Friday, September 19, 2014

The MOST important thing in a #CRE purchase

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We are immersed in a seller's market in Southern California...AKA, we are close to the end...because buyers are committing to CRAZY numbers for industrial buildings.

An imbalance between available inventory and buyer demand has sent the prices of well appointed (and even misfit toys) buildings past the pre-recession highs. Rents have not quite followed suit, but soon will, as buyers cannot find anything to buy...need to grow...and will lease instead of losing business.

So what do market conditions in my patch of the world have to do with the MOST important thing in a commercial real estate deal? Allow me to digress and meet you on the other side...

I provide Location Advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I have witnessed three price peaks in that period of time...and the resultant price busts...which qualifies me as an expert to discuss the market today...I believe.

So, back to the MOST important thing in a commercial real estate purchase:

Location: We have all heard that the three most important aspects of real estate are location, location, location. Although this has merit, I don't believe that location is the most important thing in a commercial real estate purchase. As an example, if the prime area for appreciation is an hour's drive from your home, what do you gain?...other than a commute in and out of the office of two hours per day. What if the location places your business farther from your customer base or your key employees, thus increasing the cost of your operation? As you can see, location is not the most important thing.

Function: Certainly if you are occupying the building that you buy, the function must conform to your use and the size must mirror your growth projections. The real estate must have ample power for your operation, generous loading and freeway proximity for your logistics, and sufficient sprinkler capacity and clear height for your warehousing. The office space within the building must be adequate to comfortably house your staff. The function must work...but at what expense?

Investment Metrics: If you are buying a piece of commercial real estate strictly for investment purposes, several factors should be considered...capitalization rate, current rental rate that the tenant pays, stability of the income stream, price of the building, general lease-ability, etc. In a moment you will discover the MOST important.

Financing: The interest rate and terms at which a commercial real estate purchase is made can cure a lot of ills, but is it the MOST important item in a purchase? Imagine if you achieved a 2% interest rate but the rate could increase at will. We saw an awful lot of prime rate adjustables in the early nineties that when adjusted crippled the borrowers. What if the loan comes with an enormous pre-payment penalty that will hamstring your ability to sell the building?

Pricing: Some would offer that if commercial real estate is purchased at the right basis (price), then any deficiency with the real estate can be overcome. Really? What if the reason for the pricing is functional obsolescence? A building fifty miles from civilization is going to trade for a much cheaper price than one in the heart of the central business district. There is generally a reason why something is cheap. The best alternative for your business may be a building right next door...but you will probably pay a premium.

Ok, so what is MOST important?

The answer is they ALL are the MOST important! In my experience the stars must align...AKA, all of the reasons must point to go in order for a purchase transaction to occur. Just like the pre-launch scene in the movie Apollo 13, you MUST be go for launch.