The Importance of Dates

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Today, dear readers, I’d like to talk about dates. No, not those that emerge from swiping right - where’s the challenge there, btw? Or, for those frothy products of palm fronds that find their way into a shake. But, those calendar creatures that presage the passage of time. You see, dates are quite important in a commercial real estate transaction. Indulge me, as I share a few examples.
 
Time is of the essence. A fancy legal way to let you know - hey, pay attention! I learned this the hard way early in my career. We negotiated a five year lease. My guy ultimately wanted to buy the building. Thus, we convinced the landlord to grant us an option. Well, the date for exercising said right - by notifying the owner in writing - came and went as did our opportunity. Ooops! Fortunately, the title holder was forgiving and allowed us a bit of grace - but not before a finger wagging letter was sent our way. Contained within most commercial real estate agreements are these words - “time is of the essence.” Governed are all the dates - commencement, expiration, notices, and extensions. Wise agents calendar the important ones lest they blink past. I’m penning this post three days late. Hopefully, my editor will allow some latitude.
 
Leases. Leases memorialize the terms and conditions of landlord and tenant understandings. Generally, a commencement date signals the start. Early possession may indicate an earlier date under in which the occupant is granted access. Expiration occurs at the end. Easy! Not so fast. Don’t forget rent increases that bump throughout the term - typically on the anniversary and by a preset or calculated amount. Then there are expense reconciliation dates. Expect these in February. As mentioned above - extension rights such as options to renew, extend, expand, contract, and ownership options such as rights of first offer, refusal, to buy come with dates. Fortunately, in the case of options to extend - you’re afforded a window - like no earlier than nine or later than six months from expiration. Approaching expiration - you’ll make a decision to stay or move. Staying might be for an additional term or month-to-month. Yes. Dates are involved.
 
Escrows. Purchasing commercial real estate is a rather involved dance defined by days on the docket. A signed purchase and sale agreement is delivered to a clearinghouse of documents and dollars - AKA an escrow holder. Date of the agreement, yep. Date of full execution, sure. Dates for deposits to be received, uh huh. Date for additional deposits, boom. Ok, got it. But, lurking within the boiler plate are dates under which contingencies are outlined. How much time will a buyer have to arrange financing, inspect the condition of the roof, visit the city and check on uses, review title for any exceptions - etc. And. When will these time stamps commence? Upon buyer and seller signing the contract, seller delivery of an important document, preliminary title commitment or the opening of escrow? Yes, yavol, oui, and si! As you may have gathered - a cacophony of calendar credits consists. And ALL of the dates are as important as your first one with your significant or as memorable as waiting in line on PCH. You may be wondering - how does an agent keep track? Many employ a critical date calendar produced by the escrow holder. Or, we group certain waivers together. Or, we simply write into the contract language that reads - “the later of 30 days from opening of escrow or five days from receipt.”
 
So, don’t date yourself by using a paper calendar or singing “Eye of the Tiger”. Simply, use a modern tool that can provide calendar alerts - like when it’s time to head to Laguna and wait in line for a shake.
 
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.blogspot.com. 

True Down Payment Amount

As you’ve read here a number of times - purchasing commercial real estate is a great way to build generational wealth. It’s like a jelly of the month club. By that, I mean the gift that keeps on giving! Many who read this column founded an enterprise housed in a parcel of commercial real estate which they also own. So. The occupying company earns income through its business operation and pays rent for use of the building. Company value increases over time and the address appreciates. A double whammy! Southern California has countless entrepreneurial stories whereby a generation took a risk, formed a company, bought a location and succeeding family members benefited. I have the privilege of counseling these family owned and operated manufacturing and logistics businesses. 

Recently, a conversation occurred which I believed column worthy. Specifically, how much should be allocated for a down payment when considering a buy? The easy answer is 10% of the purchase price if leveraged through the Small Business Administration and 20-30% when financed conventionally. Boom. Done. See y’all next week. But, there is substantially more to the story of originating a loan. So please stay tuned for a minute more. 

In addition to the 10-30%, suggested would be to budget for the following: 

Appraisal. Regardless of your lender choice - SBA, bank, insurance company, or hard money - an appraisal will be completed. Contained within the bank’s underwriting - this confirms the price paid is in line with the market. Plan on $2500-$5000 for this review. 

Environmental. Lurking beneath the surface of your purchase could be a problem. These unseen issues are caused by something toxic deposited in the soil. A review of the previous occupants in the building, messy neighbors, and the smokestack down the street combined with a look at old aerial photos - forms what is known as a phase I environmental report. Generally, this does the trick and provides a clean bill of health. If recognized environment concerns - such as stained concrete or containers of waste - abound, a phase II will be employed. Soil borings are sampled and tested. Recommendations range from no further action to remediation. Have you ever witnessed a pile of dirt inside yellow tape next to a gas pump at your local station? No. It’s not an episode of CSI. Aeration is one way to get the bad stuff out of the soil. Plan on $2500 for a Phase I to ?? If remediation is required.

Legal. You’re going to want an attorney to review the purchase agreement, title commitment, and draw your LLC formation documents. Budget around $10,000. 

Escrow and title. Sure. Seller pays for a standard policy but any lender policies or extended coverage are yours to bear. Plus, you’ll pay 1/2 of the escrow fees. Another $10,000 but dependent upon deal size. 

Survey. Not always necessary unless you’re after an extended policy of title insurance. Unrecorded easements, abandoned driveways, and recorded leases are typically not covered with a standard policy. Utility locations, property lines, and underground pipes are clearly mapped as well. $5000 is reasonable. 

Loan points. In addition to the interest payments due over the term of your debt - you’ll pay a percentage of your loan amount to the bank. 1-2% is pretty typical. 

Cost segregation. One of the really cool things about owning commercial real estate is the depreciation which lowers your income tax burden. The improved portion of your parcel - the buildings - can be depreciated over 39 years on a straight line. 1/39th each year. But, other components of the improvements such as walls, doors, glass, and air conditioning have a shorter useful life and if properly segregated - can be written off sooner. Usually your CPA can help with this. She’ll want to be paid, though. $15,000 seems fair.

Once you become the owner, gather and total your receipts. Add all you spent to the 10-30% down payment. What results is the “true” investment into your buy. 

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.blogspot.com.

Deal Issue? Now What?

Last week I reviewed the the steps in purchasing commercial real estate. Whether you’re buying to house your company’s operation or simply to enjoy the rent a parcel of commercial real estate produces, the steps are essentially the same. The possible exception could be the financing portion - which some investors abandon in favor of deploying large sums of cash into the buy. 

Today, I will complete the orbit and describe some challenges that can occur and some suggestions on how to overcome them. 

From last week:
 
“Due diligence. Also referred to as a “contingency period”. Ranging from as few as 15 days to as long as 90 - a ton must occur during this time frame. Financing must be secured, title exceptions approved, inspection of the building - roof, electrical, HVAC, etc. accomplished, vesting documents drawn, financial aspects of the tenancy - if any - analyzed, and environmental health diagnosed. Whew! Within each of the main categories of approval - there are checkpoints which guide toward the end. Financing, for example, involves - credit of the buyer, the tenant, an appraisal, an enviro report, and lender concurrence. There’s a lot to be done in a short time. What if something isn’t approved? That, dear readers, is a subject for another column.”
So, here goes.
 
Generally, purchase and sale agreements include a mechanism for solving issues that arise in a deal. Specifically, the most widely used contract is published by the Association of Commercial Real Estate - AIR. Clearly defined within paragraph 9 are the various categories of approval items - inspection, title, tenancy, other agreements, environmental, material change, governmental approvals, and financing. Within the boiler plate language are roadmaps for resolution. If your contract is not the standard AIR form - results may differ. As always, it’s wise to seek legal counsel before engaging. But within the document - typically, offered are three choices - cancel, accept, or fix. A fourth creeps in which is a buyer and seller compromise.
 
Indulge me as we walk through some quick examples.
 
Let’s say a building inspector discovers the HVAC units are past their useful life. From experience - this is quite common. So, here’s what happens. The buyer objects to the condition of the cooling systems by disapproving a portion of the physical inspection contingency. You may be wondering. Wait, I thought the buyer was buying the building “as-is, where-is, with no seller warranties”. She is. But that refers to relying upon her inspection to alert her to any fixes necessary. Confusing? Yes, it is. Sure. A seller may simply refuse to repair or replace the units and cancel the escrow but cannot do so immediately. You see, here’s where the “mechanism” takes place. Buyer objects. Seller has 10 days to respond - yes, no, or maybe. A no vote on the recall - ooops, sorry. Wrong issue. If seller refuses, buyer can cancel the deal within another ten days, opt to continue and purchase with the faulty units, or accept a compromise - the “maybe” offered by the seller.
 
Financing is trickier. You see, if the buyer is unsuccessful in their pursuit of a loan by the date specified - generally, the seller can walk away. Therefore, it’s imperative to be quite transparent with the seller during the loan approval process. Because prior to the financing condition date - there may be some leverage. If an appraisal comes back less than the contract price - which causes a lender to renege on the amount - it’s recommended to level with the seller. Sure. You or the seller can cancel, additional dollars can be added to adjust for the delta - accept, an appeal can be made to the lender - buyer fix, purchase price can be reduced - seller fix, or a compromise between buyer and seller can be struck whereby buyer adds some dough, seller reduces the price - and voila!
 
I’ve witnessed these go every way you can imagine over my decades in the business. One certainty - there must be issues. It’s a thing. The next deal I close without one will be the first. But, fair warning. In today’s overheated industrial market, I’d not plan on a seller being terribly receptive to what’s referred to as a “re-trade.” Chances are there is a line of suitors waiting for the chosen buyer to blink.
 
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.blogspot.com

 

Buying Commercial Real Estate - Closing the Deal

Today, I focus my labor on the closing process. After all, I’m penning this post prior to the Labor Day weekend - so it proved prescient. Whether you rely upon the rent generated or for the utility gained by your business - an investor or an occupant - you execute a similar process to become a owner. Let’s dive in, shall we?
 
A search is conducted, a candidate for purchase selected and negotiation commenced. Simple. Once the terms of the buy are settled between you and the seller, a contact is drawn - known as a Purchase and Sale Agreement. Easy. But now the fun begins. The parties - buyer and seller must now complete the deal. What occurs after the paperwork is signed is the subject of this column.
 
Purchase and Sale agreements - whether standard or proprietary - provide a roadmap for how to proceed. Price, financing - if any, due diligence period, escrow holder, title company, deposits to open, deposits once contingencies are waived, and closing period are all neatly niched.
 
Price. Fairly straightforward but typically a combination of cash and debt. The seller - unless providing a loan - receives all the proceeds - less closing costs once a deed is recorded. Can this sum vary from what’s agreed? Yes. See “due diligence”.
 
Financing. Many deals we see these days are financed but not subject to lender approval. Confusing? Yes. But this seller’s market, in which we are mired, has produced this wrinkle. A seller may say - sure, Mr. buyer. Go get a loan. But, failure to qualify won’t allow you to cancel. Plus, if your lender is tardy - tough taco. In a more conventional approach, a buyer seeks loan proceeds to couple with her cash infusion to make the buy. If she can’t get a loan, she walks away and her deposit is returned.
 
Escrow. Generally, in California, an escrow holder is a clearinghouse to accept the agreement and conduct the symphony - also known as executing the deal. Deposits, documents, and closing instructions are all neatly folded into an escrow holder’s task.
 
Title. Most title companies also have an escrow department but frequently, these two functions are separate. Your title officer will produce a preliminary title report - a “prelim” early in your transaction. This uncovers things such as loans the seller has ordinated that must be paid, easements, liens, status of property tax payments, legal description, and other “exceptions”. A commitment to insure a clean title will be issued. Should a problem arise post close - you’re covered.
 
Deposits to open escrow. In commercial deals - there is no real standard. It’s whatever the buyer and seller negotiate. However, typically these run about 3% of the purchase price. Should the buyer elect not to proceed with the purchase and prior to waiver of contingencies - in most cases, the deposit is returned.
 
Due diligence. Also referred to as a “contingency period”. Ranging from as few as 15 days to as long as 90 - a ton must occur during this time frame. Financing must be secured, title exceptions approved, inspection of the building - roof, electrical, HVAC, etc. accomplished, vesting documents drawn, financial aspects of the tenancy - if any - analyzed, and environmental health diagnosed. Whew! Within each of the main categories of approval - there are checkpoints which guide toward the end. Financing, for example, involves - credit of the buyer, the tenant, an appraisal, an enviro report, and lender concurrence. There’s a lot to be done in a short time. What if something isn’t approved? That, dear readers, is a subject for another column.
 
Deposits once contingencies are waived. Ok. You’ve traveled the gauntlet of contingencies and are full speed ahead. You’ll now add some “skin” - in the form of an increased amount of money - to the escrow. Deposits, by the way, are generally applicable to the purchase. But, once you nod your head - deposits are non-refundable. Can you still back out? Sure. But not for free.
 
Closing. A cacophony of chords completes the transaction. Akin to a family reunion group photo - all must be looking at the camera and smiling before the image may be captured. Lender funds the loan, buyer adds the supplemental dollars, granting deeds are deposited and recorded, and monies are apportioned - seller gets hers, buyer gets title, lender gets a trust deed, and agents get their fees. Boom!
 
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.blogspot.com.

Why Make it So Hard?

My neighbor constantly reminds me my voice echoes with commercial real estate owners well above his pay grade. Certainly not my intention but I take any comments to my missives seriously and attempt to morph into a more meaningful messenger. Regardless of the size of a commercial real estate portfolio - one multi-family property or global holdings of distribution boxes populated with Amazon-eque tenants - investments are simple! Why do we make them so hard? You see, any investment of money seeks a return. Period. Sure. You’d like the return to be commensurate with the risk. But after all the fancy terms of capitalization rates, internal rates of return, replacement cost, source of capital, exit strategy, expense leakage, cash on cash, leverage, etc. it’s really about this. I shell out this much money and get this much back. Mic drop.
 
Commercial real estate brokerage is simple. Why do we make it so hard? A real estate transaction - a sale or lease of commercial property - has two sides - an owner and an occupant. Now. The occupant may seek to lease or own and the owner may want to sell or lease - but you get the idea. Inject our representation and you now understand what we do. We are matchmakers of sorts. An owner engages us to locate a tenant or buyer to fill her vacant building and/or an occupant awards us the opportunity to source a location for their use. The former assignment is known as a listing and the latter an occupant representation. If you ask me what I do and I respond - “I sell commercial real estate” - you’ll probably wonder - “what the heck is commercial real estate?” But if I explain - “many of our clients are family owned and operated manufacturing companies experiencing a transition - such as a move” - my guess is you’ll have a better idea what fills our days.
 
Networking is simple. Why do we make it so hard? I’ve often opined - “the true value of a commercial real estate professional is the depth of her network.” Need a roofer? Got you covered. How about a legal professional to draw a new LLC? Hold on - I have several. Someone to install new warehouse racking? Yep. Got just the gal. But all of these examples are “downstream” of the deal. By that I mean the need is after - or “downstream” of the sale or lease. But, what about “upstream”? What classes of professionals see a transaction before it takes flight? The answer harkens back to what we do. Remember - “many of our clients are family owned and operated manufacturing companies experiencing a transition - such as a move”? If we focus on those professional service providers who complement not compete with our efforts - a treasure trove emerges. As an example - let’s say a manufacturing concern experiences a record year but leases their building. During a periodic meeting with her CPA these facts are discussed - revenue and leasing. If the CPA advises his client to buy a building - you get the idea.
 
Business is hard enough. Your commercial real advisor should make it easier for you.
 
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.blogspot.com.

When is Commercial Real Estate a BAD Investment?

When risk outweighs return. Our neighbor has a tidy portfolio of single and multi tenant properties. The good news? Single tenant buildings are easy to manage - one tenant, one rent check. Multi-tenant - such as an apartment building or strip center don’t crush your cash flow if someone bolts - but you have several rent checks to chase. For our neighbor to eliminate her management and convert to single tenant - a risk greater than her tolerance, ensues. Thus her balanced portfolio. Think of single tenant assets as a share of stock and multi-tenant as a share of a mutual fund.
 
Good for business. We recently represented a family owned construction company. The company found its origins in the 1950s in a part of town that was booming. Owning the location from whence the business resided was a solid plan. Flash forward. A decision was made, by the next generation, to shutter the enterprise. Boom in the 1950’s was replaced by blight in this decade. Consequently, with no occupant to pay rent to the family - the construction company was closed - and little upside - selling and redeploying sale proceeds became the direction. Therefore, an investment good for the business evolved into one less favorable years later.
 
Metrics are skewed. Replacement costs, rent, capitalization rate and return, sustainability of the income stream, and exit plan are ALL considered by most investors of commercial real estate. Should one of these measures of an income property’s value need alignment a future problem may arise. As examples. If you buy a Starbuck’s location and pay $1000 per square foot for a building go that can be replaced for half that amount - your basis is artificially inflated. So long as Starbuck’s stays current, no harm. But if folks start brewing coffee at home and store sales wane - you see where I’m going. Finally, investors focus on a return on their money. If a check is written to acquire the asset then the return is the cap rate. Easy. Layer in some debt and the answer is a bit more complex. Simply. If the capitalization rate exceeds the interest rate on your mortgage - positive leverage occurs. This is magical - as the return on your invested down payment now is greater than the overall cap. Clearly the opposite occurs when a borrowing rate eclipses said capitalization.
 
Tax laws change. When Ronald Reagan was President. Yes. I was around the industry then. But I digress. At the end of 1986 - a tectonic shift happened with our Federal tax laws. Lower marginal rates of taxation were swapped by eliminating certain write-offs. I believe our present depreciation rules - 39 years - were examples. Real estate bought with certain tax shelters in mind were no longer great investments.
 
Improvements are specialized. We toured a building last week with a client. Our occupant processes food but does so in an ambient environment - no specialized freezers or coolers are required. The vacancy we walked was complete with tons of cooler space. Our premise was some of the cooler infrastructure would translate to our use. For those who need these special purpose goodies - rent is not an object. As the cost to create them is astronomical. But for those who don’t - which is a much greater universe of tenants - they won’t pay for the extras.
 
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.blogspot.com.

Things to Consider When Buying a Building

Commercial real estate ownership - especially when it houses a business operation in which you have a stake - stabilizes your costs, provides some tax breaks, and appreciates over time. The trifecta!

 
Cost stabilization. If you rely upon a series of 3 to 5 year leases for your location strategy, over time your rental rate will increase based upon the change in the consumer price index or by a fixed annual amount. Sure, you might time a dip in the market with an expiration - but don’t count on these ends meeting very often. So, using fixed rate debt over a 20 to 25 year amortization period can provide a level amount.
 
Tax breaks. Infinite are the incentives Uncle Sam provides for those who own income property. Mortgage interest, operating expenses, and depreciation can all be deducted. In some cases - capital outlays, such as a new roof or parking lot can be expensed.
 
Appreciation. Depreciating an appreciating asset is one of the marvels of commercial real estate investment. As an example - say you buy a structure for $5,000,000. The improved portion (not the land) can be depreciated over 39 years. But at the same time - over a ten year span - your $5,000,000 could be worth double!
 
With these benefits, you may be wondering. Why don’t all companies own their buildings? Why would anyone lease? And what should be considered before buying?
 
Fluctuating space needs. Many fast growing operations opt to lease vs own. You see, the amount of square footage required can vary. If you own and outgrow the footprint - money is tied up in a facility that is obsolete. Conversely, a series of short term leases and options to extend can handle the fluctuations without consuming precious capital.
 
Use of the down payment. Most finance an owner occupied commercial real estate purchase through the Small Business Administration - SBA. Originated is a loan(s) for 90% of the buy with the balance coming from the borrower. But 10% of a $5,000,000 deal is still $500,000. In some instances, this capital can be better deployed in new employees, machinery, or equipment.
 
Financeability. A lender considering making a loan will look at the credit worthiness of the borrower as well as the occupying entity. Is the business cash flow - after all the expenses are paid - sufficient to service the debt?
 
Company structure. As mentioned above, depreciation - for those who can benefit - is awesome. Publicly traded companies frequently avoid ownership of their buildings so that depreciation doesn’t ding their earnings.
 
Age of the principals. Years - an important consideration as commercial real estate ownership is a long play. Meaning. If the principals are in their eighties - chances are great - they won’t live to see the appreciation. Certainly, their heirs will thank them.
 
Exit strategy. Owning for an operation should also be considered in light of your horizon for the enterprise. Simply, if you plan to dispose of the business within the next five years - what remains is the facility. I’ve witnessed this work quite well as the acquiring group needs a place to live and signs a lease. I’ve also watched the value of the operation be diminished because a duplication of addresses occurs.
 
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.blogspot.com.

Two Things that Derail Most Sale-Leasebacks

You’ve opted to own the location from which your company operates. A great move by the way! A Limited Liability Company was formed and owns the building. Presumably, the LLC’s members are similar to that of the occupying group.
 
You struck an agreement with the resident - your enterprise - to pay you (the LLC) an amount of money each month for the use of the address. In effect, you’re paying yourself. It’s a beautiful thing! Tax benefits are afforded the ownership LLC - depreciation of the asset, write-offs for any mortgage interest, property taxes, and operating expenses. Over time, the LLC’s investment appreciates.
 
Your occupying business pays rent just as it would to a landlord who has no stake in the company. Plus, because the owner of the real estate and operation are synonymous - if business ebbs and flows - so can the rent you pay yourself monthly. We are fortunate to have such a situation. We own the building from which we ply our brokerage. Each month Lee & Associates Orange - occupant - pays Taft Lee, LLC - owner - a dollar amount that provides a nice return on our investment. However, during the term of our ownership - we have deferred rent increases, banked reserves for a new roof, and kept the rent commensurate with market conditions. We can do this because we are the landlord AND the tenant.
 
Generally, a business or ownership transition will create a commercial real estate decision. As an example, if you acquire a competitor - will the real estate you own and occupy adequately house the marriage? Conversely, if you sell the business - your “tenant” - does the buyer of the business have their own location? Thus making yours excess? An election to move your enterprise out of state requires some time to facilitate and the equity in the real estate to buy your new location. In all cases - as you can surmise - you’ll make a decision. Keep the building or sell it.
 
When selling is chosen, one of the strategies employed is a sale-leaseback. By definition - a sale-leaseback inserts an investor - the sale - to replace the LLC ownership. The group - your company - stays in the building - the leaseback - and pays rent to the investor.
 
With that as a backdrop, let’s discuss what the title previews - two things that derail most sale-leasebacks.
 
The operating company cannot afford a market rent. Remember. One of the reasons you own your business location is to provide flexibility during tough times. Maybe the amount you allow your operation to pay is well below what comparable rents are. This is done because your two interests - business and building - are satisfied. In order to maximize the value of your investment, however - you’ll need to shore that delta. Someone buying your real estate - and relying on rent - is only concerned with a return on their money. Therefore, the price an investor will pay you is based upon a formula - known as a capitalization rate or cap rate. A cap rate is determined by net income (rent less expenses) divided by purchase price. The relationship is inverse - lower cap rate, higher price. But, the higher the rent - the higher the price…within reason. If the group housed cannot afford a market rent - the sum an investor will pay will result in a lower value. As a seller, you’d like to max your sale proceeds - but don’t want to saddle the business with an unsustainable monthly rent. Dilemma!
 
What to do with the proceeds? Your ownership LLC with a related company paying you is a tidy investment. If you sell the real estate, where can you reproduce the return? Recall, you’ll need to accomplish a tax-deferred exchange into another income property or be faced with a whopping tax bill. In the three transitions above - acquire a competitor, sell the business, or move out of state - a sale-leaseback could ensue. However, each presents complexity. Buying a competitor is easy - especially if you need more space. No lease-back needed. You simply sell the smaller and exchange into a larger. Boom. A business sale - especially if the business buyer doesn’t need your real estate - is challenging. You’ll have to fill a vacancy by selling or leasing. The timing of an out of state move works great for a sale-leaseback. Simply, point A is sold. Lease is created for two years. Point B is bought and rented short term while you prepare to move your enterprise. Lease expires on Point A and the relocation to Point B completed.
 
More on these later.
 
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.blogspot.com.

Three Additional Ways to Avoid Rent Increases

If you attended last week’s column - you learned the two main ways to avoid a rental rate increase - know your owner and understand the value of your tenancy. If the bottom of your birdcage housed the Real Estate section prior to consumption - here is a brief recap.
 
Industrial lease rates have increased a whopping 134% over the past ten years. Recall, our market for manufacturing and logistics space was awakening from the ether of the 2008-2010 financial reset - errr meltdown and they’re were bargains galore. Now with the classic increase in demand from pandemic fueled buying and a pinched supply of available buildings - rates have skyrocketed! But, you may be fortunate to rent from an owner that appreciates your worth as a tenant and wants to avoid a costly vacancy if you bolt. If this is your situation and you’re approaching a renewal - count yourself among the lucky. Conversely, if maximizing the monthly income is your landlord’s objective - you could face an increase of double what you’re currently paying.
 
But, there is hope. Please keep in mind these three strategies to stem that spike in your monthly payments.
 
Buy a building. Historically, purchasing has been costlier than renting on a pure monthly outlay basis. Meaning - if we stack a mortgage, allotment for property taxes, insurance and upkeep together - the total will be higher than most leases. Plus, you must come up with a sum to bridge the gap of what a bank will loan and your purchase price - 10-25%. However, this is many times shortsighted when looking at a projection over the life of a company’s occupancy. You see, lease rates escalate over time - generally fixed at 3-3.5% annually. And, when a term expires, your landlord will bump the number even higher to compensate for the market variance. Currently, we’re seeing a huge boost in rental rates which eclipses that 3-3.5% annual escalator. Some find it better to own, finance the buy with fixed debt - thus stabilizing “rent”, enjoying appreciation and the tax benefits that accrue. A word of caution. If you enter the buying fray - be prepared. Structure your A-game with proof of your down payment, lender pre-qualification letter, and a well reasoned story of your desire to purchase.
 
Move to a cheaper geography. Once, the Inland parts of SoCal were cheaper, newer, and alternatives were plentiful. If you’re a logistics provider and you look East - this affordability gap is quickly narrowing. However, there are still “deals” to be found. Don’t forget areas just outside the state borders - such as Arizona and Nevada. You might even find a business climate that welcomes enterprise with goodies - tax breaks, employment incentives, and fewer regulations.
 
Do more with less. We toured an operation recently. Occupied was a big chunk of a larger address. Since they leased the space five years ago, several distribution centers had been added to their supply chain thus lessening their need for the square footage they leased locally. By trimming their premises by 40% - a great building popped up which fit their requirement. Another client of ours took advantage of the relative softness in the office space market and peeled away that portion of the company. Eliminating the people component from their warehouse created several new buildings to consider. Don’t forget. Your additional capacity might be found if you look up and maximize your stacking. Frequently, a group will believe they are out of space because their floor is consumed. Ignored is the two or three feet in height not used. With the advances of material handling equipment - you can literally use every inch if you narrow your aisles and pile your product high.
 
More on these later.

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.blogspot.com.

Dramatic Rent Increases - Ways to Avoid Them

Lease rates for industrial properties in Southern California continue to rise! To place this in some context, if your direction - as a business owner - was to rent a location in 2011 and your operation consumed 100,000 square feet - you could expect to pay around $45,000 per month in rent. Of course, charges for things like property taxes, insurance and maintenance would have been in addition to the $45K. But, the additional charges would have added around $12,500 per month - bringing the total to $57,500 - $.575 per square foot. Flash forward to our pandemic fueled shortage of space these days and a comparable building leases for $135,000 per month! For those scoring at home - that’s a 134% increase in ten years. Or, a 13.4% annual increase. Simply nuts! Am I saying if you rented an address in 2011 and signed a ten year lease - when your lease expires this year - you can expect your rent to more than double? Yes! You got it. Wow! How are businesses able to afford such a whopping spike? Better still, are there strategies you can employ to stem the bumps? The answers are - I don’t know and yes. Indulge me as I outline a few ways to lessen the blows of gigantic rent inflation.
 
Know your owner. The gentleman to whom you send your rent each month, falls into a category of investors. Your tenancy is singular or multiple. Unfortunately, if you’re one of many and his buildings are full - your leverage is limited. You see, he may opt to push rents even if a move-out ensues. He’ll simply replace you. Conversely, if your rent is the biggest part of his retirement income - a bit more realism happens. If you relocate - and his music stops - so does his lifestyle. He’ll be more flexible with you to keep you in residence and avoid a costly vacancy.
 
Know your value. As a tenant, your worth is two-fold. First, the capitalized income you pay each year determines the dollar amount of the investment. Simply, $100,000 in annual rent - at today’s cap rates of 4.75% suggests $2,105,263 ($100,000/4.75%) - if a sale or refinance was considered. Why is this important? A bank would lend a percent of this amount if your owner needed cash. Plus, the market would gladly pay him this figure if a decision was made to cash-in or redeploy the money into another income property. Second, your tenancy is costly to replace. By this I mean - free rent, downtime, refurbishment, and professional fees - are forked over to secure a paying customer. So, let’s say the title holder of your location believes he can get $100,000 a year if you bolt. You currently pay him $80,000. If he’s correct in his assumption - he can achieve approximately $538,406 if he’s finds a five year tenant ($100,000 with a 3% annual rent escalator). However, if he lays fallow for two months, incentivizes the new group with one month of free time, paints and carpets the offices, and pays a commercial real estate professional 6% - count on an up front expenditure of $72,303 - ($16,666 for downtime, $8333 in free rent, $15,000 for fix up, and $32,304 in fees). If we subtract $72,303 from our expected new income stream of $538,406 our net take is $466,103 - $93,220 per year. You’re willing to pay him $90,000. So, he could be slightly better off replacing you. But, if any of his assumptions are wrong - he sits four months vs two as an example, he is better off renewing you at $90,000 per year. Plus, presumably you’ve paid on time, taken care of the premises and sent him a Christmas card. Those intangibles have credibility. He may have to chase the new guy to get his rent.
 
Know your alternatives. Don’t forget. You could buy a building, consider a cheaper area or opt for a shorter lease term.
 
More on these later.
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.blogspot.com.

Sublease or Buyout?

We have previously discussed the ways in which you can extract yourself or your company from a lease obligation. As a quick recap. Leases are contracts which allow occupancy for a certain period of time (term) and for consideration (rent). As an inducement for your tenancy, an owner (landlord) may offer some goodies - free or abated rent, an allowance to fix up the place, or a right to extend your lease or buy the premises (options). In return, you agree to pay on time, stay the full period of the lease, and take care of the building. Easy, right? Not so fast.
 
Sometimes circumstances arise whereby the agreement must be tweaked. In the extreme - a dramatic decrease in revenue - leading to bankruptcy. Conversely, an uptick in sales could cause the need for more space. If a competitor is acquired or if the operation is sold - another shift occurs. Now, you have redundancy - too many facilities serving the same purpose. What to do with your lease(s)?
 
Remedies abound. You can sublease the building, buy-out, allow the term to expire, reject the lease through a bankruptcy, or default. Clearly the last two are not recommended as there are legal consequences - but they are a way clear.
 
Most opt for one or a combination of the first three - sublease, buyout or term out. But what are the differences and when should they be used. Please allow me to dive a bit deeper.
 
Sublease. Simply, you locate a surrogate. A group to replace you. But, don’t forget, there may not be another you readily available. Did your operation lease the first building you toured? Probably not. You considered multiple locations until you found the perfect fit of lease rate, landlord motivation, amenities, concessions, and term. Now, you are the landlord and must meet the nuances of tenants in the market. All, while having little flexibility. Your goal is to get out - with as little downtime and expense as possible. Remember, your rent and term are known. Where is that rate compared to comparable availabilities - above, below or right at market. If you’re below - count yourself fortunate! You’ve something to offer. But, how do you deal with an enterprise seeking a three year lease when you’ve committed to ten. Plus, you’ve consumed the inducements. By that, I mean your free rent burned off or the new carpet is old now. To compete, you may have to consider offering some giveaways. Subleases are messy! I’ve found the the most success when the rent is below market, a lengthy term remains - 5 years+, and the building is in pristine condition.
 
Buy-out. An owner of commercial real estate spends significant dollars to originate your occupancy. First, he sat vacant while his agent marketed the availability and searched for a tenant - all while continuing to pay the bank and operating expenses. Secondly, that free or abated rent is another cost. Third, painting the offices and adding new flooring isn’t cheap. Finally, he paid professionals to negotiate the lease. All told, an owner will outlay 15-25% of the lease term’s rent in origination costs! He then recoups the expense over the term. Therefore, if you approach your landlord with the question - “what’s it going to take to let me walk?” - he will account for all of the above. Generally, tenants find the price too steep and opt for another avenue. But, I’ve encountered situations where buyouts make sense. Typically, a spread exists between the stated rent and current market. A mid term remains - 2-3 years. And little cleanup is necessary.
 
Term. Clearly, the easiest. But seldom used. Why you might ask? Because the ends rarely meet. Sure, if you could time your company’s demise with the expiration of your tenancy - boom! Problem solved. Unfortunately, the dangling participle of term generally must be severed.
 
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.blogspot.com.

Are Tax Deferred Exchanges Worthwhile?

One of the perks of our profession is we get insights into future legislation at the state and federal level that can affect our livelihood. You see, the commercial real estate lobby is quite influential. Recall, the enormous push that occurred last year in California to defeat Proposition 15 which would have altered the way property taxes are calculated for commercial properties. 

Presently, there is talk in Congress to gut tax deferred exchanges that are accomplished through section 1031 of the Internal Revenue code. Payback for the enormous infrastructure plan must come from somewhere and wealthy commercial real estate owners are a likely target. 

Yesterday, I consumed a webinar hosted by David E. Franasiak, a Principal and Attorney at Williams and Jensen, PLLC and Julie Baird, President of First American Exchange Company. Discussed was the Biden Administration’s American Families Plan. Underpinning the direction - “The President would also end the special real estate tax break which allows real estate investors to defer taxation when they exchange property - for gains greater than $500,000”. Dissected were the three main components of the plan - a limit of $1,000,000 for couples filing jointly, Section 1031 would effectively be killed, and the proposal - if passed - could take effect for deal closed after December 2021. 

As a quick review, tax deferred exchanges allow title holders of commercial real estate to defer capital gains taxes upon the sale of an income producing property. Certain criteria and time frames must be met. Otherwise, if a sale occurs - approximately 50% of the appreciation is consumed by Uncle Sam and Cousin Gavin. Therefore, motivation to sell would be stripped except in extreme cases. 
Today, I’d like to look at exchanges from a different view - do they really matter to those without commercial real estate ownership? As I’m admittedly biased - I’ll simply offer three thoughts to consider. 

Commercial real estate transactions employee a significant number of people. My premise? Elimination of transactions lured by tax deferral would also crater all the jobs associated with those deals. I once calculated 32 different folks were involved in a purchase. Specifically, escrow agents, title officers, environmental surveyors, roof inspectors, general contractors, sub-general contractors - air conditioning, electricians, plumbers, flooring. Not to mention professionals such as CPAs, attorneys, and wealth advisors. Loop in a few brokers and the ensemble is complete. Dollars earned - by those involved - are circulated back through the economy and groceries are purchased, rent is paid, and college funds established. And, state and federal income taxes are paid from their earnings. 

Small business owners who reside in commercial real estate through ownership use the tax deferred exchange mechanism to expand their operations. Keep in mind, business owners use the IRS section 1031 to purchase larger facilities and grow their businesses. Operational growth means equipment is purchased, workers are hired, and taxable revenue is created. 

Elimination of the tax deferred exchange mechanism would reportedly generate $19.5 billion over 10 years on a $2.4 trillion stimulus package. Unfortunately, the increment is so small - it’s akin to a rounding error. Too often, we lose sight of the unintended consequences of actions we take. As an example, when access to home loans was expanded in 2006 - the sub-prime meltdown resulted. Granted, there was more to that story - but you get the idea. 

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.blogspot.com.

More Space Than Needed - Now What?

Recently, we represented a tenant in a successful lease transaction. Provided by the new location are ample space and amenities for years to come. This address is one of four occupied by the company. We’ve now been approached - by the client - to review their other three buildings. You see, an acquisition of a competitor is in the works. Thus, there could be a redundancy of capacity very shortly. Our counsel to them was column worthy. So, we mashed up an old column on the subject along with an update on the new information. So, if you find yourself in any of the following scenarios - consider your alternatives:
 
Your company was just purchased and the operation will be rolled into another location - check!
 
Or, you've out stripped the capacity of your facilities but you have time remaining on an existing lease - check!
 
Or, you have decided to shutter the operation, and outsource the manufacturing to Texas - but your lease expires a year from now - check!
 
Or, you decide to take advantage of  historically low interest rates and buy a building but there is that landlord who wants to receive her rent for the next two years - check!
 
ALL of these situations and more can cause the need for a lease termination. But, just how do you accomplish this?
 
First, ask yourself these questions:
 
How much time remains on your lease? If the term remaining on your lease is less than two years, be prepared for your owner to use your remaining term as a "free" marketing time. The owner has the luxury of rent payments while searching for a replacement tenant or buyer.
 
What type of entity owns your location? A private individual may be a bit more flexible than an institutional owner such as a pension fund advisor or a REIT.
 
Where is your rental rate in relation to the current market? If your rate is above market, plan on subsidizing payments on the remaining term - if a replacement tenant can be found. If your rate is below market, your remaining term could provide a good alternative for a fast growing company concerned about a long term lease.
 
How does your lease treat assignment or subleasing? Most commercial leases allow for subleasing or assignment. Rarely is there a removal of your obligation, however. This means that if you sublease or assign the remaining term, you may still be liable for the payment of rent if the sub tenant defaults.
 
If your are moving to a bigger space, what is the rent amount monthly? If you are doubling or tripling in size, one month of rent in the old building could be a fraction of the monthly rent in the new location. IE: Old rent is $5000 per month. New rent is $15,000 per month. There are nine months of term remaining in the old digs or $45,000. If you negotiate three months of rent abatement in the new unit, you avoid a double payment.
 
How long would your building take to lease? Any competent commercial real estate broker can answer this for you. The answer to this question will have bearing upon a lease buyout.
 
Can some portion of the operation stay through the term? I just sold a building to a company with 15 months remaining on a lease term. Rather than try to sublease the space or negotiate a buyout, my client elected to open another related operation in the space.
 
Are any of your neighbors crowded and in need of square footage? A fast growing neighbor can consume your space with a moment's notice - AND thank you!
 
Once these answers are clearly understood, you have some options:
 
Negotiate a buyout: I generally will suggest that an occupant call his owner and discuss the reason that the space is no longer needed. I suggest that the occupant ask the owner if she would consider a buyout of the remaining term and if so, for how much? Depending upon an up trending or down trending market, the owner response will vary. Assuming 12 to 18 months of term remain, an owner will generally compute the marketing time to find a new tenant, lease concessions (free rent and improvements), brokerage fees, and the variance of the current rental rate to market. All of these factors form the basis of a buyout offer.
 
Sublease or assign the space: If more than two years remain on your lease, unless you are dramatically below market, most owners will not consider a buyout of the remaining obligation. You then must find a replacement tenant to live out the remainder of your lease term. You can either do this yourself, hire a commercial real estate professional, or ask the owner to do it.
 
Cease payment: I have NEVER recommended this but it is an alternative.
 
Live out the term: In the example above, my client loved the old location so he created a business operation to house the space and live out the remaining term.
 
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.blogspot.com.

How to Become a Commercial Real Estate Legend? Simple! R.I.P. Bill Lee

The Commercial Real Estate Industry lost a lion this week. Bill Lee passed away peacefully on April 5, 2021 surrounded by family. We are deeply saddened by our loss but grateful that Bill suffers no more and is with the Lord. Many of you knew Bill, transacted deals with him, and had great respect for his prowess. In honor of the life Bill led and the impact he had on our business - I revived a column I wrote in 2019 in his honor. Rest well my friend!
 
I am penning this post from a palatial suite - not the font seat of my car, btw - at the Aria in Las Vegas. It's early and I am one of the few that is witnessing the sunrise at the BEGINNING of my day. My company, Lee & Associates, journeys to Las Vegas each fall for our annual Summit. My thoughts drifted to a Summit past - the last one Bill Lee attended.
 
At that Summit - I re-connected with my old friend - Bill - hint, his name is on the front door. It was so great to see Bill and spend some time with him. Bill, unfortunately has been absent from recent Summits. I REALLY miss him. The cool thing is, it felt as though we talk weekly. He watches my TUESDAY Traffic Tips - my weekly video series - and complimented my work. Bill is LEGENDARY. But, how did he become a legend?
 
Bill observed a problem. Bill was the top guy at Grubb and Ellis before Nixon was a crook. He was/is the most competitive guy I've ever met. But, Bill realized that intra-office competition was wreaking havoc on the greater good of the office. Bill tells it like this. "I had a 30,000 sf listing. A guy (competitor) in the cube next to me had a 30,000 sf occupant requirement. I didn't tell him about my listing because I didn't want him to get part of the fee. The culture of the office dictated that approach." Bill later realized that the "company" suffered and created a platform, that through profit sharing, rewards cooperation but still encourages competition. This was heady stuff, folks. Talk about disrupting the way in which commercial real estate is brokered. WOW!
 
Bill had the courage to change. Great, there was a problem. Now, Bill had to convince some fellow brokers that CHANGE was the key to their collective future. Getting brokers to change ANYTHING is tantamount to separating conjoined twins. But, Bill, ever the persuader, convinced a small band of brothers to follow him into the cooperative abyss. John Matus, John Sullivan, Mel Koich, Larry O'Brien, John Vogt, Tom Casey, Dennis Highland, Len Santoro, Bart Pitzer, and Bill's college friend, Al Fabiano heeded the siren call and left the building. 
 
Bill had a tireless vision. One of the other old timers and I were marveling at how those eleven guys, in an executive suite in El Toro, California, created a company that now boasts 65 global offices, close to 1200 agents, Billions in revenue, an International presence, coast to coast visibility, and the BEST place in the world to transact commercial real estate. Period! I asked Bill if he ever, in his wildest dreams, believed the company would someday be this big. He looked at me rather puzzled and said, "of course! Once we got your Orange, California office opened, I knew we were on our way to becoming an international company." Tireless vision!
 
Bill got out of the way. At a point, Bill realized that for Lee & Associates to grow, he needed to step away and let the eaglet fly. Knowing Bill, as I do, this was warranted but was the toughest thing for him to accomplish. 
 
Bill along with Craig Coppola, a recent William J. Lee lifetime achievement winner, have authored a book entitled Chasing Excellence, Real Life Stories from the Streets. It is available on line and in book stores.
 
So, want to become a LEGEND? Just do those four things. Simple, right?
 
 
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.blogspot.com.

10 Things to Seek in Lease Negotiations

As commercial real estate professionals - a portion of our day is consumed negotiating leases. These can be renewals - someone stays put; or new deals - which are triggered by a relocation. Depending upon your specialty, up to 90% of your time is spent in lease endeavors. Compare this to a residential agent and you find the opposite - 90% in the sale of homes vs the lease of homes. So, with so much of a commercial real estate broker’s bandwidth filled with lease conversations - we get pretty good at the “ask”. In other words, what to seek from a landlord. If you find yourself in the midst of such a back and forth - consider the points below.
 
Rental rate. Folks in the business speak in terms of per square foot. You’re most likely concerned with the size of the check you write each month. Regardless, both are important. Why? Prices per square foot provide a benchmark by which alternatives can be compared. And, the total allows you to determine affordability. Your rent will be net of operating expenses (known as a Triple Net, NNN, or modified net figure) or included within the sum (Gross, Full Service, Modified, or Industrial Gross). Each has its pros and cons. Make sure your professional explains.
 
Term. Your enterprise is committing to lease the premises for a period of time. Generally, the smaller the space - the shorter the term. As an example, incubator locations - fewer than 5000 square feet - are month-to-month to two years whereas a 250,000 logistics hub might carry a 10-15 year arrangement.
 
Increases. Unfortunately, your rent will increase throughout the period of your tenancy. In theory, these are tied to inflation. But, with inflation all but flat - a bump of 3-3.5% per year is standard. The crazy thing is - rents have increased far in excess of 5% per year for the past two years.
 
Tenant Improvements. Generally, a TI will fall into one of two categories - special purpose or general purpose. Think of the former like a chef’s kitchen for your home. Sure, you may require a 12 burner Viking range but will the next occupant find value. If the answer is no, most owners won’t spring for it. Conversely, an upgrade of the power that feeds the plant will appeal to the next resident. Therefore, you may find a willingness to participate in the expense.
 
Refurbishment. Typically - paint, carpet, flooring and cleanup. Depending upon how recently the landlord rolled over a tenant - refurbishment may be more involved.
 
Extension Rights. Relocating is expensive, time consuming, disruptive, and inefficient. Therefore, in addition to the initial term of your lease - consider requesting an ability to stay past the expiration. Also known as “options to extend” - your tenancy is preserved if you decide to exercise.
 
Options to buy. Rarer today than an open amusement park, options to buy are a concession frequently sought by a prospective tenant and seldom given by an owner. Ask away. Expect the answer to be - ummmm, no.
 
Opt-outs. Seen this year with office leases - where space need uncertainty prevails - flexibility is achieved. Given is the right to walk away before the lease term expires. If a parcel holder agrees, expect there to be a penalty.
 
Free or abated rent. The difference? Free is Free and can’t be clawed back if you default - whereas abated can be. Some relief - in either flavor - can ease the expense of a move.
 
Form of lease. Finally, your agreement will but placed into a contract for both parties to sign. This becomes the document from which rules are noted, obligations created and a mechanism for settling disagreements outlined. Therefore, the form is critically important - so make sure you know what the owner is proposing and seek counsel.
 
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.blogspot.com.

Shortage of Inventory? No Problem

There is an acute lack of available buildings for lease and sale in Orange County and the Inland Empire. In most cities and size ranges, 98 to 99 of every 100 spaces is occupied. The culprits? Lack of new construction, exponential growth of industrial operations, and increased competition from well funded investors. In short, demand outstrips supply and has for several years. This time last year - when a pandemic fueled pause persisted - we believed the end to shortages was finally near. But alas, in June of 2020, the turbo charged appetite for manufacturing and logistics locations voraciously returned.
 
But, there are ways to creatively solve the dilemma. Below, are just a few.
 
If you’re looking to buy, consider leasing. Currently, we represent a well qualified buyer looking to purchase 200,000 square feet in the IE. Alternatives to buy are rarer than Elvis sightings. A quick scan of the multiples yields fewer availabilities than digits on your left hand. However, a similar survey of lease options is brighter with several more choices. Sure. With a lease you pay rent to another when you could be funding your retirement - but at least your revenue will grow in the larger building. Once your lease terms out - consider re-entering the buying fray.
 
If you’re looking to lease, consider buying. Our food processing client is having a bear of a time locating a facility to lease. Ideally, the spot will have some of the special purpose goodies he needs - floor drains, washable walls, and substantial power. Slim pickings! However, we did source a prime deal for him to buy. We can couple our tenant with an investor who can buy the building, construct a long term lease and voila - everyone wins!
 
Make unsolicited proposals. Occasionally, we will find a gem by panning for gold. Be aware - offering on a property not on the market is inefficient. Generally, there is little room for negotiation. Sellers have not fully considered the tax impact. Third party reports such as inspections, surveys, environmental, and appraisal must be generated. Finally, motivation to sell is strictly based upon the price you offer. Any variance from your offered price - if you discover something wrong - will be met with a resounding no. We have found a few sale opportunities by scanning buildings for lease. The math of selling a vacancy vs waiting for a tenant can sometimes make sense.
 
Wiggle, wiggle, make it work. My wife is a seamstress. In the past, she taught countless young folks to sew. One of her sayings was “wiggle, wiggle make it work” when shoring up a pattern. If you look at your current setting, additional square footage may be found. How wide are the aisles in your warehouse? If you slim them down to “very narrow” - you multiply the capacity. Are you maximizing the cube of your space? By stacking higher - this is accomplished. I’ve seen some very cool production mezzanines which double your floor space. If you have no place to put that new injection molding machine - consider a mezzanine.
 
Find the soft spot. Recently, we completed a deal with a logistics company. When all of their musts were identified - nothing was available to tour. The reason? Required was more office space than the typical warehouse building sported. Our solution was to separate the office need from the operation. We found a plethora of available suites close to the mother ship.
 
Outsource! People, inventory, machinery. Generally, these three drive increased revenue - and require more space - albeit different types. Folks require an air conditioned, carpeted office. Inventory? Racking and stacking. That new CNC machine that cranks out parts needs floor space. A careful dissection of the increased enterprise is in order. Will the business be generated by a larger sales force? Maybe a virtual group could be considered. Factory reps do this sort of work. For finished goods that need a place to rest - many of our clients use a third party logistics provider for the ebb and flow of warehousing. Avoided is a long term commitment to square footage. Have you considered using another producer to manufacture for you? Until you scale and the cost benefits level - you can produce more without the investment in machinery and the need for a place in your plant.
 
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.blogspot.com.

Reconciling Operating Expenses

Today, we venture into the weeds to discuss an event that occurs this time of year. Nope. Not Chinese New Year - which is cool, by the way. But, that of reconciling operating expenses including common area maintenance charges. Fun stuff - huh? Generally, this proceeds with occupants of commercial real estate who do not own their building. In other words, tenants. You see lessees have contracts with landlords - also known as leases, rental agreements, or the like. Contained within each understanding is an outline of such things as base rent, commencement, expiration, rental increases, and responsibility for mowing the grass and fixing a leaky roof. It’s VERY important you - or someone within your group - understand how each of these cost categories is handled.
 
Typically, leases call for you - as the resident - to pay for expenses related to the operation of your address. If your company occupies a suite of offices - most likely you executed a Full Service Gross lease. Similar to other Gross Leases, a FSG lease lays out a rate inclusive of rent, property taxes, insurance for the premises, and general exterior maintenance. Unique to this arrangement is a charge for utilities and janitorial services which are baked into the monthly check you write. If you consider a high rise building with many enterprises - there is a prorata sharing of electricity, water, trash, and the crew that vacuums your conference room in your absence. It would be impractical to contract separately for these services - so owners don’t. Most, however, include an Expense Stop. Simply, anything above is billed to you. Below, base tent takes care of it. More on this in a moment.
 
Industrial landlords take a slightly different approach to re-capture costs. As an occupant of a manufacturing, warehouse, or service building - your lease probably is a TRIPLE Net Lease or an INDUSTRIAL Gross Lease. The main difference here? Rent with a NNN Lease excludes operating expenses with your monthly payment whereas an Industrial Gross Lease lumps them together. Am I saying no expenses are passed along in a NNN arrangement? Quite the contrary. They are invoiced as they occur or annualized and collected monthly.
 
So with that preamble - let’s get to the meat, shall we?
 
Each year between October and December, owners of commercial real estate budget for the following year. Taken into account are such line items as rent, property taxes, insurance, and yes - common area expenses like parking lot sweeping, trash collection, landscape maintenance, and system repairs. Considered? Is a vacancy anticipated? Are lease term extensions expected? Reviewed is how the current year fared. Were expenses properly predicted or dramatically overstated? Next, will the gardener charge us more next year? Have insurance coverages been impacted by a hurricane in South Texas? We know property taxes will increase by 2% unless a change of ownership occurred. Once calculated - a projection of next year’s - starting in January - plus budgeted expenses is forwarded.
 
You may be wondering - what happens if the principal collected too much money this year? Ahhh. That is where the February reconciliation begins. Akin to sending Uncle Sam too many tax dollars in anticipation of a refund - an accounting of charges collected vs realized is accomplished. If you paid too much - expect a bonus from your landlord. Conversely, an underpayment will foster a note that you owe more. Please understand. You have full rights to request backup information on anything for which your owner seeks payment. Typical would be a request for documentation outlining why a winds in Texas would affect a California insurance premium. Or why did trimming the trees cost so much.
 
Finally, the “more on this in a moment” promise. Delve into the terms - Base Year and Expense Stops which Full Service Gross and Industrial Gross leases highlight. Simply, these clauses limit the amount of common area expenses an owner can recover.
 
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.blogspot.com

SOLUTIONS for Your Commercial Real Estate Requirement

A couple of weeks ago, we discussed a system for analyzing an investment property, commercial lease, or potential building purchase,. Known as the acronym - FOCUS - I deferred our conversation on the S - Solution step - as the final letter of itself was column worthy. As you may recall, the F stands for Facts, O for Opportunity, C - Consequence, and U - Understanding. If you missed the missive and would like to check it out - you may do so here. 
 
Solutions may splinter into several directions. However, they generally fall into one of three categories - do nothing, do something, or defer a decision. Simply, if you’ve sold an income property, have used the FOCUS approach to determine your next move, and are to the Solution step - you may choose to pay the gains (do nothing), purchase another asset (do something), or wait (defer).
 
As you approach an expiring lease - the process could suggest you renew your lease (do nothing), relocate into a new address (do something), or allow the contract to expire and hope your owner doesn’t force you to vacate. By the way - with today’s obscenely low vacancies - I’d not suggest doing this. 
 
A lessee considering a purchase could opt to renew the leased premises (do nothing), pull the trigger on the buy (do something), or wait until the nutty prices level (defer).
 
Unfortunately, Solutions are rarely as straight forward as outlined above. 
 
Using our income property sale situation - hours of analysis precede the Solution. Doing nothing and paying the taxes owed appears simple. But, when you consider Uncle Sam and Cousin Gavin will clip an enormous chunk of your profit - this may pale in comparison to another route. Doing something - by affecting a tax deferred purchase and buying another parcel comes with myriad complexities. First, you must decide to do this before your sale closes. Next there are finite time frames guiding your acquisition. And don’t forget. You MUST find something! Sellers are bullish. The pool of suitable offerings is limited. As Tom Petty crooned - “the waiting is the hardest part”. Deferring a decision - if you sell an income property - forces you into the “Do Nothing” mode. If you close without designating your desire to exchange - you lose the option. A fat tax bill awaits.
 
Now, let’s take the example of an expiring lease. Sure. You could elect to find a new spot. In effect “do something”. But the thinking behind the decision warrants some dissection. Frequently we meet with a tenant and hear - “once our lease expires, we will DEFINITELY RELOCATE!” But, these days the majority of occupants don’t. After careful consideration, most realize renewing an existing lease has many benefits - an expensive move is avoided, disruption is nullified, and downtime is erased. The industrial real estate market suffers from an acute lack of available spaces. In some size ranges, our vacancy is zero! Your fine intention to upgrade into a newer facility might be met with very limited choices - and costly at that. Finally, some just cannot pivot into a new address. Generally, we see as motivators such things as - custom improvements, special permitting, or an irreplaceable area.
 
A direction to purchase your business home and pay rent to yourself is a sound plan - sometimes. Doing nothing means you’ll stay, continue to rent, and run your business with little change. Hopping into a purchase - doing something - would require you to survey the market, get yourself approved for financing or tap your piggy bank, and execute a transaction. Don’t forget to look into the “true cost of ownership” by adding - mortgage payments, property taxes, insurance, and some little things like maintenance. It’s generally much cheaper to lease. Oh yeah. Your down payment isn’t free - even if it’s in a liquid account. You could choose to hire, invest in machinery, or open a new market with the cash. In some cases, these alternate investments yield bigger returns than buying a building. Deferring until our pricing settles could make sense. My opinion is we’re long overdue for a correction. But, so far, even a Pandemic hasn’t stalled the upward march.
 
Sometimes FOCUSing on the Solution is tough! 
 
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.blogspot.com.

Making a Commercial Real Estate Decision Requires FOCUS!

As a frequent reader of this column, you know how much I like acronyms! You may have seen my missives on NUCLEAR, ask MR BOB, and even one from my friend and neighbor, Rudy - CLIP. Acronyms and their sister, nemonic devices, got me through school - somewhat unscathed - as they train your mind to remember lists and/or a process. Today. Yep! Another one. Proper attribution must be given to my business coach, Rod Santomassimo of the Massimo Group for this sequence. If you’d like to learn more - he’s written a great book entitled Knowing Isn’t Doing - Don’t Kid Yourself. If you’re facing a commercial real estate decision - specifically a relocation - I’d suggest you run down the list and ask yourself a few questions. In other words FOCUS!

F. Facts. Your current location as an owner or an occupant of commercial real estate contains a set of knowns - facts. You been at your location for a period of time. You lease. You own, etc. Layer in such things as the expiration of your rental agreement or a loan maturity. Consider the drivers of your business and how those may have changed. Was a competitor acquired? Did you add employees or machinery since you moved in? By the way. At this point - you may already have a direction. Humor me. Work yourself through the balance of the exercise. Sometimes - results may vary. 

O. Opportunity. Let’s now carefully delve into what’s working with the building and importantly, what’s not. Examples of what’s working could be - your customers know where you are, freeway frontage provides free advertising, or the lease rate you negotiated is 20% below the market rates. However, if the spot causes your employees to park down the street or if your warehouse must be completely unloaded and reloaded so folks can work - those are problems. You may also want to give some reflection to the motivators when you leased or bought the real estate. Was the market on fire and you took what you could get with the promise of re-evaluation? 

C. Consequence. Simply. You’ll need to do some math here. Consider what happens if you do nothing vs something - in dollars and cents. We recently counseled a logistics company. Considered was converting a leased premise to an owned one with a lot more space. Clearly, the new digs were going to cost a great deal more. However, the downside of staying put and continuing to lease would cripple their ability to grow their business. The loss of revenue - by standing pat - was enormous. 

U. Understanding. Now you know your situation, have dived into what’s working or not, and have calculated the monetary impact of your options. All that remains is a road map. Proceed to the next step. 

S. Solution. As the solution is column worthy itself - you’ll have to tune in next week for some suggestions. 

So, please don’t lose FOCUS this week until we meet again. 

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.blogspot.com.