Friday, November 17, 2017

ADVICE for this CRAZY Commercial Real Estate Market

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This commercial real estate market reminds me of an opened bag of potato chips - with 98.5% of them eaten. The full chips are consumed - functional buildings, with good owner motivation, priced aggressively but still within reason.

What remains are the remnants of the whole crunch - dysfunctional, over priced locations with zero owner motivation to meet the market and make a deal! A normal ebb and flow of availabilities and interested buyers has been usurped with feeding frenzies and bidding wars.

Sellers are enjoying these times. Many of us are warning a correction is near - but we also struggle to pinpoint the trigger. So we continue to call owners of occupied buildings to see if they will sell, monitor the LoopNet, Costar, and Commercial Seach alerts - and hope for a new vacancy.

With this as a backdrop, what advice would I give an occupant looking for space or an owner considering his future?

Plan early. One year may not be enough time - especially if some complexity exists with your requirement. Please don't believe you'll waltz out into the market and lease or buy the first thing you see. You won't have many choices. Time will be needed for additional spaces to make themselves available.

Consider ALL of your alternatives. We met with a company today. Their lease expires the end of this year. An ownership change has caused a re-evaluation of their space. Moving is the direction they are pursuing. Hold on! Let's keep the existing location in play - just in case. When we surveyed the market, we discovered ONE space that meets their needs. All of a sudden, their current home looks better. Recently, we scoured the Santa Ana area for a client. Industrial is their use - trucks, building materials, minimal office. With Santa Ana as ground zero, we are now considering a retail building - because it's located in the right area and is the correct size.

Don't assume next year will be the same. Remember that call you received from a broker claiming to have a buyer interested in your building? You blew him off but he was persistent. A multitude of calls morphed into a tour and subsequently an unsolicited offer. The price caused you to double take. Well, if he's willing to pay this today, what will the building be worth next year? You don't want to be that guy at the cocktail party talking about the deal you should've done.

If a deal seems obscene - it is. Last week we toured a project which is light years from the freeway. Mismanaged was the theme - low rents, high expenses, ownership squabble, vacant space, SKY HIGH asking price. Yep, you guessed it. Three full asking price offers. My buyer and I shook our heads in disbelief and consoled each other - the deal wasn't for us!

Friday, November 10, 2017

LEASING Commercial Real Estate - In the FUTURE

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Recently, we received a call from a dear client - they're all dear by the way. When we constructed his lease seven years ago, absent were any extension rights - not for lack of trying - because the owner was unwilling to grant any extension rights.

When we viewed the deal in its totality, the lack of extension rights were out manned by the other good things the deal had to offer - rate, term, tenant improvements, abated rent, etc. So we proceeded.

Then, WHAM! The owner decided to sell the building to a company that gave our clients the heave ho - and we were looking for another location.

By definition, an extension occurs at the expiration of your commercial real estate lease - but is agreed upon when you sign your lease. So, you are truly leasing commercial real estate - in the future. Unlike a residential lease, you, as the occupant, are not guaranteed you can stay past the lease expiration. There are nasty little creatures called "holdover provisions" which allow an owner to jack your rent way up if you stay - or worse - cause you to move. With this experience as a back drop, and guided by the definition, today, I will discuss the various extension rights you should consider when negotiating a commercial real estate lease.

An option to renew or extend. You, as the occupant, are allowed to stay in the building after the conclusion of your lease at a pre-determined set of deal points - such as the rent you will pay and the increases in your rent on an annual basis. Typically, in a down market, owners will be willing to grant an option to extend at fixed rent amount. When markets are more robust - like today - the extension will be based upon prevailing market forces in the future. In essence, you will have an agreement to agree - the owner won't give you the boot but also won't commit to a rent figure. Generally, options to renew will carry certain rules of engagement such as the time window under which you can exercise the option, the method by which you give the owner notice, and exactly who must exercise the option. Also, you must have faithfully paid your rent on time or the option to extend may be at risk. If any of these boxes go unchecked, your option could be lost - so pay attention!

A right of first refusal to lease. Simply, if you have no option to extend, a right of first refusal allows you to match or exceed another occupant's offer to lease the building. Rights of first refusal to lease occur most often with adjacent or expansion space and are rare as a means to renew a lease. We commonly see rights of first refusals to purchase.

A right of first offer to lease. The owner comes to you and says "I'm willing to allow you to stay past the expiration of your lease. Make me an offer." Akin to a right of first refusal, these generally are a purchase right vs a lease extension right - but we occasionally see them with leases.

Friday, November 3, 2017

3 Commercial Real Estate Deal Gimmicks - Be Aware!

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Our commercial real estate market has progressed to the point of absurdity - in many instances.

Six full priced offers on a new listing whose ask eclipses the recent comps by 15%.

Or, sellers who are "dug-in" and not willing to listen to reason and therefore unwilling to budge on their expectations.

Finally, an occasional tear in the fabric which defies logic - a well located, improperly exposed building sells for 20% less than it is worth because the seller experienced a transition and couldn't wait upon a normal marketing process to unfold.

During these times we encounter some "gimmicks" which this column is meant to diffuse and provide warning to unwary buyers.

I'll just guarantee the rents. Occasionally we encounter a building with remnants of the last downturn - the occupants signed up during the downturn and consequently are paying a rent less than the current market will bear. As we discussed, the economic value of an income property is dependent upon the rent the occupants pay. More rent more value. Enter rent guarantees. The owner - hopeful to get maximum value -  will supplement the difference between market and the amount his tenants pay. Good in theory. Bad in practice. Any savvy investor will ask - what happens when the guarantee ends? Now I am stuck with an under market rent on a building for which I overpaid.

Below market asking price. This suggests one of two scenarios. Either the building has a latent issue - partnership squabble, non pre-payable loan, environmental contamination, long term lease at an under market rent, imminent city action for re-development, or the like. Or, the listing broker has priced the building this way in order to attract multiple offers, create a bidding war and generate activity above the market rate. If you are a buyer caught in this vortex, the pain never stops until someone says uncle!

A seller lease back. As we mentioned in previous columns, be wary of a seller leaseback - the rent he is willing to pay, his financial capabilities, and his motivation - especially if you are relying on his rent as a justification to buy at his value. Conversely, if the seller requires a lease back after you own the building to accommodate his move out schedule, make sure he has a place to go. In our market of skinny vacancy - a replacement may not be easy to locate.

Friday, October 27, 2017

4 Random Commercial Real Estate Leasing Thoughts

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Today, I decided it would be fun to regurgitate a few random thoughts as they pertain to LEASING commercial real estate.

As we have discussed before, leasing is a big part of our daily activity - unlike our residential counterparts. We, as commercial real estate professionals help occupants find space to lease or buy.

Typically, leases account for 70-75% of our deal volume - sales the balance.

We differ from our residential counterparts. Our fees are based on a percentage of the deal's total consideration - purchase price or the amount of rent paid over the term of the lease. Generally, commercial leases run 3-10 years - so the amount of rent payments negotiated is a significant sum. Whereas, residential leases are month-to-month or a year maximum. Consequently, the potential fees on a residential lease - because the term is much shorter - make it unprofitable for residential agents to pursue.

Subleases are a pain. A sublease is necessary when an occupant no longer needs the building - for myriad reasons - yet has a term of lease remaining. The owner of the building still wants his rent. So, the occupant resorts to finding a substitute - a subtenant - to move in and assume the rent payments. Differences in uses, credit, number of players, and changing market conditions all create the pain in a sublease transaction.

Credit requirements of a property owner. At a minimum, the owner will look at the total amount of the lease - let's assume $10,000 per month for sixty months or $600,000. The owner is leasing an occupant the building in return for $600,000 in rent payments. Therefore, the owner is extending the occupant $600,000 of credit - so to speak. Carefully scrutinized is the occupant's ability to repay the $600,000 - through an analysis of the business's sales and credit history.

Process. Searching for a space to lease is similar to searching for a building to buy. The similarities: Facility requirements are discussed - loading, power, amount of office space, warehouse ceiling height, etc., geographical areas are considered, a list of alternatives is toured and a candidate is chosen. Now, the differences occur. A sale deal will proceed to a negotiation, an agreement, an escrow, due diligence and closing - approximately 60-90 days. But, a lease will involve a negotiation and a lease - much quicker - fewer than 30 days, in most cases.

If ever we can assist you in leasing or buying a building, please call us at 714.564.7104 or email us at abuchanan@lee-associates.com.

Friday, October 20, 2017

Commercial Real Estate Sale Leasebacks - the DOWNSIDE

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I've advised a number of my clients recently to consider selling their commercial real estate and striking a three to ten year lease with the investor that buys it. A few have listened.

This structure, in our parlance, is known as a sale leaseback. Different than a straight lease and not a short term lease that accommodates a purchase, a sale leaseback allows an owner occupant the chance to sell at today's high prices and remain in the building - albeit as a tenant - and avoid a move.

It's a slick arrangement when the correct motivations are involved. I wrote about those reasons in a past post. You can read about it here. 

Today, I want to spend a moment and discuss the downside of a sale leaseback.

The message it sends to the market. When a sale leaseback is listed and marketed for sale, the questions from buyers range from - "why is he selling?" to "is his company leaking at the gills and needs cash to survive? Generally, there is a story. Its critical to understand the story, why a seller is selling, and how the current financials present.

I will just pay more rent. Value is determined by taking the rent your company is willing to pay and packaging the rent as a return on investment. Simply, if your company can afford to pay $10,000 per month or $120,000 per year and the return is 5% - your building is worth $2,400,000. Easy, yes? Now the fun begins. Where is $10,000 per month in relation to what other comparable buildings achieve in rent? It's either above, below, or at par. Par or below - you're golden. Above and you're scrambling. You see, an investor looks at the worse case scenario - you spit the hook after a year, can't pay the rent - or worse file bankruptcy - and he's stuck with a building he can't rent for the same amount you were paying.

You strap your operating company. If you own your building and times get tough, you can adjust the rent your company pays you - after all, you are the owner AND the tenant. Once you inject an arm's length investor into the mix - that flexibility evaporates. You are now bound to a lease. If you don't pay, you may get evicted.

There are tax consequences. As we've discussed, selling appreciated commercial real estate comes with a heavy tax consequence - unless you employ a tax deferred exchange. Yes, you free your equity, but at a significant cost - in some cases up to 35%.

Friday, October 13, 2017

REASONS Your Commercial Real Estate ISN'T Selling

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I've opined for months that Southern California is immersed in a seller's market - there are many more buyers in the market than sellers - advantage sellers!

Today, however, I want to discuss WHY your commercial real estate isn't selling.

After all, with more buyers around than sellers, you should be flush with offers  - folks clamoring to buy your building - but nothing - crickets! So what's up?

Below, are my reasons why your building isn't in the sold category.

Your building is over priced. As we've discussed, asking prices are tricky. Hopefully you've looked at recently closed sales, compared those to what is currently available, checked the trends - up or down trending, and finally placed your building under careful scrutiny to determine its value. Great. You've established an asking price. However, if the asking price has no basis in fact - comps or avails to support it - your building will sit. Oh, you'll get tons of inquiries - there are not a lot of available buildings - but no one will want to tour. Or worse, offer on your commercial real estate.

Your building lacks a key amenity. If you own a space with challenged loading, a logistics building with low ceilings, a manufacturing location with insufficient power, a service depot without an outside storage area for trucks - congratulations! Your building lacks a key amenity. Some of these issues can be solved with dollars - others cannot.

You are un-realistic in your expectations. If you have received a number of showings - with no offers - chances are there is a problem. You are likely overpriced or your building lacks a key amenity. With this market intel, if you continue to believe your kitty is the cutest in the contest and refuse to consider others may be cuter - your expectations are out of whack with the market.

There are use restrictions. We toured a building recently with a prospective buyer. Our guy liked the possibilities because there was a large outside staging and storage area - a key requirement of his occupancy. As we were completing our pre-proposal research, we discovered the area in question was unusable for the purposes our client intended. Furthermore, there was a giant easement running through the middle of the yard. Ooops. No deal here.

Your representative is un-cooperative. I'm honored to work in an industry with so many highly skilled professionals. However, on occasion we encounter a rogue element who sees the real estate brokerage business as a way to pad his bank account vs working in the best interest of his seller. If your activity is waning - it could be your representative is not doing what's necessary to ply nicely with others.

Friday, October 6, 2017

The Downside of a FAST Growing company - Where would Amazon go?

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The genesis of this post came from two sources. First, a very well written article in the New York Times entitled: Amazon Plans Second Headquarters, Opening a Bidding War Among Cities. Secondly, from my Orange County Register editor who posed the question, "where would Amazon locate if they chose Orange County?"


Clearly, Amazon's footprint in the Seattle area is massive - around 80,000 folks draw a paycheck and consumed is about 20% of the available prime office space in the city - roughly equivalent to 8,000,000 square feet of space! Imagine the chaos created if Amazon were to vacate even half of that occupied space - incredible.

For the HQ2, Amazon's plan would include 50,000 new hires and a facility to house them. Close to an international airport, skilled labor, affordable housing, access to mass transit, fiber optic capabilities, and a business friendly environment are all on Amazon's checklist - with all the appurtenant goodies states like Texas seem willing to dole out - tax breaks, free land, employee relocation expenses, no state income taxes, cameo with the governor, etc. 

Although many of the checklist items can be found in the OC - labor, airport, fiber - California has shunned economic incentives with the abolition of redevelopment districts and enterprise zones. Gone are the halcyon days of California cities writing a check for the promise of future sales tax and incremental property tax revenue increases - the proverbial "I scratch your back" scenario. 

So, where would Amazon go in the highly unlikely event the OC was in the running? Well, it depends. On what, you ask? On the type of facility they are seeking. It appears the new headquarters would house a number of engineers and skilled labor - therefore a facility much like Broadcom abandoned when they were recently acquired. 50,000 employees at 100 square feet each would require around 5,000,000 square feet of office or flex industrial space - like those that litter the Irvine Spectrum. A quick search yielded approximately zero existing - occupied or vacant - buildings that could garner that amount of footage in the county. Therefore, someone would have to build the building for Amazon to occupy. If we stacked the building with two stories, this new construction would require close to 100 buildable acres - roughly the size of the old Boeing campus in Anaheim, an eighth of the Great Park or around half the size of Angel Stadium - parking and field. Probably ain't happening. 

Lets go a different route. Amazon has constructed 77 warehouse buildings around the nation since 2005. A number of others were either planned or under construction and Amazon became the occupant. Generally, the buildings are 750,000-1,000,000 square feet apiece. To put that figure in context, we are describing 25 football fields - under one roof - plus, the appurtenant parking and circulation around the building - or another 10-25 football fields. The only vacant building in Orange County that could house an operation such as that would be the former JC Penneys building in Buena Park. But, there is an issue - the ceilings are too low for Amazon's proprietary procurement system. Ooops!

Have fun in Dallas, Amazon. Go Cowboys!