Does the demise of Silicon Valley Bank portend bad news for commercial real estate.

As we dawned 2022, yield on ten year treasuries was 1.73%. Also referred to as T-bills - the rate today is 3.4%. Last week the rate eclipsed 4% for the first time since last October. But prior to that, rates had stubbornly refused to budge north of 4%. During the Federal Reserve’s loosening in the pandemic - rates on ten year treasuries were below single digits. That’s right! In mid 2020, if you agreed to tie up your money for ten years - until maturity - you’d receive a paltry .52%. Let’s say you were quite cautious, risk averse, but wanted some return on your cash and bought a pile of these government issues. If you planned to redeem the bonds in 2030 - no problem. The return would be there, along with your principal amount. Let’s say for example you parked $100,000 in this manner. You could expect your investment to yield $520 per year for its duration. But. What would happen if you needed the principal before the maturity date of 2030? You could sell the bonds on the market. But at a steep discount. How much, you may be wondering? Using the yield of 3.4% today, your principal would be worth $15,294! That’s a hit of close to 85%. This very over simplified example is partially what caused Silicon Valley Bank to fail and be seized by federal regulators. When the run on deposits occurred last week - the bank was forced to take a loss on its bond portfolio in order to cash out investors. Bonds move inversely. As the price of a bond increases its yield decreases and vice versa. Capitalization rates on real estate behave in a similar fashion. As cap rates increase - the value of the underlying property decreases.
 
So. To the question above - what impact a bank failure might have on commercial real estate - here goes.
 
The Federal Reserve may not raise rates as aggressively as it planned. When the federal reserve started its march toward a federal funds rate target of 6% - in an effort to lower inflation to 2% - a series of .75% rate hikes ensued. These .75% rate increases morphed into .25% rate increases early this year as inflation showed signs of easing. We’ve now experienced a couple of months of strong jobs numbers paired with increased wages and a resilient consumer who refuses to stop spending. Before the bank shenanigans of last week, many believed a .5% increase was in the works for the March Federal Reserve meeting. However, because of the rapid increase in the Fed Funds rate - remember we’ve gone from a half a percent to 4.5% in less than a year - some believe we could avoid an increase altogether.
 
Borrowing costs may increase. If depositors believe certain banks are riskier than others, they’ll demand a greater return on their money for the added risk. Read. Higher depository costs. If failures cause a revamp of banking regulations - similar to what we experienced in 2008 - reserve requirements might increase. The impact of these two mean fewer, more expensive dollars to lend.
 
Investor activity may slow. We saw a dramatic decline in institutional investor activity in the second half of 2022. Left were private capital investors. Historically, this investor genre will pay less than institutions. Primarily because they borrow money to affect the buy. A classic disconnect is now occurring between buyers and sellers. Unless there is distress on behalf of a seller and/or tax motivation on behalf of buyers the dance ends before the band tunes up. I don’t see this ending soon.
 
Cap rates may be higher. Expect higher cap rates because of all of the above. Keep in mind. A year ago 3.75%-4.25% cap rates were the norm. Traditionally reserved for the bondable absolute net investments - such as Amazon on a ten year lease with 4% annual rent hikes - capital, seeking return, was pouring in to anything with a truck door. Many eschewed long term leases in favor of shorter terms where a rent pop could be sooner realized. Now. The government will pay you 4.2% for a two year treasury backed by the full faith an credit of the United States. Sure. You don’t get the appreciation or depreciation of a real property investment but the risk is minimal. 
 
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.
 

Is NOW a good time to sell?

With the uncertainty that permeates the media these days, many may be wondering if now is a good time to sell their commercial real estate. After all, interest rates are roughly double what they were just a year ago, rabid investor appetites have moderated, world turmoil persists and there is in again some rumbling we could recede later this year? Remember, you heard it here first in January - I believe we’ll avoid a recession - but I digress. To the question de jure. Is now a good time to sell? My answer is - it depends. Allow me to expand. 
 
In the universe of sellers there exist three types - equity, non-equity, and distress. Daylight appears between the market price  of a property and any debt owed in an equity situation. The reverse is the case in a non-equity circumstance. However, not all non-equity sellers are in distress and some distress sellers still have equity. 
 
Equity seller. A property owner with equity views their situation as a “I don’t have to sell”. But. Is their equity earning the type of return it should? I spoke to a private investor last week. He’s owned and operated an industrial property since he bought it in 1998. He owes very little - which means a large pool of equity resides. He’s facing a maturing mortgage. He can refi the underlying debt, pull out some cash and the property will still cash flow - provide income after the mortgage is serviced. But is that the right move? With the rampant appreciation experienced since he acquired the property and only moderate rent growth - the return on his equity is skimpy. When I explained what sort of return could be achieved by selling today and redeploying his equity via a tax deferred exchange - he was intrigued. He can’t sell for early 2022 pricing but won’t have to buy at 2022 pricing either. There is a trade off. Sellers who occupy buildings with their companies generally are guided by business motivations - vs real estate market conditions. Specifically, if more space is needed and the residence will become excess - a selling decision might be made. Because the proceeds will be funneled into the next buy - less emphasis is placed on extracting the highest dollar amount - and more on certainty of close. 
 
Non-equity seller. Those that purchased in late 2021 and early 2022 with 90% small business administration financing could presently be a non-equity owner. With the price softening this year coupled with maximum leverage from last year - chances are no equity remains. An aggressive loan repayment or a rampant run up in pricing can remedy the imbalance. Given this scenario - I’d suggest holding unless some distress appeared.  
 
A seller in distress - equity or non-equity. In the non-equity example above, should loan repayment be required, distress emerges. Now this owner may find his only recourse is to sell - at the best price attainable. Certainly, refinancing the debt could be an option but with no equity - lender alternatives will be limited to non-existent. Because this is a forced sale of sorts - market conditions are secondary. The seller must do the best he can under the circumstances. 
 
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 Sale-Leasebacks still viable?

Our practice centers around family owned and operated manufacturing and logistics businesses experiencing a transition. Recently, I wrote about common transitions small businesses experience. Included among these were - dissolution of a partnership, sale of a business, acquiring a competitor, or the unfortunate circumstances of the death of a principal, divorce or some other distress within the enterprise. 
 
As reviewed, all of these transitions come with their own brand of commercial real estate solution. As an example, when a competing company is acquired - two cultures must be forged into one - akin to a blended household. As you can appreciate, this can cause some drama. As the operations are morphed - so must the locations from which they occur. Frequently, redundancy is experienced. Specifically, two buildings within the same submarket - where only one is needed. Consequently, one must be jettisoned. 
 
But, let’s examine the flip side - the seller of the acquired competitor. When the sale of a business happens, the addresses from which the trades are plyed are either owned by the principal selling or leased by said principal. In the circumstance mentioned above where two facilities are within the same geography, two different strategies are employed. If the redundancy is leased and a decision is made to abandon the building - we can sublease, pay double rent until the term boils off, or default - never recommended. If owned - now without an occupant - we can sell the empty building or lease it and hold on or possibly sell the leased location to an investor. 
 
But how about the chosen building - the one selected to carry forth the business of the company and not deemed excess. Then what? A building owner finds herself in position to assign the lease agreement if appropriate, or sell or lease the building to the acquiring group. 
 
All of the above scenarios contemplate the moves made AFTER the business sale. But are there maneuvers before such a liquidation? Certainly. And I’ll spend the balance of my words describing one such arrangement - the sale-leaseback. If you’re unfamiliar, a sale-leaseback allows the owner of the location to liquidate the real estate while allowing the occupying company to remain in residence under a long term lease arrangement. 
 
We were fortunate last year to complete five sale-leasebacks. Four of the five were done in anticipation of a sale of the occupying companies. In one case a principal’s death caused disruption and the need to quickly restructure and liquidate for the heirs - who had no desire to own a company or the real estate it occupied. In the other three - the principal was in his late seventies, had experienced a business downturn from the pandemic, but wanted to capture the appreciation of the real estate today in anticipation of a business sale in a couple of years. 
 
So, why do this prior to a company’s sale? After all, rent will no longer be received by the seller. In our experience, the reasons that follow are typical. 
 
A market rent is established from which a company’s value is derived. 
 
Real estate values ebb and flow. Taking advantage of a hot market can make sense. 
 
A marketable lease can be structured - with appropriate lease rate, terms, increases, and maintenance responsibilities. 
 
You may be wondering. Does selling real estate prior to a company sale affect the company buyer pool? It indeed can and this should be carefully considered before such a strategy is completed. How you may wonder? As mentioned above - a buyer with similar locations my view a long term lease as a liability. This occurs frequently when a strategic player emerges - a group in the same industry. 
 
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.
 

CRE Brokers Defined

I delivered a presentation to a sales team of material handling specialists last week. Why you may wonder? I would share with you two reasons. First, I’ve transacted nineteen deals with the president since 2009 all over the western United States - we’ve grown together. This was one way of giving back to an organization that’s  been very kind to me. Secondly, we work closely with their sales team in assisting us execute deals. The better they understand our world - we both benefit. 
 
Some of you reading this column are commercial real estate practitioners. Others of you own or lease commercial real estate and pick up tidbits along the way. Still others  may be considering the field as a career or a way to supplement your income. Regardless, of your vantage point, I believe you’ll find value in todays topic. 
 
Let’s center the column on three of the four topics discussed - CRE brokers defined, how we’re paid, why you should care. 
 
CRE brokers defined. Said simply, commercial real estate brokers assist owners and occupants of commercial real estate in finding buyers or tenants for vacant buildings in the case of owners, or finding a place to relocate in the case of occupants. Commercial real estate companies are generally local, regional, national, or global, determined by the reach of their brokerage. These firms service a geography through their network of agents. Additionally, most firms find their agents on either or both sides of the transaction - representing the owner and/or the occupant. “Dual representation” describes an agent on both sides of the deal and is a much larger subject I’ll reserve for another day. However, there are companies who specialize in tenant or buyer rep. As a service provider seeking relationships with us - all of these elements are important to understand. 
 
How we’re paid. Full commission, no salaries or bonuses and only when we transact. Yep. We can spend days, weeks, months or years on initiatives that never pay us. Unlike those with salaries or hourly service providers such as CPAs or attorneys - our profession “eats what it grows” so they say. 
 
So what, you may be wondering. We enter through the C suite in many cases deal with the president, CEO, CFO, or the COO. This gives commercial real estate practitioners a view from the top, as opposed to some service providers who must begin with a warehouse manager, or a purchasing agent. Because we start in the C-Suite, our engagement is recommended from the boss, and in most instances we don’t have to compete.
 
We are the arbiters of change. Generally, the involvement of a commercial real estate broker is preceded by some sort of a transition. Whether it’s a death, a divorce, a massive debt that must be repaid, some distress, a dissolution of a partnership, or a disposition of the company - our job is to assist a company navigating these transitions. 
 
We are upstream from most relocation decisions. By this I mean, we must network with trusted advisers, so that we are in proper position once a transition occurs. Business attorneys, CPAs, commercial, insurance, brokers, investment, bankers, business, bankers, and wealth advisors are all professions. That will see a transaction before we do. But, we are in front of all those that must rely upon a transaction to occur such as contractors, escrow, agents, architects, and the like. 
 
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.
  

Advice if you’re considering selling your leased building

Occasionally, I’m asked how I get column inspiration. For me it’s a combination of reporting on macro trends in our industrial real estate market, advice I give my clients, issues that have arisen in transactions, and happenings with the business owners I counsel. Sometimes, a column idea falls from the sky - which happened today. 
 
Allow me to set the stage. I received an email from a client who recently relocated his business to a smaller leased location. The previous business address is owned. Upon my client’s vacation of the premises - he leased it to a neighbor. His plans - near term - are to move to a bordering state. Continuing to OEM real estate in California would create a undo tax burden on the income received vs selling the California asset and redeploying the proceeds into a leased building in a tax friendlier state. This, his motivation to sell. My client asked what considerations should be given for the framework of the lease agreement - allowing marketability and security. 
 
Below is the advice I offered. 
 
The lease should reflect a market lease rate - or as close as you can get. Value is a return on this rent. Consider swapping a couple of months free to get a higher rent figure. 
 
Build in sufficient annual rent increases. Most are written with 4% annual bumps these days
 
All “purchase rights” - options, rights of first refusal, rights of first offer should be eliminated. 
 
Make sure the tenant is responsible for all property tax increases when the property is reassessed after sale. 
 
The AIR Single Tenant Net Lease is widely used to document the deal. It’s common and most investors are familiar. 
 
Most investors want a relatively new roof and hvac units. Under a NNN lease, your tenant is responsible for maintenance and repair of these items but replacement is the owner’s responsibility - which can then be billed to the tenant monthly over twelve years. So, consider replacing these before sale. 
 
These days a five year lease is a minimum. 7-10 is much better - especially if you have the 4% kickers. 
 
Finally, credit of the tenant is huge. You’ll want to have two years of P and Ls, balance sheets, and corporate tax returns on hand. I’d see if you could get the principals to personally guarantee the lease to add a layer of security. 
 
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.