Friday, August 18, 2017

The DOWNSIDE of an Off-Market Commercial Real Estate Deal

Image Attribution: www.biggerpockets.com
As recently discussed, our commercial real estate market these days is heavily weighted toward sellers – akin to a boxing mismatch, buyers are outclassed and must muscle up to counter the punches thrown by a market favoring seller. 

If a seller lists his commercial real estate for sale, prices it fairly – or even unfairly in some cases – and assuming the building has good amenities, a ring full of buyers crowds his corner – with gloves full of cash – shortly after the first bell.

We, as the trainers – AKA, the buyer’s representatives – set out to find a fairer fight. We contact owners of commercial real estate and ask them if they would consider selling to our buyers. In rare instances, we find a willing seller which creates an “off-market” deal. Great! But, what are the problems with such a transaction? I propose we spend a moment and discuss the downside.

The seller has no advocate. Generally, a seller engages a broker to represent him. Incumbent upon a seller’s rep are the duty to place a seller’s interest above those of the broker. Included in the representation is a pre sale conversation involving a review of the current market conditions, an outline of a comprehensive marketing plan for attracting the highest purchase price in the least amount of time, candid discussions about the tax impact of selling, agreeing upon the touring protocol, and disclosing the selling plans to employees who occupy the building. In an “off market” transaction, none of these confabs occur and the seller potentially enters the deal uneducated about the process. Without a seller advocate, the buyer enters the ring with an advantage. Good for the buyer. Bad for the seller. Generally, the seller figures out he is not benefited by the lack of representation. In this market, a seller’s rep will counsel his client on the importance of running a process to find the BEST buyer – rarely the outcome of an off-market deal. I recently witnessed an off-market transaction that yielded a price for the seller 30% below the prevailing values. Ouch!


No vetting has occurred. Unresolved title issues such as tax liens, un-recorded easements, or loans against the property have not been investigated. Systems – the roof, fire suppression, and heating ventilating and air conditioning, have not been inspected. The tax impact of a sale has not been calculated. Are there any pre payment penalties that must be addressed prior to closing? Any and all of these issues can cause a knock out which means the bell rings on your commercial real estate deal and you are not the winner.

Friday, August 4, 2017

Is it Better to OVERPAY for Commercial Real Estate or Pay the Taxes?

Image Attribution: www.express.co.uk
You've sold your commercial real estate. Proper steps have been taken to funnel the sale proceeds into a qualified intermediary as the first step to perfecting a tax deferred exchange - a way to buy more commercial real estate and defer the tax obligation. 

A careful review of buildings available for sale has given you the sense the market is over-heated. You are concerned you may overpay for a building - pay more than the building will be worth in future years - after all, its a great time to sell but not a great time to buy. 

So, is it better to overpay today and risk the building declining in value or simply pay the taxes - which as previously discussed could amount to 35% of your take. 

One thing is certain. If you don't buy commercial real estate and perfect your exchange - you WILL pay the taxes. Let's use a hypothetical amount of $2,000,000 as the sale price for the property you sold. By the time you layer in federal, state, and Affordable Care Act taxes, your tax bill will approach $700,000.

The overpay is not as certain.

If you are considering replacing your $2,000,000 sale with a $3,000,000 buy and you overpay, your $3,000,000 must decline to $2,300,000 - a market adjustment of almost 25% -  for the offset to equal your certain tax liability. We witnessed the market decline by over 25% in 2009-2010. But, now our values are back and have exceeded our previous 2007 highs by 30%. Plus, three things have changed since the lows of 2009-2010 – new construction hasn’t and will never match demand, thousands of square feet of industrial inventory have been scraped in favor of multifamily development – thus a lower base, and 98 of every 100 buildings are occupied - the lowest vacancy in history.
 
One way to compensate for an overpay is with a long term lease – a bridge greater than five years. Commercial real estate values tend to ebb and flow over seven to ten years. I have a client who made a lease in 2008 - at the top. Through the term, market lease rates dipped. It's now renewal time and the lease rates are back to the top.  

Still not convinced? If you believe you are overpaying – would it make sense to overpay for a perfect building vs over paying for an building with challenges? My experience is good buildings stay leased.  A challenged building – even in good times – will have leasing issues.