Recently, I’ve spent time with three business owners
who made a decision to own the building from which their companies operate. The
benefits are myriad including - stability of rent the enterprise pays,
appreciation, depreciation, and pride of ownership. But our conversations
focused on a downside of ownership - rent subsidy and the impact this can have
on the value of the company. Therefore, I endeavored to consider other
disadvantages of ownership - which is the subject of this column. Let’s start
with rent subsidy and its impact on a company’s value.
Rent subsidy. Some would opine
this is actually a benefit - the ability to charge the occupant a low monthly
payment. Yes. In fact, one of the reasons to own a building that houses your
operation is to keep the rent steady and avoid the ebbs and flows from a series
of three to seven year leases. But, in my three conversations - the price an
investor would pay for the company was affected. You see, all of the
entrepreneurs are approaching an age where “what’s next” creeps into their
consciousness. Many times this means a sale of the business. But if one of the
cost elements - rent - is understated and the business can’t afford to mark
said rent to market - the enterprise value suffers.
No agreements. Frequently, an
entity is created to own the real estate and another to own the business.
Typically, synonymy exists between the two. Although the real estate ownership
may be Allen C. Buchanan, LLC and the operating company Allen C. Buchanan, Inc.
with a common ownership - they are two separate
companies with tax reporting, business licensing, regulatory and state
registration requirements. Since one “owner” receives payment from the other
and the “owners” have the same underpinning individual - seldom are proper
lease agreements forged between the two. This lack of documentation can be
particularly painful if an owner dies and her estate must now attempt to
assemble paperwork justifying rent.
Maintenance. If an occupant
leases space from an unrelated landlord and not one with an interest in the
company - strict language as to maintenance, repair, and replacements of the
buildings systems is contained in a lease agreement between the two parties.
Sans such an arrangement, maintenance of the roof occasionally becomes an
afterthought. No big deal unless a sale with a leaseback of the premises is
considered - in which case the buyer of the real estate will want an airtight
roof and functioning air conditioning.
Lack of flexibility. If a
company’s capacity outstrips the physical plant of a building - ownership of
real estate may inhibit growth. Should this need for additional space occur in
a down market, uprooting from one building to another will be complicated. If
financing requires the building be occupied by the business - as many SBA loans
do - a real quandary arises. Sure. A move may occur and the former location
leased or sold but it’s more complicated than simply moving at the end of a
lease.
Equity is bridled. With the
amount of appreciation which has occurred in industrial properties in SoCal -
many owners are sitting in mountains of equity which if tapped could be used to
hire employees, buy machinery or inventory, acquire a competitor or expand out
of state. But unless the real estate is sold or refinanced - the equity just
sits idle providing the rent subsidy as described above and a smaller return to
the owner than an alternative investment.
Friday, February 24, 2023
Five downsides of owning your building
Friday, February 17, 2023
Artificial Intelligence and Commercial Real Estate
The new rage is Chat GPT - a free research project by OpenAI.com. Microsoft purportedly is making a huge investment in the technology. Unfamiliar? Ask a question or make a request and it spits out a string of text which some would consider column worthy. What in fact is column worthy is the potential impact machine learning can have on our industry and the ways in which agents will use it. Let’s face it. For content creators this can be a game changer. As an example, I asked Chat to write five tweets on the state of the industrial market in Orange County. Fifteen seconds later - here’s what I got:
1. "Orange County's industrial market sees strong demand with low vacancy rates and rising rental prices. #industrialrealestate #OrangeCounty"
2. "E-commerce growth drives demand for industrial space in Orange County, leading to new developments and expansions. #ecommerce #OrangeCounty"
3. "Orange County's transportation infrastructure, skilled workforce, and proximity to LA make it a prime location for industrial companies. #OrangeCounty"
4. "Orange County's industrial market continues to attract investors and companies looking for a strategic West Coast presence. #investment #OrangeCounty"
5. "Orange County's industrial sector sees a surge in creative office conversions, appealing to tech and creative companies. #creativeofficespace #OrangeCounty"
Friday, February 10, 2023
The Trades
Today
takes on a personal note from several perspectives. First, on my industrial
deals, I’ve worked with general contractors and their sub contractors for over
four decades. Secondly, my neighbor Rudy - my biggest fan and occasional column
critic - made a great living working for Arciero Brothers. Their specialty was
concrete work for massive tilt ups, multi family buildings and office towers.
Rudy managed projects for them until his retirement. And finally, my wife and I
are on the home stretch of completing a remodel of our house - a much needed
freshening of a forty year old structure. Freshening is a bit like saying -
some moisture recently - to describe the deluge of rain we’ve received this
month in California. Yeah. We took the exterior down to the studs and replaced
aging siding, drafty windows and cracking doors. We added square footage and
remodeled interior finishes. The end result is amazing - but oh what a journey!
Rudy suggested I write a column about the contractors - trades - that brought the
completion forward. Jobs such as ours - tiny in comparison to the construction
of a project of new logistics buildings - employs so many people. Allow me to
elaborate.
Let’s take one of the new developments in the Inland Empire as an example. First, a land owner must be willing to sell. Then a developer must be willing to buy. Their dance is choreographed by folks in my profession - commercial real estate brokers. Generally, both seller and buyer have representation.
Once the points of the transaction are hammered out, an attorney or two enters the fray to insure the writings match the letter of intent and any verbal agreements.
A fully signed contract now transfers to an escrow company for execution. Title is involved to issue a preliminary report of things such as loans, liens, and easements affecting the ground.
So far, I’ve counted four professions in addition to a buyer and seller who’ve touched this deal - and it’s just underway.
Architects, soils engineers, civil and structural engineers, environmental people, city personnel in planning, building, police, fire, and council members all have a part in the opening acts. Six more professions and city employees are involved and the property hasn’t changed hands.
Someone must be willing to finance said project during its acquisition, construction, and hold period if leased. Loan brokers, banks, insurance companies, and lenders complete the encumbrances. Another profession gets a taste.
Once escrow closes, entitlements are completed and a building permit is issued. Now the fun begins as our project can go vertical. A general contractor is engaged to build and he deploys legions of sub-contractors including concrete, electricians, plumbers, carpenters, structural steel erectors, crane drivers, pavement, glass, roofers, heating ventilating and air conditioning, framers, drywall, landscapers, flooring, and many more. The number of jobs created by just one new industrial project is in the dozens. And that’s just one example.
Imagine the number of families supported by new construction. Thousands! And I’ve not mentioned the trades needed for day to day repairs and installations.
By
the way, these are good jobs - capable of options for those employed such as
saving for retirement, purchasing homes, sending their kids to great schools,
and sponsoring awesome vacations. Many are unaware of the career opportunities
available in the trades. It seems some believe college and management positions
are the way. Certainly nothing against that path as it rings a familiar tone.
But, you’ll know I’m right next time you need a plumber on Sunday or that
faulty breaker trips. The helpless feeling of “whatever it costs - just restore
my electricity” will resound. We once were a society that built stuff and
lauded those who swung the hammers. I for one would enjoy a return to those
days.
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.
Friday, February 3, 2023
Transitions
As I’ve mentioned here before, our commercial real estate
practice is centered upon family owned and operated manufacturing and logistics
businesses. These companies may lease, or they may own the buildings from which
they operate. Common among them, however, is generally a transition is
experienced which causes a commercial real estate requirement – the need to
sell, lease or buy. Today, I’d like to discuss the five D’s of transition and
how locations are impacted.
Death. Recently, we found ourselves engaged to sell a building where the principal of the company had died. This is tough. Taken too soon from his family and business and with a limited amount of planning – after all he died suddenly – some quick decisions had to be made to keep the business viable. After long discussions and many meetings with their CPA, banker, wealth advisor, and attorney – both the business and real estate that housed it were sold. One silver lining when a real estate owner dies is the tax basis is stepped up – meaning the gain when sold is based upon a value at time of death. Therefore, the gains taxes are not quite as severe.
Disposition. Its uncanny how many manufacturing businesses are on the blocks these days. I spoke with ten last week. Two had been sold in 2022 and the other eight are either in serious negotiations, have recently purchased a competitor, or were considering a sale of the enterprise this year. Why you may wonder? Money has been cheap and the same dynamics that govern real estate investing have been felt in the merger and acquisition world. Private equity sees great returns in solidly positioned and profitable small businesses. Each – merger, acquisition, or sale requires real estate decision to be made. Say a competitor is acquired. Chances are they have a facility from which they operate that is redundant. I’ve witnessed this excess capacity jettisoned via a sale or sublease. What if the business is sold and the commercial real estate retained? A lease needs to be negotiated between the new owner (tenant) and the previous business owner.
Debt. As interest rates have spiked over the past few months, companies carrying revolving lines of credit or term loans that come due are faced with a different rate environment than when the debt was originated. Sometimes the answer to paying off the loan is a sale of the real estate and possibly leasing back the premises.
Dissolution. Dave Ramsey once opined “the only ship that won’t sale is a partnership.” I don’t necessarily agree as I’ve seen many limited partnerships thrive – but I’ve also experienced two or more folks joined through agreements and there is a squabble which leads to a partnership buyout or in the alternative – an outright sale of the buildings.
Divorce. When a marriage ends, husband and wife must divide the assets and go their separate directions. Throw in a family business and a couple of addresses and the split becomes quite complex. When one party demands the settlement proceeds be paid in cash and there is a lack of liquidity – what’s left is a disposition of commercial real estate.
Much of the drama surrounding a “D” can be eliminated with some careful planning and a game of “what if”. You’d be well serve to consult your trusted advisors and plan for any eventuality.
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.
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