A Proper Opinion of Value

Often in our commercial real estate practice we’re asked for our opinion of the value of a commercial asset. These can be as loose as a “back of an envelope” guess to a full blown appraisal conducted by an MAI appraiser. If you’re unfamiliar, the MAI designation is for a certified appraiser and member of the Appraisal Institute who has met strict testing, standards and experience requirements. Minimum requirements include: Meeting the standards and ethics requirements, Completing an approved 4 year degree, Passing all Appraisal Institute required exams including a comprehensive examination, completing 4,500 hours of specialized work, completing a demonstration appraisal report, and finally submitting an application for review and approval. Generally, an MAI appraisal is required if financing is being originated or if one of the title holders has died - necessitating a “time of death” appraisal. The commercial real estate brokerage profession works arm-in- arm with appraisers. You see, we track key data which is included in an appraiser’s work - such as lease comps. Generally, in return for our cooperation, an appraiser will share her data with us. Sometimes we’ll even get specifics on the appraisal task - address, nature of the value assignment and results. But today, I’ll focus on the appraisal’s little sister - the Broker Opinion of Value and what elements it contains. by the way, these are excepts from a live opinion. The names were changed to protect the innocent. 
 
Scope of the Assignment: Something like this…We were engaged by a local property owner to provide a broker opinion of value. The real estate was purchased in 1997 for the purpose of housing their operating company. Now sought is an opinion of the value of the real estate for internal purposes. 
 
Property Description:
General:
444 Boardwalk offers approximately 100,000 square feet of warehouse space suitable for manufacturing and distribution purposes. It features both ground-level and dock-high loading doors, providing flexibility for various types of operations. 24 foot minimum warehouse ceiling clearance is advantageous for storing and handling large inventory or equipment. With 1200 amps of power, the property can support a variety of industrial manufacturing uses. .33 over 3000 sf feet sprinkler system limits the stacking height of some commodities. Ample parking spaces - approximately 200 - for employees and visitors are provided. A fenced yard adds security, staging and storage options. A strategic location offers excellent access to Los Angeles and Orange counties. 
Specific amenities:
Outlined in this section will be the specific features - square footage, % of office, etc. 
 
Methodology: Here a description of the way in which you determined value is described. It could read like this - Our understanding of the Orange County California sub-market dates back to 1984 when we began our career at Lee & Associates. Our company, and specifically our team, has been very active in the industrial arena - leasing and selling buildings of all sizes to a variety of investors and owner occupants. We consider ourselves to be market experts in this asset class of commercial real estate. To properly estimate the value of 444 Boardwalk, we analyzed four specific segments of the market - comparable sales, comparable leases, available sales, and available leases. A comparison was drawn to buildings that closely approximate the amenities contained in 444 Boardwalk. We only included deals that afforded specific transaction points. Additionally, we considered the types of buyers that would be in the market to purchase 444 Boardwalk if it was available and potential tenants that would consider leasing 444 Boardwalk if it was available for lease. Finally, we examined general economic trends and their impact on industrial vaues. 
 
Review of COMPS and Availabilities: Ideal is an analysis of three-five of each. Many more and confusion is created. Four comparable sales and five sale availabilities were considered. Analyzed were four comparable lease transactions and three lease availabilities. Specific details on each are contained in the succeeding sections. 
 
Comparable sales. We surveyed 75,000-125,000 square feet in six cities. In order to get a proper number - four - we included sales dating back to July 2022 - because only one sale has occurred this year in the range and cities surveyed. Of the four considered, square footages ranged from a low of 76,232 to a high of 123,650. Pricing ranged from $295-$316 per square foot. However, the $316 COMP occurred  before the increased interest rates took effect and slowed sale volume. Two of the buildings were purchased by occupants and two by investors. 
 
Sale availabilities. A similar narrative to the one for comparable sales is detailed here. 
 
Comparable leases. A similar narrative to the one for comparable sales is detailed here. 
 
Lease availabilities. A similar narrative to the one for comparable sales is detailed here. 
 
Potential tenants or purchasers: 444 Boardwalk would appeal to a variety of logistics providers or light manufacturing companies. Logistics providers require dock high loading, adequate sprinkler calculation for high pile storage, and proper turn radius for 53 foot trailers. 444 Boardwalk lacks the cube and sprinkler calculation for most modern logistics providers. A light manufacturing operation would require heavy power, office space sufficient to support different department operations, and a fenced and secured yard area for storage of raw materials and staging. 444 Boardwalk contains all of these amenities. Therefore, 444 Boardwalk would have great appeal for a buyer looking to occupy the building with his manufacturing business or a tenant needing a location. Many private investors are in the market and looking for good quality industrial investments. Most are driven by a return on their invested capital. Returns are in the 5.5 to 6.5% range for all cash purchasers. If a private investor must acquire the property using financing, the capitalization rate would have to be greater than his cost of financing - 7.5-8%. Sale activity throughout Southern California has waned since the halcyon days of 2021 and 2022 when institutional buyers were active. Declining sales have led to fewer exchange motivated investors in the market. 
 
Market conditions: Discussed here would be the total square footage of the market and corresponding vacancy plus the footage of the specific size range - in this case 75,000-125,000 square feet. If this distinction isn’t drawn - an improper look at vacancy emerges. Well also sprinkle in some economic head or tail winds - interest rates, global factors such as war or pandemics, elections, and recession fears. 
 
Special circumstances: These vary. In our example - here were the considerations. Ownership of the real estate and the operating company - have owned and operated from this location since 1997. We have seen a tremendous upward elevation of rental rates and sales prices since that period of time. Ownership of the real estate has subsidized the rent the operating company pays for several years. Consequently, the rental rate paid is substantially below that of the market. Such a subsidy causes an inflated estimate of the EBIDA and an understatement of the value of a capitalized market rent. 
 
Conclusion and Estimate of Value: We believe the buyer who will value 444 Boardwalk the highest is an owner occupant followed by a private investor. We don’t believe the building would garner any interest from a developer seeking to demolish the building and seek a higher and better use. 
 
               •             Occupant purchase - insert estimate
               •             Occupant lease - insert estimate
               •             Investor purchase - insert estimate
 
Finally, we include a disclaiming paragraph so that our opinion is not mis-used. You could word it this way. 
 
Disclaimer: This broker opinion of value is based upon sources from which we deem reliable. This is not an appraisal. Portions of this opinion could be used to form an appraisal. 
 
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 I’m Giving These Days

Much of my time is spent counseling family owned and operated manufacturing and logistics providers. My role is one of a trusted advisor. Ironic in this approach - is I’m not paid like other advisors - CPAs and attorneys. Their services are billed by the hour. Commercial real estate professionals are paid to transact. No deal, no paycheck. Many have asked why I have approached the business this way for nearly four decades. To me it’s simple. If I focus on the payday rather than the advice - I become a commodity. If a premium is placed upon my counsel a relationship is formed. I become less transactional and more oriented toward the long term. Fortunately, some companies I encounter need to immediately lease or buy a location or find an occupant for a vacant one. But many times I’ll spend years grooming before my brokerage services are employed. So what advice am I giving these days. Please indulge me as I share a few examples.
 
Carefully watch the market - pricing finding support and resistance. As discussed previously, since the halcyon days of 2021 and early 2022 where space was being gobbled like a pizza on grad night - the leasing and selling pace has slowed. There’s no better example than what’s occurring in Class A industrial offerings. In 2021, any new construction brought to market was pre-leased prior to completion. Once the walls were tilted, the activity commenced. Once the roof was on, the lease was signed. Now we have several concrete boxes awaiting a resident. Many more will follow this year. Interesting is the activity in “less than class A inventory”. Aging buildings suffering from substandard warehouse fire protection, compromised loading, or ceiling heights which don’t allow for maximum stacking are finding favor because they’re 25% cheaper than their Class A cousins. Advice: The fish are there - you just have to go a little deeper. Read. Lower asking rates.
 
How to deal with MASSIVE rent increases. Tenants are choking on the massive rent increases landlords are proposing and which have occurred over the past three years. This may sound contrary to the previous paragraph. You may be thinking “hmmm. I thought he said rents are coming down”. Both are true. Here’s how. Let’s say you leased a 100,000 square foot facility in 2018. The prevailing rates during that time were around $1.00-$1.25 per square foot. For easy math, that’s $100,000 per month in rent. Most leases have annual rent escalators built in. In 2018 we were writing deals with 2.5%-3% annual bumps. So. That $100,000 you paid initially, became $112,550 or $1.12 per square foot for the fifth year of your lease. The last flurry of deals happened at over $2.00 per square foot or $200,000 per month - a whopping 77% increase! If you’re facing renewal time - you encounter those crazy new rates. But now inventory is sitting. No one is dealing at those $2.00 rates. They’re compromising by leasing a location with fewer amenities - because they can. In 2021 they weren’t available. Now they are. Advice: So don’t jump at that first offer your owner makes. Understand things will further soften until all this new stock is filled.
 
If you sell the engine, you’re left with the vehicle. For those operators we counsel who made a decision to own - vs rent - the location from which their company operates - a different challenge emerges. We see countless examples of the real estate value eclipsing the worth of the enterprise. The most extreme case we’ve witnessed was ten fold. Yes. The address that houses the operation is worth ten times more than the business. Wow! Orbiting in conjunction we find the operation has its rent subsidized. A real conundrum exists here. Part of the benefit of owning the building from which your business operates is you can charge any rental rate you want - within reason. The lease payments are deducted by the business as an ordinary business expense and the owner of the building receives monthly payments. These lease payments are a ding on profit. If the rents are subsidized - not at full market value - an unreal picture of the business’s profitability is painted. Should these rents be “marked to market”, the value of the enterprise declines because the multiple of the EBIDA returns a smaller amount. By the same token, if the business is not paying full market rental value, then the value of the real estate is understated. So what’s a mother to do? Advice: Ratchet up that rent.! If the company can’t afford it, maybe it’s time to seek cheaper quarters.
 
Excess space is challenging today. If you find yourself with space you don’t need, you have four alternatives to rid yourself of the excess. You can approach the owner of your building and ask him to let you out of your lease, you could propose a buyout of the remaining obligation of your lease, you could find a sub tenant who will take over your lease, or - and we never recommend this alternative - you could simply stop paying rent and cause your lease to go into default. Because many of the leases written over the past two years are over market today - alternative one is a non-starter. Most find the amount needed to buy out their remaining obligation is too hefty. Unless you’re an unfair dealer, four is out. So subleasing is left. Advice: Your goal should be to minimize the amount of time you continue to pay rent. In other words, find a replacement as soon as you can. Understand you are limited in what you can offer to the market in the way of tenant improvements and a term exceeding that of your of your lease. The best way to make a sublease space attractive to a perspective occupant is to trim the rate by 25 to 30% and hit the market with shock and awe.
 
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.
 

Key Things To Do In 2023

Last week I shared my forecast for the balance of 2023. Discussed were my view on where interest rates might be headed and their impact upon our industrial market, class A industrial absorption, the possibility of a recession, and finally politics. My mom always suggested I not discuss politics or religion in an open forum - but alas, politics touches so many areas of our profession - sometimes venturing in is necessary. Today, however, no politics, but a review of a few things you - as an owner or an occupant of commercial real estate - should consider as the days shorten and the “ber” months unfold. 

Property taxes. One of the first lessons I learned when I became a real estate practitioner is how property taxes work in California. By the way, each state is different. Proposition 13 in 1978 set the course for how California currently handles levies on real property. Simply, 1% of the assessed value is computed to form the amount each parcel owner will pay in the fiscal year. Fiscal years run from July 1 to June 30 - therefore stemming parts of two calendar annuals. Assessments generally arrive to parcel holders in mid summer. Unless the parcel traded hands or improvements - requiring building permits - were made, the math is simple. Law requires a 2% increase. A sale will reset the assessment to the amount of the transaction and improvements increase the assessed amount dollar for dollar. Then. The first half taxes July 1-December 31 - are due November 1 and are late December 10. Second half - January 1-June 30 - are due February 1 and are late April 10. The nemonic device No Darn Fooling Around has been employed by real estate professionals for decades as a date reminder. 

Your landlord - if you lease - will do one of several things with the tax bill on your rented premises. If you operate under a triple net lease arrangement - she’ll send you the bill when it’s received and expect you to pay it. Or, she’ll pay it and expect reimbursement. Or, she’ll collect an estimate of the annual amount on a monthly basis and pay when received. Under a gross lease, she’ll pay the bill and expect reimbursement for the increased amount over the first year of your lease. Don’t know the base amount? Simply visit the Orange County tax assessors web site. You can easily research past years. 

Understanding the mechanism of property tax computation can potentially save you dollars. So keep this column as a guide. By the way, you should be able to question - and require proof - of any property tax increase. 

The fall is a great time to check on insurance coverages, building system repairs, and upcoming key dates. As you’ve read, insurance carriers are bolting our state. Those that remain behind - with a lack of competition - are jacking up rates. This can affect coverage on your premises as well as your operation’s liability. Do yourself a solid and schedule a visit with your insurance provider. You’ll be happy you did. With the dog days of summer behind us and shorter, wetter days ahead, now’s a good time to have your roof inspected and any repairs performed. Also, if your location is equipped with a well for truck high loading - check the sump pump lest you have a water feature after the first major rainfall. Finally, take a look at the key dates of your lease - expiration, options, rights to terminate or refusal to purchase, or any upcoming rent increases. 

You’re now equipped to complete the year and head into 2024!

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.

Last Four Months of 2023

Happy Labor Day! It’s now September. That time in SoCal when Christmas decorations take the place of lawn furniture in Home Depot. College football has just begun yet we’re expecting St. Nick to return the next kick off. Fall is my favorite time of year, however - cooler temps, changing leaves, shorter days, and all of the holidays that follow - Labor Day, Halloween, Thanksgiving, Christmas and News Year’s Eve. Travels for the summer are over, kids are back in school, and hopefully no more hurricanes will mass in the Pacific. Now to the balance of the year. What the next four months have in store for commercial real estate owners and occupants is the subject of this column. 
 
Watch interest rates. Borrowing for houses just eclipsed 7%. Historically average but so much higher than the sub 3% rates we witnessed in 2021. What’s followed is a lack of available houses for sale as folks with cheap loans don’t want to sell and new buyers can’t afford today’s prices financed at the higher rates. Sure. Commercial real estate borrowing is also impacted but another element evolves from high rates - small businesses ability to finance growth through acquiring competitors, buying equipment and leasing larger quarters. Our Federal Reserve seems bent upon taming inflation and causing unemployment to rise in the process. Higher interest rates - when business expansion is quelled - can create uncertainty among business owners. 
 
Class A Industrial absorption. Amid the resounding echoes of new construction, there's a curious absence - a noticeable lack of tenants ready to move in and occupy these freshly minted spaces. The question looms, why? Conditions that once fueled the previous industrial boom have evolved into a new breed of challenges. Gone are the days of localized manufacturers and logistics providers securing their own spaces with owner-occupied financing. Instead, our market has produced spaces that align with the needs of large-scale tenants. And therein lies a conundrum - the needs of these tenants hinge on a degree of certainty, a stable backdrop before they commit, amplifying the vacancy issue. We’ve overbuilt the high end of the market. Someone will have to concede to lower lease rates in order to attract a tenant. Once this happens, others will follow as a new paradigm will emerge. 
 
Recession. I predicted in January we’d avoid a recession as the resilience of the consumer would steer us past a downturn. So far, I’m correct. What lies ahead in the next four months of 2023 will be interesting to watch. So far unemployment is low, wages are higher, and folks are spending money on services such as travel. Most would agree the consumer racking up too much credit card debt in the process. As this debt is recalibrated into higher monthly payments because of higher rates - fewer dollars are available to throttle consumption. 
 
Politics. We have a long list of Republican hopefuls, an indicted frontrunner and months before the primaries. On a global level, war still rages in Ukraine, China stealthily observes, and record heat, rain, and storms rage like no other time Incan remember. The list of contenders will thin and we’ll be safely past storm season. 2024 will bring the promise of an election year. 
 
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.