Merry Christmas! Here are your CAM Charges

This time of year, landlords all over Southern California, present their tenants with a Christmas gift - a bill for operating expenses. Merry Christmas indeed! Also referred to as Common Area Maintenance Charges - CAMs - these lumps of coal disguised as presents - anticipate the cost to operate your location.

So what’s included? Contained within the invoice is an estimate of property taxes, insurance for the structure, and various maintenance line items - such as roof, landscape, air conditioning and so on. Typically, these estimates take into account what’s known and what’s anticipated for next year.

Property taxes. Specifically, property taxes will be known - sort of. Owners receive their property tax bill in October for the last six months of the current year plus the first six months of next year. Yep. You got it. If you receive a bill now for expected charges next year - the last six months of next year are unknown. Confusing? Yes. Since County fiscal years run differently than calendar years - most landlords simply figure a small pop will occur and invoice accordingly. However, if your building sells or if The California Schools and Local Community Funding Act should pass - prepare for a large increase!

Property insurance. Insurance on the structure tends to be fairly easy. Policies are written annually. If the owner of your building and his insurance broker are in synch - not the Boy Band, BTW - these renewals can occur in December - allowing for the owner to allocate accurately.

Maintenance. Other expenses - such as mowing the grass and clearing leaves from your roof - can be predicted through yearly renewable maintenance contracts.

But what’s not included? If your owner hires someone to collect the rents and pay the mortgage - AKA a property manager - most likely this isn’t included in your CAM. Bank charges, depreciation, legal and accounting bills, and debt service are not generally your responsibility.

Major improvements - such as resurfacing the parking lot, changing the storefronts, installing drought tolerant landscape, employing solar panels, or replacing the roof - are afforded special treatment in your lease. Known as capital expenses - significant dollar expenditures - they are normally billed back over a number of years vs a lump sum transfer to a tenant.

Do I pay these? Yes! Companies who rent their business home are bound by lease agreements - unless your landlord has allowed the contract to lapse - at which point a month-to-month relationship exists. Regardless of the term remaining - lease contracts are generally one of two persuasions - a Net or Gross lease. And you pay operating expenses with BOTH.

With a Net - or sometimes called a NNN or Triple Net lease - you commonly pay as you go. Base rent is paid monthly and operating expenses are paid separately as they occur. In other words - property taxes twice a year, insurance once a year, and other maintenance as it happens. Remember - roof, HVAC, and trimming the bushes are all your responsibility - in addition to your rent. Some owners figure it’s easier to simply calculate what their occupants will pay and divide the number by twelve vs relying upon the tenant to pay when due.

With a Gross - or sometimes called a Modified or Full Service Gross lease - your expenses are baked into your base rent. A word of caution here. Some believe a Gross lease limits increases in monthly payments. After all - a base rent bump is specified. But, most Gross leases allow an owner to recapture an increase over your first year’s expense - known as a base year. A double whammy!

Can I dispute the charges? Of course! Typically you have a right to audit the invoice - even requesting specific calculations and back up documentation. Plus, if an owner over or under estimates - there is a reconciliation the following year.

It’s been my honor, dear readers, to converse with you weekly - not weakly hopefully - this year! My best wishes to you and yours for a magical holiday season! Merry Christmas, Happy Hanukkah, and Joyous Kwanzaa to you all and to all a good night!

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.com.

Pitfalls of an Limited Liability Company - AKA 3 Horror Stories of LLC Ownership

In California - the Limited Liability Company or LLC is the most common entity with which commercial real estate is owned. Individuals within an LLC are known as members. Members are governed by an operating agreement which outlines whom within the LLC are authorized to sell, buy, and borrow. Also, percentages of ownership are specified in the case of multiple members. Why an LLC? Because of a multitude tax advantages and liability protection - which are beyond the scope of this column. However, as commercial real estate practitioners we encounter some pretty hairy issues involving LLC ownership.

Waking a Grizzly. Annual fees must be paid to the Franchise Tax Board and tax returns must be filed each year with the state of California. If not, the LLC may be declared inactive. To re-activate an LLC is akin to awakening a hibernating Grizzly. We once experienced an LLC that was formed, owned a parcel of commercial real estate, and was allowed to lapse - for thirty three years! Now the owner wanted to sell but couldn’t. You see the individual - with whom we were dealing - was not the owner because title was vested as the LLC. Therefore - with an inactive LLC - the individual member couldn’t sign a listing engagement, execute a Purchase and Sale Agreement, or transact any business until the past returns were completed and overdue due fees paid. Fortunately, no income had been reported through the LLC - thus no taxes were owed. Therefore, it was a matter of preparing tax returns dating back to 1986 and forking over thirty-three years of filing fees - which now - with interest and penalties - were in the tens of thousands of dollars. Oy vey!

Who’s in the mirror. Frequently, we experience this challenge. An LLC owns a building which is occupied by a business. Even though the entities of ownership may vary - building LLC and business a corporation - the individuals of each entity are synonymous. In a recent case - over time this changed - two of the three members of the building ownership LLC died and the business corporation was sold to the employees. Created was a difference of objectives - the occupying company needed less space or a correspondingly cheap rent. Desired by the LLC - now comprised of four heirs and an original member - was maximum return from the investment. So now what? The LLC sold and the business relocated to a building half the size.

But we are divorced. Sure. But your real estate ownership may not be. In a particularly nasty situation - we were thrust between LLC members - an ex husband and wife. The only remaining joint asset was a piece of commercial real estate once occupied by a business they operated. While still married - the business was sold but the real estate retained - providing a nice cash flow for the couple. When the two divorced - now desired was a sale of the building. Problem was - the divorcees also wanted to defer the taxes which would inure from the sale. The solution was a risky tactic known as a “drop and swap”. Title was changed to tenants-in-common from the LLC. This change in ownership vesting allowed the individual members - divorced husband and wife - to go their own ways. Please seek legal counsel and tax advice before attempting this.

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.com.

Hunters vs Farmers - a Parody

Commercial real estate professionals must be transactional - they must close deals - to survive. However, the pathway toward those deals can be through the transaction treadmill or through fostering long term relationships with owners and occupants of commercial real estate. Today, I vary a bit through a parody that describes the difference between transactional and relational brokers. I hope you enjoy the comparison.

Once upon a time, in a land far away - before the Internet - there lived a buffalo hunter and a seed farmer. Buffalos were plentiful and slow, and would graze for hours on the grassy plains. Because the flat lands were populated by bountiful bison, the seed farmer found very little land on which to plant, cultivate and harvest his crops. Farming subsisted on small hilly plots here and there - unsuitable for grazing. 

Buffalo hunting was easy. These herbivores were huge and habitual. The hunter - without much skill or effort - in a couple of hours - could "harvest" all of the meat, hide, and hooves he and his family could handle. Others were attracted to the bounty. Times were good to be a buffalo hunter! Eventually, the hunting became more difficult, the hunters outnumbered the hunted and buffalo became extinct. Now what?

As the hairy hunted's haunts - the grassy plains - became less populated by the buffalos, the seed farmer found acres of fertile soil from which to extract the Earth's green goodness - crops. Although the growing cycle was long, the work tedious, the benefits and payback uncertain, the seed farmer continued to plant. When the Earth's bonanza was broadcast - the seed farmer was overwhelmed. Seeds beget seeds, the output grew (sorry) and the farmer was able to feed his family forever. 

Searching for new prey, the buffalo hunter happened upon acres of cultivation and decided to become a seed farmer - how tough could it be, right? After all, he was a mighty buffalo hunter. Unfortunately, the buffalo hunter failed at farming. The hunting chops he possessed - sitting around and shooting a large animal - didn't translate well to the skills required for seed farming - patience, perseverance, nurturing, tilling and harvesting.

The buffalo hunter eventually was forced to sell fax machines. Hmmm, how many of those are around today.

So, can you guess which one has a transactional focus vs building relationships?

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.com.

Cut Out the Broker - Save 6%! Maybe Not

I told the owner of my building, hey if you decide to sell, call me first. I'll buy it and we can avoid paying the 6%". REALLY? This was a conversation I recently heard. I was not eavesdropping, mind you. I was the guest of a network buddy of mine at the monthly meeting of trade organization. The conversation was between my friend and one of his clients - that I had met previously. As I stood there with them - I recalled trying to help him last year with some space issues he was facing - for FREE!

The comment really irked me and I flippantly responded, "yeah, by all means, cut out those greedy brokers!" The client quickly excused himself and walked away. He realized the comment struck a nerve.

I've thought about that encounter a lot over the past week and have tried to imagine myself in his position. If I leased a building and had an opportunity to buy it, would I "cut out the middle man?"

Indulge me and I will attempt to explain why I wouldn't - with full disclosure that I have seen the "end of the movie." By the way, I believe this buyer's sentiment is rooted in the premise that "we didn't find the building or negotiate" the deal - so where is the value? I also believe his position is on widely held by most occupants of commercial real estate.

Here is the value - a commercial real estate professional can anticipate the issues and structure the deal around them or formulate a suitable alternative. This is BEST done before final terms are negotiated, but sometimes, we are shackled.

So let's assume we are talking about a 20,000 sf building, a $4,000,000 purchase - or a $240,000 ($4,000,000 x 6%) dollar savings (potentially). $240,000 represents $12 psf on the square footage of the building. A lot of money for sure! However, if the buyer overpays (based upon market data that brokers track) this "savings" can be consumed quickly.

What if the property doesn't appraise? How does the buyer bridge the gap? Brokers are skilled at solutions due to the market comps, current avails, etc.

What if something "untoward" is discovered - historic hazardous materials, seismic zone, non ADA compliance, unpermitted office or other improvements, a sprinkler system that is inadequate, a lien against title? OK you get the idea. A seasoned professional - has overcome these challenges many times before.

Who will handle the management of the deal's execution - escrow, title, inspections, loan qualification, review of leases, estoppels, etc? A real estate attorney trained at identifying issues - but equipped to resolve them?

What if specialized consultants are needed in the execution process? Buyers can utilize our networks.

So how do you "hear the buyer's concerns?” Remember, the buyer is convinced you are excess baggage.

From experience, I reduce the fee and offer to manage the transaction. Specifically, in return for my involvement, the fee is 1-2%. I justify this because I didn't find the building or negotiate the terms - just like the client believes. But, I can add significant value from the agreement forward to close.

As we know, negotiating the terms is generally the EASY part. The execution is the difficult step. Win win, done!

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.com.

Leases, Subleases, and the Like

Your business expansion will enjoy more space very soon. Now your employees can park at their place of employment vs down the street. Crisp new offices or tons of manufacturing space await you in the new location. You cant’t wait!

You’ve opted to lease the new spot and postpone ownership. You’ll encounter two leasing scenarios once you scour the market for suitable addresses - leases and subleases. So what are the differences? Indulge me while I describe them.

Leases are negotiated directly with the owner of a parcel of commercial real estate. Therefore - they are referred to as direct leases. Normally - your initial conversations will be through your commercial real estate professional. The deal you get depends upon the landlord’s motivation, competition in the market and the skill with which your broker volleys. She will work with the owner’s rep to craft your agreement. Outlined will be a monthly payment amount - rent, number of years - term, increases in rent throughout the term - bumps, and concessions - free or abated rent, refurbishment, and extra stuff - tenant improvements. An early termination right, extension rights through an option to renew, right of first refusal, or right of first offer to purchase may also be included. Once you reach a pact - you and the owner will sign a lease, you’ll deposit the requested amounts and secure insurance. Now your company can live in the new location for the agreed upon period - let’s assume five years.

But during the lease term - something untoward occurs - a decline in sales, someone acquires your company, you decide to move your manufacturing function to China, or California imposes a huge levy on your product - which dictates a move out-of-state. You find yourself with a glut of space - for which you’ve committed! Now what? Well, those circumstances, dear readers create subleases.

A sublease is akin to a remnant sale at your favorite carpet retailer. A full roll of flooring is not available - so you get to pick from what’s left. Because a finite amount remains - little flexibility exists. If the scrap fits your area - great! You benefit. But if you’ve a larger area to cover - you’re hosed. Also, the smaller the amount of over run- the fewer takers. Now a price discount must be employed to liquidate. Ouch.

With a sublease - the primary motivation is to stem the bleeding. Excess space wastes rent payments. The thought of providing any concessions runs contrary to a desire to move-on. Consequently - a different dynamic unfolds compared to a direct lease. Plus - another layer of decision makers will be involved. Remember. A lease is in place - with a landlord and a tenant. Now the tenant becomes a de facto sub-landlord and you are the sub-tenant. All parties - master landlord, sub-landlord, and you - sub-tenant must agree and all must approve.

So with the descriptions of leases and subleases as a backdrop - how should you proceed?

Consider all your alternatives. If you need a ton of abated rent, extensive tenant improvements, or a 10 year term, a direct lease might be your best bet. Conversely - absent these requirements - a sublease can provide you with an adequate solution.

Seek counsel. Leases are complex. Subleases are uber complex. They are not for the squeamish. If your “landlord” stiffs the owner - your sublease is in jeopardy. You’ll need two sets of approvals. Plan on extended time frames to get all resolved. We recently encountered a sublease that took ninety days to get the nod!

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.com.

Repairs During Escrow - Who Pays?

Buying a commercial building for your business to occupy is similar to acquiring a residence from which to raise your family. After all - your business will “live there” and grow for many years to come.

Most commercial deals are structured with a time frame to conduct due diligence - a fancy way of saying - figuring out if you want to complete the purchase. Generally - if something untoward is discovered during this contingency period - you can cancel the deal without penalty.

Some sellers are very organized and greet you with all manner of reports, studies, and opinions on the condition of title, roof, HVAC, office improvements, and environmental history. Others will simply allow you - as the buyer - access to snoop around on your own. By the way - the organized seller - the one with all the provided documents - has typically priced his offering in accordance with the report’s findings. Therefore - if you confirm the building needs a new roof - chances are the seller won’t pay. More on that in a bit.

A word here about purchasing a building in its “as is” condition. Normally a buyer relies upon his own investigation of the property’s condition - and commercial contracts are worded this way. So does this mean you must close a deal with a faulty wiring system? No. It just means the seller is not representing or warranting it or agreeing to mend.

So what happens if you realize the air conditioning has eclipsed its cooling life and blows about as hard as a defeated politician? Or - you discover - the roof is akin to a slice of Swiss cheese? Clearly, you have three choices - buy the building with all its faults and deal with the issues later, ask the seller to remedy, or walk away.

Let’s presume you love everything about the property and have decided you want to proceed - but feel its incumbent to ask for some repairs. Plan on the seller responding in one of the following ways.

He will tell you no. Certainly in the case of the organized seller - he preempted your request for repairs by investing in condition reports. He knew deficiencies existed and alerted you. Slim are your chances of convincing this seller otherwise. Conversely - if your seller was unaware - you may be able to extract some repair money. Make sure you fashion your ask with copies of your findings along with a reasonable dollar amount. What is unreasonable? Asking for a new roof on a forty year old building.

He will tell you yes. Bingo! However - the way in which the request is fulfilled is as important as the seller agreeing. A reduction in price is common. This makes a lender happy although he must re-work the loan percentages. Credits through escrow used to be the norm. Lenders now frown upon this as buyers supplemented their down payment - a no-no. Finally, a seller may simply offer to make the repairs. I’ve seen this approach work well when the dollar amounts are small or quick fixes are possible. Most sellers will not opt to do the refurbishments - however - as they don’t want the liability or the timing delays.

He will not respond. Similar to saying no - but akin to your parents answering “we will see.” So why would a seller not respond? Because a no is final. A non-response could be one of the following. He believes you’ll proceed anyway if he waits. Or - other parties to the transaction - IE the real estate professionals - might kick in. Maybe the seller wants to gauge the interest of bridesmaid buyers. Our AIR CRE Purchase and Sale Agreements allow for this “maybe” period with a ten day response requirement.

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.com.

When is a Commercial Real Estate Deal Most Vulnerable?

Akin to those toddlers who taught me lessons recently - a commercial real estate transaction is born and grows up. In effect, it has a life. Every stage is fraught with vulnerability. It starts as a need for more space, a downsize, a move out of state, a consolidation, or a sale where capital gains must be deferred. The end occurs when the new digs are occupied or the exchange is perfected. What happens in between - navigating the process - is column worthy - and where deals are most fragile.

Determining the need. All commercial real estate deals - leases, purchases, investments - begin with a need. If your company just acquired a competitor - chances are - excess locations must be considered - sold, subleased, or occupied. Exponential growth in your revenue may be handled with additional employees, new machinery, or a re-work of your plant’s layout. But - where praytell will the new hires sit if you’re out of space? A deal for another building may be spawned. However, many transactions are squashed at this stage because no move occurs. Another solution arises - additional offices are built in the existing location, new warehouse racking is installed, or a production mezzanine is added.

Deciding on a process. Testing the market of available space will require you to go it alone or engage a commercial real estate professional. If you search Loopnet for what’s available - you may quickly become jaded. The information isn’t as readily available to you as residential data published by Realtor.com or Redfin. Therefore, you’ll need a tour guide - AKA a commercial agent.

Searching. Touring a few vacant buildings may dissuade you from moving. You see - many times “there’s no place like home!” Will a cost savings occur? How about a better efficiency? Double the amount of square footage - is your increased revenue able to handle the bump in rent? Is your purchase down-payment better used in the business vs. buying a building?

Negotiating. Go in too hot - you’ll lose deals. In this owner tilted market - there aren’t that many to lose. If you fail to anticipate the needed time frames for securing financing, achieving city approvals, and checking out the roof, air conditioning, plumbing - and structure accordingly - you’re deal might crater when you request more days.

Executing. Once the paperwork is signed - the fun begins. You must now figure out if you can perform. You’ll have a decent idea - because you will have secured a pre-qualification letter from your bank - and your down payment funds are tucked away in a liquid account. But, unless the seller has provided you with a complete package of due diligence information - Enviro report, building inspection, zoning uses, plans, permits, and operating statements - you must create these reports. Countless deals die on the battlefield of due diligence as something untoward is discovered - the property once housed a landfill, the roof is porous, or the HVAC units are original.

Closing. Once contingencies are waived - a significant deposit is non-refundable. Simply, you cannot walk away without penalty. Do deals die at this stage? Sure - but rarely.

So, when is a commercial real estate deal most vulnerable? The easy answer? Before it closes! However - there is a bit more to dissect - as outlined above.

Allen C. Buchanan, SIOR is a principal with Lee & Associates Commercial Real Estate Services. He can be reached at 714.564.7104 or abuchanan@lee-associates.com

5 Ways to Close your Commercial Real Estate Deal Faster

Two weeks ago - in this space - I discussed the reasons your commercial real estate deal is taking so long to close. As promised - today I will discuss ways to close your commercial real estate deal faster. Our discussion two weeks ago focused upon several areas which I will use as a framework for today’s conversation.

Search. Before you search - give some real thought to all of the solutions to your space needs - staying put and re-working your layout, out sourcing a portion of your operation, taking an additional building from your current owner. Also, engage someone who can assist in zeroing in on precisely how much square footage you need.

Negotiations. In a word - Realistic! If you attempt to scalp an owner these days - you’ll be disappointed. Figure out why you are moving. Will you top line revenue increase by a large percentage? Will you be able to give a key employee a private office and thus increase her efficiency? Will a move translate into cost savings? Are you more proximate to labor or suppliers. When considered through this lens - a few cents per square foot or dollars on the purchase price pales.

Due diligence. As a commercial real estate owner - do yourself a huge favor and prepare your building for sale. Please don’t use your precious marketing time unwisely! Order an inspection so you know what repairs are needed. How’s the roof? Does the property have a rich environmental history? Make the necessary repairs. Disclose the others and price accordingly. Gather all of the pertinent documents a buyer will need to review such as - utility bills, leases, operating statements, insurance, plans, and permits. Stage your building as though it was appearing on an episode of Property Brothers. You’ll be grateful!

Financing. Buyers. Get yourself pre-qualified! I would also suggest choosing a lender, having them do a thorough underwriting of your package and know where your source of funds is originating. Many times in today’s competitive market - without a prequalification - your offer will simply be overlooked for one that is complete.

City approvals. Two suggestions here. The first would be to visit the municipality where you are considering relocating. Ask ask them where they would suggest you locate. The second suggestion would be to hire a person who can help you navigate the various city issues you will encounter.

Transition planning. Moving is expensive, disruptive, and inefficient. While considering your area of re-location – also have a moving and storage company give you a bid on the timing and cost of your move. Armed with the specifics - you’re now equipped to venture into the available space market.

Allen C. Buchanan, SIOR is a principal with Lee & Associates Commercial Real Estate Services. He can be reached at 714.564.7104 or abuchanan@lee-associates.com

What’s Taking So Long with my Deal?

Commercial real estate deals take time to complete - generally, a lot longer than buying your family’s residence. Best case - but rarely? The deal is completed in thirty to forty-five days. More typically? Seasons change with no conclusion to the transaction.

What begins with a simple framework of search, locate, negotiate, contract, execute, and close - many times morphs into a mire of minutiae. Layer in some professional advisors - lawyers, bankers, environmental engineers, accountants, appraisers, building inspectors, contractors and commercial real estate agents - who all must have their say - and the complexity begins.

What - you may ask - takes so long? Indulge me as I describe a few areas where transaction traffic gets pinched akin to your commute on the 405.

Search. Available inventory is at an all-time low. 98 of every 100 industrial buildings is occupied. This is great for owners - but if you’re looking for a place to re-locate your business - you are scrambling to find the right spot. So, if you could simply run out and check a half a dozen sites and choose the best - awesome! The reality is you may wait months for the right match to come along. The days are getting shorter and leaves beginning to turn.

Negotiations. Because of the historically low vacancy - owners are bullish. They understand occupants have very few - if any - choices. High asking prices follow. Motivation migrates. Concessions wane. Couple this with an occupant determined to find a “deal” and negotiations reach an impasse. The clock ticks.

Due diligence. Once you find that dream building and have struck an agreement - you now must figure out if you can buy it. Third party reports must be ordered to investigate all manner of details - appraised value, environmental history, condition of title, roof, air conditioning, structural, seismic, biological, zoning, permitting - to name a few. Normally, transactions are structured with a time-frame to complete these studies - but rarely are the time frames generous enough to allow proper ordering, investigating, reporting, reviewing and approving. One slip in scheduling can cause endless delays and the need to return to the bargaining table to beg for additional time.

Financing. Many small business owners employ the Small Business Administration - SBA - to finance their commercial real estate purchases. Depending upon the size of the loan and lender appetite - two approvals are necessary - one from the bank and the other from the Federal Government. When we experienced our government shutdown last December - SBA loan approvals screeched to a halt. Any loan package not in the approval queue before the hiatus suffered an interminable delay. Great scrutiny is placed upon the environmental health of the real estate and the value as determined by an appraisal. Unfortunately, you and your purchase operate on the loan’s timeframe.

City approvals. The use to which the property will be placed as well as any changes planned - office, power, warehouse racking, freezer cooler space - will need to be vetted and approved by the municipality. We once encountered a city approval process that eclipsed a year! This year - by the way - after leases were signed. Fortunately, we anticipated the approval timing and were able to negotiate a satisfactory structure.

Transition planning. Moving a manufacturing plant can be a bit more involved than packing your household belongings. Pair the complexity of the relocation with the inability to be “out of business” for any duration and planing becomes tantamount.

Please tune in next week as I’ll provide some suggestions to roll back Father Time and expedite your deals.

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.com.

5 Things to be a Commercial Real Estate Expert

I mentioned our summer intern in a previous column. Ahhh - the enthusiasm of youth! It’s a beautiful thing. Questions that emanate from the Cal State Fullerton senior are thought provoking and column worthy.

So here goes! What does it take to be an expert in commercial real estate? To respond - I’ll focus on the nuts and bolts vs things such as an agent license from the DRE, a Broker, empathy, professionalism, diligence, a wee bit of intellect, staying power, honesty, integrity, and the right mentor - sounds like a Boy Scout! Yeah all of those are critical - but can be said of most sales professions. To be an expert in commercial real estate you really need five things - which I’ll describe below.

Inventory. What is available for sale and for lease and more importantly - what exists at the baseline that is occupied. To determine buildings currently on the market - we use a combination of multiple listing services available to commercial agents (or those willing to pay a hefty monthly fee) - CoStar, Catylist, ILS. We supplement this information with Loopnet and our proprietary data. Baseline stats - standing stock or planned and under construction buildings are tracked using LandVision, Reonomy, CoStar, Catylist, or old school methods - such as saving brochures.

Transactions. You really must know what has leased or sold - also known as COMPS. Sale deals - because they are generally a matter of record - can be easily catalogued. Lease deals rely upon broker to broker sharing. But, the true experts understand the story behind each transaction - what caused the occupant to choose that building and the underlying motivation of the owner.

Trends. Most look in the rear view mirror of deals. But you must couple this with a look forward. Sure. Past performance can be an indicator of future success. But what if storm clouds are massing? Many of us missed the warning signs of impending doom in 2008. Using these predictions - of market direction - assist in advising our clients.

Ownership. Tricky - but crucial! Commercial real estate owners are one of two genres - owner occupants or owner investors. The former owns the premises and occupies the parcel with his business. If an owner relies upon the rent generated by the building - with no ties to the occupant - he’s an owner investor. Here’s where the expertise is needed - piercing the ownership entity. If High Dollar, LLC owns the real estate and ABC Manufacturing, Inc. is housed there - is the owner an occupant or investor? The only way to know is to research the common members of the LLC and corporation. See what I mean?

Occupancy. Easier! A simple canvass, phone call or door knock will yield this information - but its time consuming. Whether the resident leases or owns the site is another matter and relates to the ownership section.

So there you have it! Easy business. Hmmm. Not so much.

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.com.

Problems. Deal with Them!

“Solve all the problems or you won’t get paid!” Sage words from my mentor in 1984. Problems. Every deal has them - to the point if something is going too smoothly - you get a nagging feeling the apocalypse is brewing - just wait. I learned early in my career to expect issues as necessary in any business transaction.

Some of my faves. A buyer and seller who manage to entrench themselves exactly apart on the purchase price. Does 6% ring any bells? Yep. The amount of most real estate fees. An owner who refuses to approve a sublease because of the proposed use of the premises. A gaping hole in a parking lot during escrow - the buyer was convinced the site was a former landfill. A buyer 350 miles away and a document that needed his signature immediately - lest the time sensitive close couldn’t occur. A seller headed out of the country for three weeks - who insisted upon meeting with the buyer before departure.

I keep my sanity by recognizing there are five universal truths. 1. Problems are a fact. 2. There are two types - those that have and those that will occur. 3. Problems are the beginning and not the end. 4. ALL transactional problems can be solved. 5. Often the solution is rooted in the problem itself.

A word about the Code Blue Team. You know - that group of individuals - hair on fire - that race in with all manner of paraphernalia to save a patient who has coded. You need an advisory panel who can look at your situation objectively. This could be one person - your spouse or business partner. Or several people - from inside or outside your firm. If a tough knot is encountered - summon your team and follow the seven steps below.

So what should you do? Five things. 1. Embrace the problem. 2. Separate yourself from the emotion - this can take some time. 3. Pray about the solution. 4. Engage a code blue team. 5. Employ a seven step problem solving strategy.

Here’s how the strategy works.

Clearly identify the issue. Often our inability to find a solution lies with an improper definition. We recently got tangled up trying to resolve one problem. The real was - we weren’t dealing with the ultimate decision maker.

Understand everyone’s interest. With your code blue team - allow each member to ask as many questions as necessary to gain a complete understanding of the problem. Warning - this is not to offer solutions but to highlight the various stake holders, share holders, influencers, etc.

List possible solutions. Regardless of how unrealistic and with no judgements as to viability.

Select an option. You’re now ready to choose a course and go.

Deliver and document. Outline the proposed solution in writing.

Evaluate. How’d we do and how to we prevent forest fires in the future?

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.com.

Is a Commercial Building Worth More Vacant or Leased?

As we’ve discussed - commercial real estate is owned by those who occupy it with a business or investors who rely upon the rent the property produces. Therefore - a slice of commercial real estate is valued according to its utility - in the instance of an occupant or to an investor - in its ability to produce income. Occasionally the lines cross - which I will cover in the last section.

Utility varies. Think about it this way. If you’re a company that tools aerospace parts - the electricity feeding a property is critical because you use it in your operation. Without the amperage - the parcel is worthless to you. A logistics company that stacks products in a warehouse relies upon the number of truck doors and inside ceiling height. Therefore - utility is found in a property with such upgrades. An easy way to consider utility? Generally, an occupant considering a selection of buildings will place a greater emphasis on utility or use in its decision. Said occupant is willing to pay more if the commercial real estate has the features he seeks.

Income production. Rent. How much? How certain? How long? Easy. Let’s assume a building has market rents and is leased to a Fortune 500 tenant for ten years. So, there is very little risk. The valuation is simple - an investor will buy the income stream for a price. His price? Easy math. Annual rent divided by his desired return - also knows as a capitalization or “cap” rate. Thus, an annual lease payment of $12.00 at a 6% return yields a value of $200 per square foot. Consequently - your 20,000 square foot building is worth $4,000,000.

If a building is vacant - is it of no value to an investor? If he is smart - certainly not! However, the analysis is more complex and the stars must align for the resulting price he can pay to compare to an occupant purchase. Here’s the way it works. Since an investor relies upon the income - rents - a property produces, he must calculate what those rents will be, how long it will take to achieve them, and at what cost. We refer to this as lease origination expense. If he’s looking at a vacant building and the seller wants $200 per square foot - the investor must factor in the origination expense. If an investor can pay the $200, absorb the origination expense, and still get his return - golden!

If a property is leased - is it worthless to an occupant? It depends. Keep in mind - an occupant looks at utility. And he must be able to occupy the building. So, if the PERFECT site - with all the bells and whistles - is available but leased for awhile - it might still work. Here is how. We recently represented a buyer. Obligated for two years in a lease - they wanted to pursue a purchase for their next move. So, if we located a building for sale with a short term lease in place - that was beneficial. We did! Plus. Because the lease on the building we bought was short term - the buyer got a better price. Because - most investors were turned off by the impending lease expiration and most occupants couldn’t wait two years to move. Boom!

When do the lines cross. We are seeing a fair number of investors buying vacant buildings these days. Recently - a high percentage of the structures in a new development in north Orange County were sold to investors - vacant! Their motivation? Money needed to be spent. Capital had to be deployed. It was costlier to wait than to buy vacant and incur the origination expense. A similar trend is occurring inland where new logistics boxes are trading without tenants in place. The reason? More occupants are seeking leases vs purchases. As an investor - if you can buy the right utility - your origination costs are reduced, you create the income, and the world is a happy place.

Negotiations are Stuck! Now What? _ Suggestions

Commercial real estate transactions require negotiation. Duh! But, candidly, the back and forth is my least favorite part of a deal. Many consider the volleying a sport - one that must be won or lost. Skillful negotiators realize - in order for there to be a successful outcome - both parties must win. I’ve witnessed sellers - down to their dying breath - decide they’d rather give the building back to the bank vs conclude a transaction with an over zealous buyer. 

Conversely - I’ve seen buyers - whose business growth depends upon buying a building walk away due to a minute tweak in the terms. The worst - however - is a stand-off. Akin to heads-of-state squared up in an intense disagreement - the mantra of “he who first blinks loses” is repeated. As commercial real estate professionals - we find ourselves between the warring factions - struggling to find common ground.

If your negotiations are mired - what can be done? Below are _ suggestions.

Why are you at an impasse. Price? Terms - such as the length of escrow or deposit structure? Maybe your issue is more esoteric - your seller has the impression the buyer can’t perform and therefore is holding firm. If the conversations have been many rounds - sometimes a party gets weary - enough already! Regardless - the solution is often contained in the reason for the roadblock.

What’s at stake. The owner I referenced above had to sell or the bank was going to foreclose. However, he had to salvage something - even if it was his dignity. Buyers came along sensing a fire sale! What the buyers failed to recognize? At a point - the seller would simply fold and allow the lender to take the premises - consequences be damned. Just when you believe a seller has no room to maneuver - in fact he does. Never underestimate a desperate seller.

What are your alternatives. Too often a buyer will confuse his operational goals with his purchase criteria. Early in the process - gain an understanding of the buyer’s motivation for the purchase. If the buy will allow him to hire more folks, generate more sales, carry more inventory, accommodate new machinery, or manufacture a new line of products - there is an economic motivation. If negotiations reach a standstill - we review the benefit and downside. Sometimes that difference in price becomes moot in light of the increase in business revenue - or loss if he doesn’t move forward.

Are there non-monetary solutions. Occasionally, parties will agree on price but stall for other reasons. Most common would be a closing date. You see, some sellers benefit from a quick conclusion while others would prefer to postpone the final bell. Sometimes a buyer requires a bit more time to process a loan or bridge a lease obligation. So hypothetically - a seller wants finality in 60 days but the buyer is adamant about 90. Maybe the buyer can beef up his deposit in return for the extra 30 days.

Time to say good bye. Once in a while - the best deal is the one you DON’T make. I’ve found if transactions are meant to be - motivations are aligned and transparent negotiations take place - a rhythm evolves between the parties. It’s a beautiful thing! However, if you find yourself working diligently to resolve minutiae - maybe the stars won’t align. Time to crank up that search for another building.

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.com.

What is a Tenant Rep Broker?

A commercial real estate professional’s work is generally divided between agency assignments - listings - wherein an owner is represented or tenant or buyer representations. In the former - an agency - needed is a buyer or tenant for a vacant building. So, we are hired to locate an occupant. The latter? Yep. We are engaged to source a spot for a buyer to by or a tenant to lease.

Today, I delve into the world of buyer and tenant representation also know as Tenant Rep. By the way - this genre of commercial real estate practice evolved in the mid eighties. Largely responsible was the legendary Dallas Cowboy quarterback Roger Staubach. Prior to that time most of us were generalists and even today most of us work both sides of the fence - owners and occupants.

When do you require a Tenant Rep Broker? Most typically a need arises. Such as - the current physical plant can no longer house the operation or the opposite - swimming in excess square footage is the company. A lease expiration portends a requirement as one of three decisions must be made - stay and extend the term, move, or stay month-to-month. Mergers and acquisitions can create a Brady Bunch of facilities with a consolidation warranted. Opening a location in a new market creates a search criteria. Sure. You could attempt to navigate the waters without help - but you recall what someone once said about the person who represents himself.

What is typical? Standard among most practitioners in this space is an engagement agreement whereby you - the occupant - “hire” the broker to conduct a search and market your requirement. Included in this marketing is a notification sent to cooperating professionals, solicitation of owners with buildings meeting the criteria, and a vetting of potential buildings submitted for consideration.

Who pays? The cool thing about engaging a Tenant Rep is the owner of the building pays him. You may be thinking - I know I must somehow pay more. In actuality, you don’t. Most market lease rates and sales prices contemplate a broker fee. If you forego representation - you pay more because you lose the benefit of her market knowledge - which leads to more favorable rates and terms.

Are other services included? In some instances - yes! Many Tenant Rep outfits employ project managers, space planners, architects, and move advisors. All are included with no cost to you.

How does the process work? Steps may vary. But generally - you engage the professional, your requirement is clearly defined, marketing collateral is created, your requirement is published to the brokerage community, submittals are received and vetted, buildings are previewed, alternatives are toured, requests for proposals are submitted, proposals are received and compared, negotiations commence, negotiations are finalized, a lease or purchase agreement is signed, the deal is closed, improvements to the space - if any - are completed, you move in. Whew! Now you understand why you shouldn’t try this untethered. It’s a complicated process with many steps.

Is Your Building Ownership a Mirror Image?

Commercial real estate ownership is a beautiful thing! What other investment can you own and experience the tax advantages of depreciation, passive income treatment, and capital gains - all while the asset is appreciating.

If you own a business that occupies your commercial real estate - even better! Now, you have the occupant (tenant) paying you (landlord) rent. I’ve witnessed this structure numerous times over the years - and it works the majority of the time.

Today’s column is centered around those few occasions when the structure hits a snag.

First a bit of background:

Common among commercial real estate ownership is an entity known as an LLC - Limited Liability Company. An LLC may have one or a number of “members” each with a percentage of the stake. The LLC owns and operates the real estate - collects rent, pays the bills, is registered with the state, and files a tax return. Generally the taxes owed are passed down to the members via a K-1. Great!

Common among operating business ownership is the corporation - generally a C or S Corp. Each have different rules of taxation - which is a topic for another day. Suffice to say this entity pays rent to the building ownership - LLC. Cool!

Here’s where things can get dicey.

The LLC and Corporation have different owners. More than once recently we’ve seen this. What starts as an LLC with members whose ownership percentages mirror the shares of the business corporation can morph over time. In one extreme example - we had a building ownership comprised of a church, an ex-wife, two of the original owner’s children, a non-profit, and a former health care taker. By the way - initially the LLC had one member - the proprietor of the company! Death of the original owner caused all manner of chaos - as you can imagine. The result? An eviction of the business and a forced sale of the real estate. Ugly!

The operating business changes hands. With the spate of merger and acquisition activity these days - this is quite common. Typically, the company is acquired, a lease is struck with the LLC and things proceed. Over time however, a disconnect can occur - a smaller footprint is needed, sales decline, expensive improvements are required, the business goes bust. All easy when the building and business are identical twins. Not so easy when the twins are fraternal.

The commercial real estate is sold. No problem if you’re happy to fork over close to half the gain the commercial real estate has enjoyed. Sell it and pay Uncle Sam and Cousin Gavin. Done! If, however, the LLC chooses to defer the gain through the use of a 1031 tax deferred exchange - the LLC - all of the members - must be in lock step. What if an LLC member wants to take his cash and move to Cabo? A complicated buyout must follow. We’ve witnessed what’s called a “swap and drop” in these instances. Simply, the LLC is disbanded and replaced with a Tenants in Common vesting. Now the “tenants” - upon the sale - can self direct their percentage of the sale proceeds. In practice, this is much more complex. Please seek tax and legal counsel before employing this strategy!

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.com.

What Can Make a Sublease Unmarketable - 5 Situations

I recently wrote about the Yin and Yang of subleases wherein I discussed the elements which make a sublease risky and non-beneficial to the owner and occupant of a building - “because subleases are generally unfavorable to the original occupant (sub-landlord) and owner (master landlord), risky, and complicated.” Also discussed was a definition of a sublease - “What is a Sublease? When a tenant must relieve himself of a lease obligation prior to the expiration of the lease, the need to sublease occurs.”

Today, I embark on an explanation of the five situations which can cause a sublease to be unmarketable.

The term of lease. We toured a space yesterday being marketed for sublease. A decision to vacate prior to the expiration of the lease was made by an occupant whose corporate headquarters are out-of-state. Now fifteen months remain on the lease obligation. Akin to a well shopped clearance rack at Nordstrom - the short term will appeal to very few occupants. You see - generally - a three to seven year term is sought by prospective tenants. A move is expensive, disruptive, and quite inefficient. Most are unwilling to move only to do so again a year later - if extension terms can’t be reached with the owner of the building.

Uncooperative owner. Owners ride the length of their leases through market swings. In the example above - additional years could be tacked onto the fifteen months - if - the owner will play ball. Where we are in a market cycle - up or down trending - can predict how a landlord will react to a request for a longer lease. If our market is improving - he has no incentive to strike today. Storm clouds on the horizon? Yes! Let’s deal.

No concessions. A tenant with remaining years on their lease wants out - as quickly and cheaply as possible. Consequently - requests for changes to the space - at the tenant’s expense - are not typically on the table. Furthermore - most occupants - who have vacated - are not interested in investing to re-furbish the interior. Therefore - a sad, worn out building greets prospective occupants. Not terribly inviting.

Credit of the occupant. An owner with an Amazon lease will not be terribly interested in accepting anything less. Why should he? He has Amazon on the hook. If Amazon has decided the unit no longer meets their needs and vacates - the owner can be quite selective in backfilling.

An above market rent. Any lease in SoCal originated after 2015 will most likely be above the going rate today. So grouped with your amazing credit, a short term lease, an uncooperative owner, and an unwillingness on your part to paint and carpet - you could be stuck. So what’s the answer? Conduct a fire sale of sorts. Take a look at what you owe and figure 75% of that amount. Now market your sublease at that reduced rate. You might just find that unicorn willing to transact.

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.com.

Six Tough Commercial Real Estate Conversations - Cooperation Can Help!

Cooperation is a reality in commercial real estate deals. Meaning - a buyer and seller or landlord and tenant - must reach an agreement. Simple. But there are other layers of cooperation which factor in - the professionals representing each side - brokers, lawyers, lenders, CPAs, and the like. All must genuflect at the alter of a deal for it to close. Generally, the level of cooperation is enhanced when the advisors do their jobs. That is - conduct the tough conversations which should precede any transaction. Indulge me while I describe a few of my favorites.

The disruption of a move. Sure. Moving to save a few dollars may seem like a good idea. But, a move is expensive! Once physical moving expenses, the potential loss of key employees, downtime, fixturization of the new facility, and customer confusion are weighed - are you really saving? Have you considered things such as internet speed, a new phone number, website changes to reflect the new address, revised marketing collateral? Add any sort of complexity to the use with which you utilize the building and a costly use permit may be needed. Someone must consider the true cost of a move before you wander into the market.

Taxes, taxes, taxes. Uncle Sam, the state of California, and the Affordable Care Act will all want a major taste of your sale proceeds. The time to understand the impact is before you plant that “for sale” sign. Easy math. You can plan on approximately 40% of your gain to be consumed by taxes. Whaaaat? That’s correct. A tax professional can run the numbers for your specific situation. Sure. You can employ certain tax deferral strategies - a 1031 tax deferred exchange, a charitable remainder trust, or an installment sale - but all come with complexities which should be fully vetted.

Market realities. Small business owners that buy or lease commercial real estate are smart. They read. They listen to their customers. They’re informed. In today’s market - unrealistic owners get crushed. The halcyon days of crazy asking prices, waves of buyer interest, and feeding frenzies have vanished like La Niña. Sure. Deals are transacting - but, at a more normal pace.

Condition of the building. During the go-go days of 2016 and 2017 - a buyer would overlook repair necessities such as the roof, air conditioning, paving or exterior condition. Not anymore. We recommend a pre-sale inspection to identity any issues and an assigning a cost estimate. Even if you opt to wait on the fixes - you know what they will run.

Limited availabilities. The weird thing is demand still exceeds supply - there are fewer buildings on the market than buyers. What’s changed since last year? Buyers are proceeding more cautiously, offers well below asking prices are the norm, and market times have increased.

Complete information. Access to scaled drawings, an office layout, a building inspection highlighting the condition and needed repairs, a current title report, copies of leases, expenses, maintenance contracts, and utility bills - all can hasten the timing of a transaction. Buyers will ask. Have them ready.

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.com.

Operating Expenses - A Primer

Generally, January is the time of year when your landlord will present you with an invoice for expenses - in addition to your base rent. This assumes - of course - that you lease your business home. However, if you own your business home - take heed - as you may be able to take a few more dollars from your left pocket and move them into your right pocket - by asking your occupant to pay for some stuff. This column is designed as a primer for these expenses.

Let’s define a couple of key terms - shall we?

Operating Expenses. Typically defined as the costs of maintaining the commercial real estate in which you reside.

Lease form. Forms of leases vary as widely as days of the week but commonly are either net or gross. Meaning - your base rent is net of the operating expenses - or in the case of a gross lease - your base rent includes operating expenses.

Now let’s dive in!

What expenses are included as operating expenses. Biggest in this category are property taxes. Currently, property taxes are based upon roughly 1% of the building’s assessed value. I say roughly because certain cities may add fractions to this percentage. You can easily check on the amount through your county assessor’s website. Next, insurance on the property - which is different from the liability policy you carry for your business and contents.

Finally, common area maintenance which is a broad category of expenses which can encompass mowing the grass, trimming the trees, sweeping the parking lot, disposing of the trash, exterior lights, property management, changing the air conditioner filters, and reserves for capital expenditures such as roof replacement. Treatment of these CAMs - as they are called - varies widely among owners. Simply, some may not bill for these until due whereas others may budget for them monthly. Still others may not ask for any reimbursement.

What expenses are not included in operating expenses. A major system replacement - such as a new roof or air conditioner - or, changes made to the exterior of the building - like new pavement or parking lot lighting - falls into a class known as capital expenditures. As noted above - some landlords budget for these through reserves while others bill their tenants when the changes occur. Please check your lease. Treatment of these costs should be outlined. Commonly - language allows your owner to bill you for portion of these expenses spread over time - but not a lump sum. Expenses related to accounting, mortgage interest, entity fees, and business licenses should not appear on your invoice.

Gotchas. If an ownership change occurred recently - property taxes will increase based upon the sales price. As a tenant - you generally shoulder this bump. Watch out for generalized expenses. Most leases allow for you to reasonably audit any expenses you’re asked to reimburse. If you don’t understand a line item or if your owner simply sends you a flat amount to pay - ask for back-up. Check to see if your lessor can require you to paint the exterior. This clause killed a deal for me recently. 

Finally, anticipate these costs when you negotiate your next lease or renewal. Simple things like asking for operating expense increases to be limited or moving a base year forward can save you loads.

Allen C. Buchanan, SIOR, is a pricipal 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.com.