limit Property Taxation) is an amendment of the Constitution of California enacted during 1978, by means of the initiative process. The initiative was approved by California voters on June 6, 1978. It was upheld as constitutional by the United States Supreme Court in the case of Nordlinger v. Hahn, 505 U.S. 1 (1992). Proposition 13 is embodied in Article XIII A of the Constitution of the State of California.” Source: Wikipedia.

 Two hallmarks of the amendment are - 1. values of ALL real estate, residential, commercial, or otherwise are fixed at their 1976 levels. Assessed values may increase annually by the rate of inflation not to exceed 2%. Exceptions are for a property which is sold or newly constructed. These are then assessed at their “new” values. 2. Maximum amount of any ad valorem tax on real property cannot exceed 1%. 

This “third rail” of California law has been in place since some of us wore shag haircuts and big-belled Levis. Thank goodness those had shorter shelf lives than the legislation!

Flash forward to now - 2020, the year of the pandemic.

A ballot initiative - Proposition 15 will appear on November 3. You can read the full text of the initiative here. California Proposition 15, Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative (2020) - Ballotpedia

 From the website above - Simply, “a yes vote on Proposition 15 supports this constitutional amendment to require commercial and industrial properties, except those zoned as commercial agriculture, to be taxed based on their market value, rather than their purchase price.”

Ok. I’m with you so far - you may be thinking. I don’t own commercial real estate, schools need our help, so what’s the big deal? Please read on.

Owners of commercial real estate either occupy the buildings they own or rely upon a tenant to pay them monthly. Commercial real estate exists in three main categories - office, retail, and industrial. Office buildings - ranging from high rise towers to two story garden varieties - house your physician, dentist, CPA, wealth advisor, tax attorney, insurance broker, residential real estate agent, homeowner’s association, news organization, non-profit outfit, and many others. Retail - neighborhood shopping, regional malls, power centers, strips, freestanding, big box, automotive - provide purchasing destinations for goods such as your cat’s food, groceries, apparel, and school supplies - or services such as your favorite bar, restaurant, theatre, or gym. Finally, industrial - generally manufacturing, service, or logistics providers - who domicile in concrete boxes. Some notables are aerospace tooling, plastic molding, warehouse distributors, and trucking outfits.

Commercial real estate is EVERYWHERE! Whether you own it or not - your life - employment, consumption, entertainment - is impacted by someone who does.

If Proposition 15 passes - in this author’s opinion - five things are certain to occur.

First, property taxes on commercial real estate will increase. Second, the increased property taxes may be used to fund local communities and schools. Third, owners of commercial real estate will pass along the increased property taxes to those companies that occupy the commercial real estate - read. Tenants. Fourth, tenants - faced with increased costs - will raise the prices of their goods and services to offset the increase. Fifth, you - as the consumer of said goods and services - will pay more.

Please, educate yourself on Proposition 15 and exercise your civic duty and vote.

 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.blogspot.com.

Friday, September 18, 2020

Are 1031 Exchanges at RISK?

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As we have now surpassed Labor Day in the election year of the pandemic 2020 - expect political rhetoric to reach a fever pitch. Sorry. Pun intended. As our nation slowly recovers from business lockdowns, distance learning, storms along the gulf coast, wildfires in California, and upheaval in our streets - and governments respond monetarily to stem the bleeding - expect the next question to be - “how on earth can we possibly pay for all of this?”

 California has proposed a 16.8% marginal tax through AB-1253. Targeted are those who earn more than $5,000,000 annually. Who cares, you may ask. They should pay their fair share. What’s another 3.5% of their income to help the greater good? Consider this, please. Many small business owners could tip this scale and face the extra burden. How long will they remain in California when Nevada, Texas, and Washington have ZERO state income tax? If we export a significant amount of our tax base - who’ll be left to foot the tab?

 Proposition 15 - on the California ballot in November - proposes to split the property tax roll and tax commercial properties differently than residential parcels. I’ve written ad nauseam about where the ultimate bill will be paid. Yep! By you as the consumer of goods and services. You see - if the cost of commercial real estate rents rise through an increase in property taxes - businesses who occupy the industrial buildings, office space, and retail storefronts will be forced to pass that expense along to their customers - you.

 A target for a significant tax grab could also be the way in which capital gains taxes are deferred through 1031 exchanges. I’ve not seen any storms massing on the eastern horizon - but it’s always calmest - so the saying goes.

 Congress could propose an elimination of this “loophole” and generate billions in tax revenue. It currently works like thus. If you sell a piece of income property - you are allowed to defer your long term capital gains taxes. Simply, you enter a contract to sell, create a qualified intermediary before you close, close, net sale proceeds go into an accommodator account, you identify upleg purchases within 45 days from close, and buy the upleg(s) at the earlier of 180 days from close or the filing date of next year’s tax returns. Easy! Literally thousands of these are done each year. Deferred are Federal long term capital gains of 15-20%, depreciation recapture of 25%, California state taxes on Capital Gains of $13.3%, and 3.8% for the Affordable Care Act. A whopping amount! Assumed is - if we tax those sales today vs allowing a deferral - think of the revenue we’d generate!

 Good in theory - but here’s the rub.

 When I visit with owners of commercial real estate about the likelihood of selling their property - I’m asked this question. If I sell, what will I do with the proceeds? After all - I don’t want to pay close to half my gain in taxes! We then have an in-depth conversation about tax deferred exchanges. So if Congress were to change the rules or disallow 1031 exchanges altogether - sellers would be left with very little motivation to sell. 

Some might say - this argument is quite self serving. After all, this guy is paid to sell commercial real estate. True enough. However, please don’t forget the multitude of industries who benefit from the sale and purchase of commercial real estate. Title companies, escrow holders, transactional lawyers, CPAs, qualified intermediaries, lenders, property inspectors, environmental engineers, contractors all drink from the trough of a commercial real estate transaction. Behind the scenes are real people - with families - whose livelihoods depend on property sales.

 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.blogspot.com.