What Are Experts Saying?

I am a huge networker and have been since the commercial real estate market tumbled in late 2008. As I scanned the scorched earth of what little remained of a vibrant business - I wondered if our commercial real estate activity would ever return. Buyers weren’t transacting, sellers couldn’t sell and lenders refused to lend. The financial world was in free fall as values lost nearly 40% - seemingly overnight. Brokers, reliant upon deals were forced to wait - something very few us were good at doing. 
 
So as 2009 dawned, I found myself with little to occupy my time. As another week ended with no revenue, my wife would ask “how my volunteer job was going”. 
 
On a whim, I attended a business forum at Cal-State Fullerton which yielded an introduction to a printer. Said printer in turn invited me to a networking event the following week. Scanning the room for leads I found no one in need of buying or selling commercial real estate. However, I discovered several professionals who had clients in need of my services. It was an indirect approach to sourcing business that opened doors for the next two decades through strategic referrals. You see, certain advisors drink from the same trough as commercial real estate professionals. CPAs, wealth advisors, business bankers, commercial insurance agents, attorneys, and those engaged in business sales all represent business owners in need of buying, selling or leasing the locations from which they operate. The cool thing is we don’t compete with one another, we complement. 
 
I’ve now settled in as a member of a group that informally meets once a month to share knowledge and industry happenings. What follows are insights from several group members and what they anticipate for 2024. 
 
Business banking. Cost of capital through deposits is more expensive. Thanks to several regional bank failures last year - Silicon Valley, Signature, and First Republic, greater scrutiny by regulators is being placed on loans and reserves. Consequently, now is not a great time to borrow money. 
 
Mergers and acquisitions. 2023 found very few companies trading hands. Rising interest rates and uncertainty among business owners caused a deep freeze of selling. Our investment banker is confident 2024 will be better as expectations have normalized and interest rates have declined. 
 
Accounting and tax. Any business considering a sale over the next five years should start now getting their proverbial house in order. 
 
Law. Our group has an attorney specializing in estate planning and one who assists merging and acquiring companies. Estate tax laws change significantly in 2025. Encouraged to act now are all affected by the lifetime exemption which sunsets next year. 
 
Echoed was sentiment that 2024 should deliver more business sales. 
 
IT. Artificial intelligence and its impact upon businesses is top of mind. Some companies are still morphing to all manner of virtual work which keeps information technology vendors scrambling. 
 
HR. The employment environment has found some equilibrium. More talent is seeking positions and businesses are finding it easier to hire. Compliance with new regulations enacted by our legislature last year requires constant monitoring.  
 
Insurance. Any company that spends six figures annually in worker’s comp premiums should consider creating a captive insurance company. Simply, you self insure along with others in your trade. Equity is built versus throwing away money into coverage not used. 
 
Wealth. Folks can actually make money on idle cash. This is great news for savers but tough for businesses reliant upon borrowing for growth. With treasury, money market, and certificate of deposit yields north of 5% last year, a decent return could be made with very little risk. As interest rates decline this year, other return instruments will have to be sourced. 
 
You can see why I enjoy this group! I get insight into all of the areas - other than commercial real estate - my clients deal with every day.  
 
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.
 

Valentine’s Day

A day for lovers. Valentine’s Day falls every February 14th and is celebrated by couples worldwide. 
 
According to Wikipedia - “It originated as a Christian feast day honoring a martyr named Valentine and through later folk traditions, it has also become a significant cultural, religious and commercial celebration of romance and love in many regions of the world.” 
 
And here I thought it was an excuse to stuff my face with chocolate and those cute little heart shaped candies with the cryptic messages stenciled on their sides. But I digress. 
 
As I ponder Valentine’s Day, my thoughts turn to commercial real estate and the parallels I can draw. Here goes. 
 
Do you love your commerical real estate holdings? I was taught early in my career to help buyers divorce - sorry - themselves from the emotion of commercial real estate ownership. By this I mean the numbers should guide your decision to buy or sell - not your feelings. I reflected upon an owner I met who owned a freestanding single tenant building in Anaheim. He was a builder. He had constructed this holding. I was engaged to be his agent whenever a vacancy was pending. Every three to five years the panic would creep in as he knew his cash flow would soon stop and he’d be forced to suffer a dry spell. His negotiating leverage was lessened and he ended up with some sketchy residents. All because he needed someone, anyone, to pay the rent. Over serious objection - after all, this was his baby, I convinced him to sell the building to an occupant and trade the proceeds into a building with multiple tenants. My theory was if you lost one or two occupants, you still had money to pay the bills - not the in and off light switch of a single tenancy. Reluctantly, he agreed. He’ll tell you that was the best decision he ever made! He now owns three such buildings and enjoys a great retirement. 
 
Send your tenant a valentine. The new year is in full swing and a good benchmark to finish old business and start new. Many landlords reconcile the past year’s expenses with their tenants in February. The crush of year end is solidly in the rear view and the first quarter is half over. If you budget your operating expenses such a property taxes, building insurance and maintenance annually, you’ll need to make certain assumptions. Now that the true costs are known, you can bill your resident for underpayment or credit for overpayment. Second half property taxes are due in February. Send in your payment this month. The county assessor will love you for it. 
 
Negotiation, compromise, and commitment. In both commercial real estate deals and romantic relationships, negotiation and compromise are key. Whether it's negotiating terms of a lease or compromising on where to go for dinner, the ability to find common ground is important. Commercial real estate investments often involve long-term commitments, similar to the commitment involved in a serious romantic relationship. Both require careful consideration and planning for the future.
 
You marry commercial real estate. You date the interest rate. For those of you who are a bit concerned about interest rates  these days, don’t forget your deal can be refinanced once interest rates settle into a more favorable level. Focus upon the basis under which you acquire the buildings. By this I mean the price you pay. If you can separate your emotion, as discussed above, and focus on the income producing capability of a commercial real estate asset, you’ll make a smart 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.
 

Subleases

Sublease listings remind me of a half yearly sale at Nordstrom. You better get there early in the markdowns to get a deal of selection and price. The longer you wait, the price gets better but the selection wanes until your only choice is an XS purple long sleeve tee. But. The price is unbeatable. If you’re like I am, an XS tee only has once use - that of a dish rag. But I digress. 
 
Much has been ballyhooed about the amount of industrial space coming back to the market - so I did a little research. My trusty spreadsheet is not quite as robust as Jonathan Lansners, but I made it work. 
 
As a quick review, a sublease is a remnant sale of sorts. When an occupant originates a lease agreement, the contracts vary in length. Depending upon the size of the premises, lease terms range from 2-10 years. Many times smaller buildings mean shorter leases. If an occupant can’t - or doesn’t choose to - fulfill the term obligation, they’re faced with three choices. These are a buyout from the owner, a default, or a sublease. A buyout is best for the tenant as they are relieved of the remainder for a fraction of the cost. Since the owner takes the risk and expense of finding a replacement, the situation must be quite compelling. A default is least palatable for both parties - owner and occupant. Subleasing is a nice compromise. The tenant markets the excess space in hopes of locating a surrogate to live out its lease term. 
 
So, on to the numbers. 
 
Presently, in all of Orange County, 92 listings in excess of 50,000 square feet exist. Of these 92, 12 are subleases or 13%. Los Angeles county came in at 497 listings, 73 subleases for 14.6%. Inland markets, spanning that vast swatch of industrial space to our east, clocked in at 245 listings of which 34 were subleases or 13.8%. Most of the give backs appear in square footages above 100,000 square feet. As an example, in the IE the percentage jumps to 16%!
 
Ok, you may be wondering, why does this matter. Allow me to expand on a few reasons. 
 
Market impact. The most valuable subleases in the industrial market closely mimic that of a direct lease. By that I mean the term is long enough for an occupant to spread his moving costs over a period of time. Using our Nordstrom half yearly sale as an example, a beautiful suit in your exact size at a 30% discount is much more appealing that one two sizes too big which will then need expensive alterations. Your savings are eaten up by the expense of making it fit. Plus, in some cases, all sales are final and you can’t take advantage of Nordstrom’s generous return policy. Subleases are similar because all sales are final. Your benefit is in the discounted price - not in other concessions such a tenant improvements. 
 
Additionally, subleases have a downward push on market lease rates. Of the 12 buildings currently available for sublease in Orange County, all will trade at a rate significantly less than that direct listings. With a few of these, the discounts can be explained as anomalies. However, if a large percentage of leasing activity is with these remnants, an adjustment of pricing occurs because the pricing is driving demand. 
 
Occupant considerations. In a sublease arrangement, the tenant becomes the sub-landlord, and the surrogate becomes a sub-tenant. Many occupant/sub landlords price their sublease at a slight discount versus a direct lease with an owner. In my opinion, this is a mistake, because a sub lease really needs to pop and provide a shock and awe price to attract demand. 
 
In order to affect a sublease, you must seek and gain approval from the owner of the property. This approval may not be unreasonably withheld, but it’s a step which must be accomplished. An unauthorized sublease can create a default, which is never advisable.
 
With your surrogate in place, don’t forget you, as the tenant, are still ultimately responsible for the lease obligation. Yes, you’ve located someone to pay the rent in your stead. However, if they fail to pay rent or break another lease covenant, the owner may look to you for a remedy.
 
Owner considerations. If your tenant is financially viable, and has simply outgrown your building thus the need for a sublease, your position is generally pretty solid. If, however, your occupant is struggling for other reasons, such as a downturn in business, or an industry collapse, it’s important to pay close attention to their process of locating a surrogate. Depending upon your tenant’s lease rate compared to the current market rents, it might make business sense to allow your tenant to buy out of their obligation. Under this circumstance, you take the risk of finding a new occupant, but avoid a potential bankruptcy by your tenant which could tie up your real estate for several months. Ultimately, you have the right to approve anyone that wants to sublease your building. As mentioned in the paragraph above, this cannot be unreasonably withheld, but it’s well within your purview to require a use compatible with your building to be sought along with a financially viable group.
 
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.
 

Selling Motivation

What’s selling motivation, you may be wondering. True that! We’ve not experienced much since the middle of 2022 when the Federal Reserve mounted its stair climber and hiked interest rates several times over the next eighteen months. Most of the selling motivation from the start of 2021 was fueled by crazy high prices investors were willing to pay paired with cheap money. Some never considering a sale of their property cashed in during this run up. We even saw the occupant premium disappear for a few months. An occupant premium refers to a higher price the user of a building is willing to pay versus that of an investor. You see, occupants consider the utility a piece of real estate has to offer its operation whereas an investor is interested in the income generated. Generally, that means they’ll pay more. Once the easy money evaporated and investor buyers were relegated to the sidelines - selling motivation ebbed. I believe in 2024, we’ll experience a different kind of selling motivation - more forced selling. Bear with me as I review five situations that could render me prescient. 
 
Transition triggered by one of the Ds. Transitions can predict a sale. Most common among the transitions owners face are divorce, death, disposition, distress, disputes, and dissolution. When a marriage ends and the combatants must reconcile the assets, sometimes a sale occurs. Death creates an interesting tax treatment known as a “step up in basis” which makes selling more attractive. Sometimes business owners decide it’s time to sell their companies. What follows, occasionally is the sale of the building the operation occupied. A vacant address with a mortgage means someone must foot the bill. Distress happens when no one wants to rent the premises. Arguments can lead to a sale. When partners can’t agree on a direction for the property, selling could be imminent. Finally, when an ownership entity is dissolved a property is sold. Effectively ending the involvement of the members. 
 
Lender pressure. Here’s my theory. Stress among regional banks has been widely reported - especially, if the bank has risky loans on the books or faces upward rate pressure in its bond portfolio. The demise of Silicon Vally Bank and First Republic are examples. If a bank funded construction loan was originated at the beginning of 2022 - which financed the construction of a new building - certain assumptions were made. These included the costs, the time to complete the build, the lease rate that would be achieved, and the amount of carrying time before an occupant moved in. The expectation was a permanent loan would replace the short term construction loan. But now the new structure is delivered into a very different world - lease rates have softened and vacancy times have expanded. Plus interest rates have risen substantially. Lenders fear their construction loans may not be timely repaid and could force a sale. 
 
Owner capitulation. Refinancing into a higher interest rate market could bring some owners to the table with selling motivation. This will especially be true with the owners of office properties. If the owner of an office building faces substantial vacancy, and must resort to lowering its lease rates to attract a tenant, the income generated by the office building is less than anticipated and may not service the debt. Additionally, if substantial capital expenditures are necessary in order to attract occupants, the money may not be in the budget. As you can see, a tsunami of issues could cause a seller to hand the keys to their lender. The lender, not wanting to own commercial real estate, then disposes of the property at a discounted amount.
 
Short term rollover. We currently represent an occupant looking to acquire a building in the Inland Empire. During 2021, this business owner was effectively blocked from purchasing because he could not compete with the investor activity. Investors were willing to pay astronomical prices with very few contingencies, and close quickly. Therefore, we sold and leased back for two years. Our theory was we could re-buy before lease expiration and we believed the market was headed for a correction. We are now noticing some building owners, faced with a pending vacancy, looking to sell rather than experience the lengthy and costly process of originating a new tenancy.
 
Investors awakening from their slumber. Who knows when we’ll see an uptick in investor activity. My prediction is this genre of buyers - faced with allocation requirements, a declining interest-rate market, and a realization of where lease rates have settled, will cause some buying activity this year. The interesting part of the equation will be how owners - not faced with any of the pressures above - will react to unsolicited investor offers. We shall see. 
 
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.