Friday, July 25, 2014

Reasons that you SHOULDN'T own #CRE

Image Attribution: www.commercialacademy.com
I received a call today from an old client of mine...in my advancing years, many of my clients are "old" clients. The question that he posed was "should I buy the building that I occupy?" My response to him was simple...I don't believe so.

You may be scratching your head about now...this guy sells buildings for a living...why would he recommend that someone NOT buy a building?

Indulge me for a moment while we hear from our sponsors...

I provide Location Advice to owners and to occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I have sold and leased hundreds of thousands of square feet over the years...as well as, talked a few folks out of buying or leasing. This qualifies me as some sort of an expert...if I can only remember why...

OK, so back to buying a building.

The reasons, that I used to form my recommendation not to buy today, were:

His age: My client is 58. Certainly not ready for the old folks home but closer to retirement than not. Unless he were to pay cash for the building, the loan would not be fully retired until well after he is.

The time in the market cycle: We are at the top. Unless the hold was for another twenty years, I doubt the building will be worth more than it is today.

The physical amenities of the building: Old, tired, and needing some stuff (similar to his broker)...roof, HVAC, parking lot, etc. Under his lease arrangement, and superior brokerage advice :), the current owner is responsible for all of these expenses.

His exit strategy for the business. He plans to sell the company that occupies the leased building within five years. When asked if he would want to own the building vacant...his answer was no.

As I thought about the reasons that this client should avoid purchasing and opt for leasing, other reasons (for not buying) popped into my greying head:

If you are a publicly traded company: Depreciation becomes an issue as it reduces earnings...bad for share prices.

If you expect to outgrow your location within 3-5 years: You will then face a liquidity event...either leasing or selling the building that you just purchased...and outgrew.

If the location that you occupy is a commodity: Meaning plentiful in the market...ie: bulk distribution space. The more of this space in the market, the cheaper it will be to lease.

If the company (your company) that occupies the building you're buying is less than three years old: Chances are the company has not established a profit pattern and may find it difficult to obtain financing.

If your company has a pressing need for operating capital: The last place your want your money if you need it for hiring, equipment, and growing the business in in an illiquid asset such as a building.

If the debt service on the building you're considering buying exceeds NNN market rents by 20%: The tax benefits will never make this purchase worthwhile...and you can't count on appreciation to bail you out...think 2008.

I really believe that my client appreciated the candor...after all, that is how he became an old client.