What A Wedding Can Teach Us About Commercial Real Estate

For those three of you - thanks Rudy - that missed my column last week, I was on brief hiatus as lwe were celebrating the union of two souls. Our son Michael and his new wife Candice said I do to a bevy of friends, loved ones and a beautiful backdrop of Mother Nature. You see, the ceremony was officiated well off the Ortega Highway at a venue called Jewel of the Ortega. A bit of a haul to get there - but oh - quite worth it. The day dawned sunny, clear blue, and warm - ideal for the exchange of vows. So many years of happiness together is my wish for the couple.

What follows seemed quite fitting for the lessons learned from the event.

Selling a commercial real estate asset is akin to planning a wedding - sure, you can do it yourself but things go much more smoothly if you have a wedding planner - AKA a commercial real estate professional.

Certainly, you can do a quick Loopnet search, establish a price, purchase a For Sale sign at Home Depot and wait for the phone to ring - set the date, book the venue, buy some suits and order the cake - this is easy!

Vista Print will create a glossy brochure of your building, mail a few to the neighbors and the inquiries will start to flow - Wow! They do wedding invitations too? Cool! Invite aunt Marjorie and a few dozen friends and let’s do this!

Just got your first hit! They want to see the building next week. Oh wait, you’ve a day job and can only meet the buyers on weekends or evenings. Hmmm, this doesn’t work for the buyers- now what? I guess you could slip out during lunch - but what if the buyer is late or stiffs you? Time wasted - and on an empty stomach.

OK, you get them through. They like it. An offer will be forthcoming. I’ll bet you’re glad you’re saving that 6% you’d have paid the broker. Why don’t more folks do this themselves?

Your prospective buyers call. Do you have a recent appraisal? Does the roof leak? When will the tenant vacate? What will be left when the occupant leaves? I noticed the building doesn’t have central air. Do the cracks in the floor portend something serious? Would you consider seller financing as we have a small credit blip - a bankruptcy? Oh, by the way, my wife has her agent’s license - so we will be deducting 3% from our offer. Next!

Three different agents - who comb the area - call. We have qualified prospects who would like to see your building. Will you pay us a fee if we bring you a buyer? Can you forward to us any marketing collateral you have? Any idea how much electricity feeds the property? - as one of our buyers is a machine shop. One of our guys stacks products high in the warehouse. Will the sprinkler system handle high-piled storage? What is the zoning? Our buyer is a trade school. Will the city allow that occupancy without a conditional use permit? Hmmm. Feeling a bit overwhelmed?

Finally, your perfect buyer appears - dressed as Prince Charming. Let the wedding bells ring! After all, a commercial real estate deal is a union of sorts. You gloat a bit as your email buzzes with a full asking price offer. No financing required, quick close, as-is - alright! Done. But, not so fast. You see, this buyer has made three full price offers to three separate owners. His plan is to tie up all three - and jettison two of the three. Will you be saying I do? Or, I wish I had - hired that broker.

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

As I pen this, it’s Good Friday and Passover. Happy Easter and Zissen Pesach! Most of you have folks from whom you solicit advice. Those of you who own a business most likely get counsel from a banker, attorney, or a CPA. Others may seek wise words from priests, clergy or a sage family member. And finally, maybe you get direction from Tik Tok, Facebook or Instagram. Regardless, you rely upon a trusted advisor. I am such a source for many of my clients. Today, I’d like to review some of the advice I’ve given this week and the situation that preceded the request for counsel.
 
Lease renewal on preset terms. We originated a lease in 2017. We are the owner Included in the transaction were five years of term with an option to renew for an additional five. As we’ve discussed here before - options are “personal” to the tenant and must be exercised within a specific time window. Also known as “time is of the essence” - you fail to give your owner the proper notice and you no longer have the option. In this case, the tenant wanted to remain in the building but missed his option window. He also wanted the owner to contribute to some construction expenses and wanted the right to buy the building.
 
So what advice did I give? I recommended the owner renew the tenant at the preset option terms and contribute a small amount of the construction expense. Additionally, I suggested not granting a right to purchase. But why? The family that owns the building relies upon the rent for their livelihood. The tenant wants to remain an keep paying. An interruption of this stream through a costly vacancy plus the expense of originating a new lease would not be offset by a small bump in rent that could be achieved with a new occupant. As to buy rights. These come in several flavors - option to purchase, right of first offer, and right of first refusal - and most favor the occupant. Vs limiting flexibility through a purchase right grant - I offered the owner approach their tenant first if they desire to sell. No commitment to the resident but they’re the most likely buyer anyway.
 
Lease term remaining. I was introduced to a light manufacturing company several years ago. They’ve not had a need for my services but we’ve kept in touch. Recently, the owner made a decision to exit the business she worked hard to build. Trouble was - time remained on her lease and the business buyer only wanted to occupy the premises for a short while - just enough time to relocate the business out of state. This is typical of a strategic buyer who purchases a competitor but has adequate physical plant to consume the operation - thus potentially creating redundancy. Consequently, some time would remain once the new owner of the enterprise vacated.
 
So what advice did I give? Fortunately, the lease rate she pays is dramatically below market - so she has a few paths forward. The easiest is to approach the owner and request a buyout of the remaining obligation. Sometimes a landlord will see a benefit if new tenant will pay more. The buyout is based upon the cost once downtime, broker fees, free rent and improvements are calculated. If that approach isn’t palpable, the tenant can sublease - in this case at more money than currently being paid. Some leases will ding you with a sharing if this profit - so beware.
  
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.
 

Will commercial real estate cause bank failures

In March of 2008 Bear Stearns failed and was purchased by JP Morgan Chase for $10 per share. The stock had hit a 52 week high of $133 a share. According to Wilipedia - “By November 2006, the company had total capital of approximately $66.7 billion and total assets of $350.4 billion and according to the April 2005 issue of Institutional Investor magazine, Bear Stearns was the seventh-largest securities firm in terms of total capital.” Among other ventures such as wealth management, capital markets, and equities trading - Bear was in the business of underwriting and issuing mortgage backed securities or MBS. Packaged were a number of risky home loans with their blended interest rates serving as a return for the offerings. When borrowers stopped paying, the securities went bust and the whole house of cards collapsed. What followed six months later was the Great Recession - the largest economic downturn since the Great Depression of the early 1930s. Bear Stearns was the proverbial tip of the iceberg for the titanic sinking of all real estate markets for a good portion of the early 2010s.
 
This March, Silicon Valley Bank failed and was taken over by the Federal Deposit Insurance Corporation. By comparison, SVB is a bank with depositors vs Bear Stearns with brokerage accounts. Depositors place money needed for short term future operations such as payroll, rent, mortgage payments, and salaries. The expectation is the money will be there when needed. If depositors lose faith in their ability to draw down their accounts - a run on deposits occurs. In this case $40 Billion in just over two hours. Unlike the scene in “It’s a wonderful life” where depositors had to line up and wait their turn - a modern run happens across myriad smart phones with the click of a few keys.
 
So, what’s the tie to commercial real estate and how could the collapse of Signature Bank, Silicon Valley Bank, and the sale of Credit Suisse to UBS portend greater peril?
 
Simply. Banks make loans to commercial real estate borrowers. These borrowers run the gambit of those who own and occupy the buildings from which they operate to owners of high rise office buildings loaded with tenants. In the former - a borrower’s ability to make timely payments is conditioned upon the strength of the business and financial wherewithal of the mortgagee. Also, some owner occupied commercial real estate loans are guaranteed by the government through the small business administration. In the continuum of loans - these are relatively safe - which means a bank is not required to add additional dollars to its reserve account for default insurance. But what about the latter example of a high rise office building? Much has been written here about the flux office tenants have experienced with hybrid and virtual workforces. It’s been difficult to predict office occupancy. Versus a single entity - a business occupying a building - you now have multiple tenants - in uncertain times - responsible for paying rent to an owner who’s in turn paying the bank. Should a high rise title holder’s vacancy creep up to levels above 50% - she must resort to extreme measures to rent the vacant space. Such things as free rent, beneficial occupancy, tenant improvements, broker fee bonuses, and moving allowances are employed to attract paying customers. ALL of these things cost money. I recently experienced these items totaling 45% of the consideration of the lease! But the problem is compounded if the physical plant of the structure is aging and needs capital improvements such as a new roof, elevators, lobby improvements or collaborative outdoor space. Once again - very expensive. Now a catch 22 exists. Declining occupancy - high tenant acquisition costs - further vacancy - lack of dollars to renovate an aging structure - solution? Give the building back to the bank. Now a fire sale takes place to find a buyer of a distressed asset for which the lender must boost its reserve accounts.
 
This over simplified example shows how commercial real estate could in fact cause additional banks to fail. 
 
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.
 

What does April Fool’s day signal?

Today is April Fool’s day. I wish I had a pithy prank to put forth however the reservoir is dry when it comes to when it that. However, with the dawning of spring, the crack of the opening baseball bat, Easter, the Masters golf tournament, and the NCAA final four - spring has officially sprung and the first quarter of 2023 is officially in the books. As I wrote about last week, there are some things to behold with respect to the economy for the balance of 2023 - however, today I will focus upon what you should have accomplished in the first quarter of this year. Don’t despair. If you didn’t get it done, there’s still time.
 
Review all of your lease agreements. Now would be a great time to put your hands on a fully executed copy of your lease and any extensions. Make sure all are signed by both parties. You don’t want to be scrambling around during a critical date with a half executed document. This is best done at the end of a year with a careful eye toward any upcoming expirations, options to extend, rent increases, options to purchase, etc. But what if you occupy a building you own. Should you have a lease agreement with your operating company? Absolutely! I could write an entire column on the horrors of handshake agreements between related entities.
 
Taxes. Normally, corporate returns should have been filed on March 15 and personal by April 15. But this year, thanks to our deluge, we get to sleep in until October 15th. Check with your tax professional as situations may vary. If your attempting to perfect a tax deferred exchange - according to PR Newswire - “The IRS has extended the 45-day and 180-day 1031 exchange deadlines for eligible taxpayers. Those who qualify will now have an extended General Postponement date of October 16, 2023 to find a replacement property and close on their 1031 exchange transaction.”
 
Reconciliation of your common area maintenance expenses. Your landlord may lump all of your operating expenses into an annual amount and bill you on a monthly basis. Normally, budgeting for this occurs in October so that invoicing may commence in January. Taken into account are things such as property taxes, insurance and maintenance. If you pay too much or too little during a calendar year - the amounts are reconciled in the first quarter. If you’ve not received a reconciliation - I’d suggest phoning your owner.
 
Make sure all of your entities are active. A good time to check this is during tax time. But since the window for taxes has moved - make sure you’ve paid the state for those corporate filings. Check on business licenses as well. We represented a seller a few years ago who hadn’t paid his LLC filing fees for 28 years! You can imagine the drama and expense to reactivate his entity so that we could transact.
 
Take a look at all of the physical elements of your commercial real estate. Now that the rain has - hopefully - subsided until fall - your roof may need more than a seasonal patch. With the crunch of repairs causing roofers sleepless nights - you may actually be able to hire one. Now is a great time to check on your air conditioning as the hot months will be here soon. The sump pump on your truck well got a good workout last quarter. Make sure he’s up for the next soaking.
 
Plans for the balance of the year. Is a move in your future? With industrial vacancies still at historic lows - don’t wait until ninety days prior to expiration to commence the search. Most will agree a year to eighteen months is appropriate for a proper search, negotiation, fit out and relocation. 
 
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.
 

2023 Predictions

Yes. I’m feeling the pressure - as last week proved I was quite prescient in my prognostications for 2022. My crystal ball was in fact clear. Good thing it dropped before 9:30 this year as I was snug in bed by then. But I digress. So akin to those holiday goodies you gorged and now have resolved to avoid - here is yet another prediction column for commercial real estate.
 
Industrial real estate. Third party logistics providers will give back space. If you’re unfamiliar with the term - 3PL or third party logistics provider - allow me to explain. Simply, a 3PL is an outsourced warehousing service. Say you’re a company that needs to get your product distributed to Walmart but don’t have the space or inclination to do so yourself. Enter the 3PL who will charge you - by the pallet - to receive, store, re-package, and ship your goods for you. For the past three years - to keep up with the demand of online shopping - 3PLs thrived and leased hundreds of thousands of square feet of logistics boxes. With the “de-inventorying” currently occurring, these providers need fewer square feet. But there’s an issue as many signed term leases which still have time to go. Therefore look for much of this excess to enter the market as sublease space.
 
Recession? I vote no. How’s that for contrarian thinking! Here’s how I read the tea leaves. The Fed came out with guns blazing last year with three .75% and one .5% rate bumps. As we’ve discussed, this increase affects the rate in which banks borrow. The theory is more expensive money will cool a white hot economy as businesses will re-think borrowing for expansion. If you look at Gross Domestic Product or GDP for the third quarter of 2022 - it actually increased over Q2. By the time you read this, we’ll have a glimpse as to how the fourth quarter fared. Now couple that with core inflation which has declined for several months. Finally, retailers are shedding inventory as mentioned above. In fact this is deflationary as things are on sale. Now some might counter by opining - we’ve not felt the full impact of the Fed rate increases, folks are spending that idle cash left over from the pandemic, and massive layoffs await. We’ll see. I choose to believe in the resiliency in the US economy. Plus. Did you visit a mall, restaurant, or attempt to book a flight during the holidays? Bedlam!
 
Return to the office. Much has been written on this subject. We’re starting the third year since all of us were forced to return to our spare bedrooms. Remember that fateful day in March of 2020? Like yesterday! Fortunately, our team had spent the previous few months figuring out how to duplicate our desktop mobily. Did we have insider scoop? No. We just wanted the flexibility to do stuff in a client’s lobby, our dining room, or the front seat of our car without losing productivity. We were lucky. When the order came - we simply unplugged, drove twenty minutes home and plugged back in. Many were not so lucky and found themselves grappling with how to remain viable. Others simply ordered a bunch online and ate alot. I heard this from a friend. 😎I predict workforces will return to the office this year. Sure, a hybrid model will be employed where - as an example - Tuesday-Thursday will be office days and Mondays and Fridays will be optional work from home.
 
Retail. A continuation of the experiences that brought us back to brick and mortar stores in 2022 will continue. As examples. On a recent visit to Main Place, we were serenaded by era dressed carolers, and our grandsons thrust into a cube of stuffed animals as human claw machines. I’ve never seen the place so packed! My wife and I commented - what recession? Sans these experiences, however, I’m afraid the on-line shopping is easier. What’s avoided are out-of-stocks, surly clerks, crowds, and no parking. Speaking of Main Place. Our favorite parking spaces are now consumed with a multi family building which is under construction. Providing your own customer base and foot traffic - once the units are fully occupied - is always a great idea. But how cities choose to eliminate tax basis while at the same time increasing police and fire service remains the tug-of-war.
 
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 We’re Giving These Days

It’s been said March comes roaring in like a lion and leaves like a lamb. Metaphorical for the weather patterns experienced - this can be said for our commercial real estate market this year.
 
Shaking off the cobwebs of a post pandemic hangover, 2022 started with great momentum - only to be cooled mid year. We received some decent economic news of late with the consumer price index not increasing as fast and some major retailers posting better earnings than expected - but our path forward still remains murky.
 
So what advice are we giving to tenants, investors and occupants who own? Allow me to categorize each.
 
Tenants. We recently recommended a client of ours renew for a short period of time - six months - to gauge the market trajectory. Our tenant is faced with a lease expiration at the end of this year and we’ve been watching what’s become available for several months. His options to relocate were limited and we’d even created a plan B to stay put if we didn’t see some loosening. Low and behold - we noticed a trickle of new buildings hitting the market in October. Now it’s running about three per week. If you’re looking for space - this is a vast improvement versus six months ago when we were lucky to see one every three weeks. Another interesting metric is the asking rates have declined. Gone are the days when a new avail was swept up before it was widely marketed. Every new deal was a new high. Not anymore. Our advice centers around our belief of future softening. Tenants are becoming valuable again - especially if they pay on time and are easy on the building - which our clients is. What’s causing the increase in supply? Some businesses, faced with the new rent structure are headed out of state or out of business. What’s left in their wake are vacancies.
 
Investors. We see two sets of motivation these days - tax deferral and non. Unless motivated by tax reasons - it may be wise to put your money in short term treasuries - two years - and wait for the right opportunity to come along. Institutional capital is largely sidelined and occupants are priced out. Private investors rule. If belief suggests a softening of rents in the face of rising interest rates - values can only decline. Will there be better deals mid 2023 than today? Our opinion is yes. Certainly, if your investment is dictated by tax deferred timeframes - you either transact or pay the gains taxes. But remember, the impetus of those buys was a sale. Our sense is they’ll be fewer equity sales as values have declined or the market’s evaporated - leading to fewer tax fueled purchases.
 
Occupants who own. We saw a voracious appetite from institutional capital targeting these arrangements. Their pitch was a sky high purchase price in return for a leaseback of two-ten years. This activity peaked in June. With the uncertainty of recession, inflation, and rising rates - these deals weren’t as attractive. With more lease deal hitting the multiples - our prediction is some of these owners will need to sell - especially if faced with a refinance bullet or a shortage of dollars necessary to refurbish the building into rent ready condition. Once again. Patience is key.

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.
 

A Conversation with Jeff Ball, CEO of the Orange County Business Council

Recently, I had the privilege of participating in a panel of Commercial Real Estate professionals at the Cal State Fullerton economic forecast luncheon held at the Disneyland hotel.

Moderating the panel was Jeffrey K. Ball, CEO of the Orange County Business Council and former CEO of Friendly Hills Bank.

Our conversation was followed by my invitation for Jeff to attend a group meeting of business professionals with whom I network. We meet monthly and discuss trends in our respective fields of commercial real estate, banking, law, human resources, information technology, accounting, peer to peer coaching, investment banking and fractional C-suite interaction.

You might wonder why the meetings? In my experience, my clients (owners of closely held manufacturing and logistics businesses) are touched by all these professions and yet we don’t compete, we complement. I’ve found great value in understanding their worlds.

But in this meeting, Jeff was our guest to describe his mission at the Orange County Business Council. If you’re unfamiliar with OCBC, here’s a brief overview I curated from its website:

“Orange County Business Council works to enhance Orange County’s economic development and prosperity to preserve a high quality of life. For more than 125 years, it has promoted economic development and served as the voice of business in America’s sixth-largest county. OCBC serves pro-business interests so that the region’s vibrant economy continues to expand, bringing the benefits of prosperity to every corner of the county.”

Jeff is quite engaging and passionate about his role. He described the tenets of the group: advocacy, research and networking events — of which the economic forecast was one.

With economic development serving as an overarching umbrella from which our county grows and prospers, we spent time discussing the retention of business within the county, attracting new companies and expanding existing firms here in Orange County.

Some of what Jeff chatted about includes showcasing Orange County during the upcoming Olympics by offering a tour package including beachfront hotel stays, amusement park and museum passes.

We also talked about how the 34 cities within our county can use the council and its available data as a repository for available manufacturing and warehousing space.

Finally, Jeff said he plans to place much emphasis on the council’s role in economic development through leadership, strategy and execution. 

All of this doesn't come without its share of challenges, he noted.

He shared how the county faces a housing shortage which causes affordability issues. In order to keep the best and brightest of our young people, he said, the council and the county will have to figure out how to add new housing while dealing with NIMBYism, CEQA, and the regulatory maze of getting new housing entitled and built.

OCBC and Jeff will help with these efforts by focusing on pro-business candidates. Advocacy in the areas of clean water, cutting edge technology, safe streets and highways are just a few ways Jeff said OCBC is taking charge.

Our business roundtable found Jeff to be knowledgeable, resourceful and well qualified to set the vision and execute the strategy of the OCBC.

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.

Three Things I’m Hearing

As I’ve written before - we as commercial real estate brokers generally serve three types of clients - investors, tenants, and owner-occupants. Unlike our residential colleagues who represent buyers and investors - and the occasional tenant - many in our industry do quite well only servicing folks with leases.
 
We can be on either side - the owner side or occupant side. So our days are filled in one of six pursuits - three types of clients but working on either side. Clear as mud? Allow me to provide details. Number one and two. Investor hires us to find them something to buy or to fill a vacant building. Number three and four. Tenant engages us find them a location to lease or to sublease excess space. Number five and six. We work to locate a parcel for an occupant to buy or they ask us to sell their company’s address.
 
With that as a backdrop - you can appreciate we have our “ear to the ground” and are a great source for what’s happening. I’ve distilled this down to one thing for each genre - investor, tenant, and owner-occupant.
 
Investors. Our industrial market crossed a pivotal point in the middle of 2020. For the first time I can remember, the occupant premium disappeared and investors started paying more for offerings than those who bought them to house businesses. Deep pools of capital, a rabid appetite for return in a stable asset class, and skimpy supply caused pricing to hit a crescendo in May of 2022. With all the world happenings - inflation, recession, global strife, and rising interest rates - investors, especially institutional investors, have hit pause. Private folks are proceeding quite cautiously. Many require debt to acquire income properties. As rates have now eclipsed 5.5% - the resulting capitalization must be north, lest negative leverage will occur (return on invested dollars less that cap rate). So with fewer buyers and higher rates - yep. Prices have started declining.
 
Tenants. The period between 2016 and 2019 found record numbers of leases originated or renewed. These are typically 3-10 years in length. Baked into the agreements are annual increases. Up until 2021 - these hovered between 2.5% and 3% per year. Around July of 2021 - we saw a big push for increases to proximate 4%. We even saw a couple of deals with 5% yearly kickers. But even with the hefty adjustments, lease coupons didn’t keep pace with inflation. Consequently, come renewal time - many tenants are greeted with rate increases of 50% -100%. Folks who lease industrial buildings are concerned with how their bottom lines will be affected and how to counteract a whopping bump in rent.
 
Owner-Occupants. Distinction is drawn between two commercial real estate owners - occupants and investors. The difference? Occupants also own the operation residing in the facility. Before June of this year, many owner-occupants received unsolicited offers from investors seeking to deploy capital. In general - these offers were at eye popping numbers and included a provision to avoid a costly move. Many carpeyed the diem and sold. But others got tangled in the two issues that arose - Uncle Sam and sky high rent.
 
The balance of 2022 should prove interesting as we navigate this changing market. As an aside, I did see a Santa display in a Lowes yesterday. Earliest I can recall. Merry Christmas!
 
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.

Should you make a Long Term Commitment in These Times?

I once authored a column entitled “Worst mistakes occupants make”. Among these are - buying when you should lease, leasing when you should buy, signing a short term lease in a downward trending market, or signing a long term lease in a peak market.
 
To review.
 
Buying. A new, rapidly growing business generally finds a better fit leasing for a term than investing precious operating capital into a static purchase of real estate. Conversely, if the company has been around awhile, is privately owned, has generated a profit for the last two years, has an ownership structure that can benefit from depreciation, and can afford the down payment and debt service - enormous generational wealth can be created by owning the facility from which your enterprise operates.
 
Leasing. When an economic outlook is fuzzy - most operations hedge by making short term lease deals. In fact, much can be gained doing the opposite - think contrarian. While the world zigs - you should zag. But, I have seen companies goof by signing term leases when things are frothy only to see the monthly amount they pay be dramatically greater than current rates - and they’re locked.
 
Most would agree we are in a changing market with respect to industrial real estate. Those occupying retail and office spaces are way ahead of us as their markets morphed years and months ago. With retail it was pre-pandemic and office as a result of the pandemic. But, now here we are with an uncertain future for manufacturing and logistics spaces.
 
So, if you lease an industrial building and you are approaching a renewal - what strategy should you employ? Assuming the space still works for you - location, size, and amenities - feel out your owner. How does she view the current conditions. Is she bullish, bearish, or running for the exits? If she falls into category two or three - she’s probably willing to forego a risky vacancy in favor of constant cash flow. Read - make you a deal! Another idea is the “blend and extend”. We saw a ton of these used in the early 2010’s and they exchange a lesser rate today in exchange for additional years added to the lease term. Both are effective. Just know your owner, know your alternatives, understand your cost to relocate, and finally - be familiar with the cost to replace your tenancy.
 
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.

The Market Disconnect

As I’ve written, in this space, numerous times - uncertainty is a killer of markets. Please allow me to elaborate. When investors or business owners have a murky view of the future - reluctance to make commitments abounds. Conversely, an optimistic opinion of what’s coming leads to hiring, equipment purchases and operational expansion. Therefore, we see long term leases and commercial real estate purchases transacted. Uncertainty is rampant in office space. Covid lockdowns, which forced many of us to work from home - was followed by tepid reopenings, high gasoline prices and a reluctance to commute resulting in a hybrid workforce. When will all of this stabilize? It’s anyone’s guess. Great deals abound for those office space occupants willing to sign a lease term of five years or greater. In my opinion, office landlords are resigned to meeting the demands of tenants by offering free rent, abundant tenant improvements, moving allowances, and bonus fees for agents.
 
We see a different dynamic unfolding in the industrial sector. When interest rates spiked in mid June, we experienced a tectonic shift in buyer attitudes - especially institutional investors. Many are on the bench awaiting an indication of which way we’re headed. We saw a similar pause in March of 2020. But, six weeks later a boom of epic proportions transpired. This rabid appetite continued through the first half of this year. Record lease and sales prices resulted. But now, we’re witnessing deal retrades - a fancy way of describing requests for price reductions - and cancellations. Even acquisitions which appear to be accretive to investor portfolios are cratering.
 
However, on the flip side - occupants of industrial real estate are thriving. One of our aerospace clients has a nine figure backlog. Another one - who slaps adhesives on tape will record his best year yet. A moving and storage operation we counsel has experienced back to back to back revenue spikes. Three peat indeed! And finally, a group we advise who provides engineering for large commercial air conditioning projects cannot keep pace with the demand. When these business boons require additional space - occupants are met with one in every hundred buildings available. Yes. Correct. A 1% vacancy! Because there’s no place to move, renewal rates have increased. Companies are being forced to get creative in solving their need for space. Some have narrowed their stacking aisles and gone vertical. Oh, but wait. That he swing reach forklift that allows you to pick orders way up high cannot be delivered for 26 months. That’s right! Over two years from now. How’s a business to plan?
 
So what’s up? Why the massive disconnect between investors and occupants? Here’s what I believe is happening. Commercial real estate prices shot up so high with expectations of rent growth and lack of supply. Then we felt some global pressure with Russia’s invasion of Ukraine, followed by four decade high inflation which caused a rise in rates to tamp down price hikes and two quarters of declining GDP. Institutional investors, en masse, chose to be bearish lest they find themselves chairless when the music stopped. Meanwhile, business marches on. Folks are working, wages have risen, demand remains strong, and the stock market is appreciating. It’s as though enterprises didn’t get the memo. Aren’t we in a recession? Isn’t the cost of borrowing more? Yes and yes. But somehow this recession is different compared to others I’ve survived. Generally, we spend our way out of downturns. But this time, the lower echelon of earners is getting crushed by higher prices at the pump and grocery store. No disposable income remains. So it’s a recession of the consumer vs a structural issue with our economy.
 
Only time will tell if I’m 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.

Deal Cancellations Abound!

The commercial real estate market has an entirely new feel these days. Gone are the buyer fueled bidding wars brought about by too few buildings chased by too many occupants - the classic supply demand imbalance. We were clipping along at warp speed for the first five months of 2022 when bam! We hit a massive speed bump named the Federal Reserve. You see, to tamp down rampant inflation - the Fed raised interest rates - some would opine too aggressively. Buyers felt emboldened to behave - well, like buyers. Personally, our team has felt the impact as we’ve had three deals cancelled at the alter. Jilted indeed.
 
Our latest divorce - terminated transaction - was the representation of a private investor in his search for a suitable upleg purchase. He sold a property in June and now must redeploy the proceeds to defer capital gains taxes. As we scoured the universe of available leased buildings - we settled on single tenant net leased industrial buildings - ideally in Southern California. Flooded in our search area were sale/leasebacks. After all, net leased real estate is created by: one, an investor believing now is the time to sell or two, an occupant who needs the equity contained in her owner occupied facility. The latter was the genesis of our deal implosion.
 
Therefore, I thought it column worthy to review sale/leasebacks and some things to consider when pursuing them. So here goes.
 
I've advised a number of my clients recently to consider selling their commercial real estate and striking a three to ten year lease with the investor that buys it. A few have listened.
 
This structure, in our parlance, is known as a sale leaseback. Different than a straight lease and not a short term lease that accommodates a purchase, a sale leaseback allows an owner occupant the chance to sell at today's high prices and remain in the building - albeit as a tenant - and avoid a move.
 
It's a slick arrangement when the correct motivations are involved.
 
Today, I want to spend a moment and discuss the downside of a sale leaseback.
 
The message it sends to the market. When a sale leaseback is listed and marketed for sale, the buyer’s questions range from - "why is she selling?" to "is her company leaking at the gills and needs cash to survive? Generally, there is a story. Its critical to understand the story, why a seller is selling, and how the current financials present. Our challenge recently was the creditworthiness of the occupant and the seas of red ink we were asked to navigate. In the end, we said - next.
 
Rent. Value is determined by taking the rent a company is willing to pay and packaging the rent as a return on investment. Simply, if the business can afford to pay $10,000 per month or $120,000 per year and the return is 5% - resulting value is $2,400,000. Easy, yes? Now the fun begins. Where is $10,000 per month in relation to what other comparable buildings achieve in rent? It's either above, below, or at par. Par or below - you're golden. Above and you're scrambling. You see, an investor looks at the worse case scenario - if the occupant spits the hook after a year, can't pay the rent - or worse files bankruptcy - then you’re stuck with a building you can't rent for the same amount she was paying. Thus was our conclusion in the failed deal.
 
Operating company is strapped. One of the befits of owner occupied real estate is the flexibility when times get tough. As an example, we own the office building we occupy. We’re the owner and the tenant. When our revenues dipped in 2009 and 2010, we simply reduced our monthly payment - to ourselves. Once an arms length investor enters the fray - you’re simply a tenant and the flexibility evaporates. In our cancelled scenario, rent was inflated in order to get the most dollars out of the sale. The problem was the rent was unsustainable.
 
There are tax consequences. As we've discussed, selling appreciated commercial real estate comes with a heavy tax consequence - unless a tax deferred exchange is employed. Yes, equity is feed, but at a significant cost - in some cases up to 35%. You may be wondering why this matters. Unless the seller has carefully thought through these consequences - the deal can screech to a halt.
 
Fortunately, we still have the engagement and are proceeding to the second possibility. This time the seller is arms-length from the company. So we’ll 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.

Commercial Real Estate Climate

August 2022. Wow! What an amazing 2 and 1/2 years. I’ve written, in this space ad nauseam, what we’ve experienced since the ball dropped on December 31, 2019. I won’t bore you with a recap. Instead, today I’d like to offer an opinion on where we are and what potentially lies ahead.
 
Industrial has hit pause from its meteoric rise in values, office suites abound with goodies for those willing to sign a term, and retail - especially Wal-mart, Target, Ross, TJ Max, Tuesday Morning, Bed Bath and Beyond, and Burlington Coat Factory are taking their lumps. With gasoline and food prices soaring - few can afford discretionary spending like before. Consequently, earnings have suffered as evidenced by Wal-mart’s 14% decline. Foot traffic in their stores is also on the wane. For us, it harkens back to the deal. Are folks still transacting?
 
I have thought about factors that motivate a transaction. I believe the three factors that motivate the deal are: Attitude, Inventory, and Interest Rates. All can influence the decision but in my opinion, only one factor can cause the decision to be changed - a change in motivation!
 
Attitude:
I have broadly lumped issues such as uncertainty, timing of a lease expiration, business forecast, market conditions, time of year, age of the business, age of the business owners, etc. into the category of attitude. As commercial real estate practitioners, uncertainty is the attitude that causes the most pain. If a business owner is uncertain about the future, a buying decision will be postponed or a buying decision could morph into a leasing decision or your ten year lease could become a two year lease or your new lease could become a renewal at the businesses present location. In Southern California, the end of 2008 and the beginning of 2009 were particularly painful! We now are told that the worst recession since the great depression began in December 2007 and ended in June of 2009. While we can debate the end of the recession, none of us will argue the beginning. Many of us in the business sensed a "change" was coming at the beginning of 2008. Financing was becoming more difficult to originate, values were at an all time high, the market was feeding off an exuberance that many of us believed was unsustainable. Our worst fears became reality in the fall of 2008 as the financial industry imploded, values plummeted, and many real estate deals cratered. The uncertainty that resulted carried into the early part of 2009 until after the Obama inauguration. Today, CEOs deciding to bring back a workforce into the office are faced with employees who are quite comfortable working from their kitchen table and $6.00 gasoline doesn’t motivate them to commute. With logistics buildings packed with holiday merchandise and squeamish retailers - the situation is akin to constipation. Something is needed to get things moving!
 
Inventory:
The market's supply of suitable alternatives can affect the timing, and viability of the transaction. We all have experienced a "seller's" market since 2019. In these times, the demand for space far out strips supply. As a result, a seller can afford to be bullish and often is. You must carefully review the inventory each day and put your buyer or tenant in the best position to make a deal. Currently, the market is changing from a  "seller’s" market to an "equal" market. Meaning, the halcyon days of multiple offers and TBD pricing may be ending. I saw my first “broker premium” for a deal done by September 30th since 2014. What is that owner seeing and trying to avoid? A costly vacancy - that’s what.
 
Interest Rates:
A wide swing up or down can motivate a deal. We saw double digit interest rates in the early eighties and have experienced record low interest rates for the past decade. Since interest rates have spiked recently by a point or two, many buyers have taken a “pencils down” approach to pursuing purchases.
 
Any combination of the above can cause a change in motivation. In my experience, this is the one thing that can cause a real estate transaction to collapse. Let's hope for good attitudes, a balanced inventory, and affordable interest rates!! 
 
 
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.

Recession, Retrades, and Fundamentals

As I pen this, we are half way through July 2022 and Christmas decorations should replace patio furniture next month. Anymore, it seems we have two times of year - before Christmas and after. Before starts August 1st and after on December 26th. Everything else is just a footnote.
 
So much has happened in the world - after Christmas. We’ve seen commercial real estate values eclipse sanity, two quarters of declining GDP - read, recession - inflation the highest it’s been since 1982, a global war in Ukraine, gasoline above $6.00 per gallon, food shortages, folks losing their minds and opening fire on innocents, brick and mortar retail foot traffic slowing to a crawl, interest rate hikes, residential activity coming to a screeching halt, and rumors of slowing in our market. My how things have changed! And in a heartbeat.
 
However, one thing that stays constant is commercial real estate fundamentals. You know, those pillars from which we base our direction. In a changing market - it’s helpful to keep these in mind. One fundamental is a lease agreement. Whether renewing an existing arrangement or originating a new deal, the following should help you bend with the changing times.
 
In my experience there at least five "gotcha" issues that should be addressed in any lease agreement. In my opinion, The AIR - Association of Industrial Real Estate lease addresses these issues quite thoroughly - with a few tweaks. In the case of an owner generated lease, the issues vary in their treatment. The five issues are: Operating Expenses; Capital Expenditures; Subordination, Non-Disturbance, and Attornment (SNDA); Rent Increases, and Miscellaneous. I will define each issue, and suggest "asks" during the lease negotiation. This is a layman's review as a practitioner and should not alleviate the need to have all legal documents reviewed by counsel. These issues are from a California perspective and may vary by state.
 
Operating Expenses (Industrial):
Operating expenses, also known as Op Exes are the expenses an owner incurs in the operation of a property. These expenses include, but may not be limited to, property taxes; property insurance; maintenance of the foundation, roof, and walls; landscape maintenance; maintenance of the building's systems - plumbing, electrical, HVAC, etc.; utilities; occupants share of the amortized capital expenditures, etc. The costs are sometimes referred to as NNN expenses or "gross-ups". These expenses vary greatly based upon an owner's management preferences but are largely skewed by the amount of property taxes. If you negotiate a NNN lease, the costs are paid in addition to your rent - either as due or monthly. If the lease is an industrial gross lease, the base year op exes are included in the base rent. I suggest postponing the base year until the first full year after the commencement of the lease. If the lease commences in February, this is a tough ask. If the lease commences in October - not so much. I suggest asking for a cap on the increases in op exes over the base year.
 
Capital Expenditures:
Capital Expenditures are expenses that are largely non recurring such as roof replacement, parking lot replacement, drive and landscape modifications, etc. I suggest there be a mechanism in the lease to specify any expense exceeding 50% of the cost to replace a capital system (roof), be the responsibility of the owner and the cost be amortized over 12 years at an agreeable rate of interest.
 
Subordination, Non Disturbance, and Attornment:
This is defined as the financing holder's means of securing their interest and the outcome of any foreclosure. Also known as an SNDA, this clause causes the lease to be subordinate to existing and future financing that is placed on the property. As a tenant, a request that the lease be non-disturbed (terms not modified), should be sought in return that the tenant agrees to attorn (recognize) an owner that becomes the owner through the foreclosure of the underlying debt. Requiring ALL of these is important in my opinion - especially during economic times that could suggest a high likelihood of foreclosure. I suggest the lease clearly provide for ALL of the components - S, ND, and A, and that where possible the lender be persuaded to sign an SNDA recognizing the lease.
 
Rent Increases:
These are defined as increases in the rental schedule during the term of the lease. Generally, the increases are throughout the term of the lease and could vary based upon the change that occurs in the CPI or a fixed annual amount. Throughout 2021 we saw these fixed amounts escalate. Recently, a lease was written with 5% annual bumps! Wow. Almost double the amount we saw in 2019. Caps and Floors are always suggested to hedge against a rampant inflationary increase.
 
Miscellaneous:
Former and existing cabling removal, Americans with Disabilities Act - ADA requirements (and who is responsible), city permitting, subleasing and assigning, rent abatement vs FREE rent, and options to extend and purchase should all be carefully vetted and when necessary, negotiated.
  
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.

Should you Acquire a Special Purpose Building?

Commercial real estate assignments ebb and flow between buyer opportunities and seller representations. Occasionally, we’re asked to market a special purpose building or find ourselves considering one for our clients to purchase. These unicorns can portend great risk and must be evaluated carefully. But before I launch in to how I caution buyers against said beasts - allow me a bit of explanation.
 
A general purpose industrial building has broad appeal to the universe of buyers. Most structures fall into this category. Such things as power, warehouse clearance, loading doors, and single story office space will be found on a typical buyer’s wish list. If an address curries favor with a narrow slice of occupants - we call these special purpose buildings.
 
We witnessed a spate of these constructed in the mid eighties as our industrial market adapted to the surge of microelectronic manufacturing. Needed was a hybrid between a high rise office and a down and dirty place where stuff was made. Enter Research and Development or R&D locations. Sporting more parking and a higher percentage of office space where engineers could work bolted onto areas used for manufacturing - this product type was dramatically overbuilt. Unfortunately, as supply was increasing - demand was falling as more of this genre’s output was shipped overseas. Thus we found ourselves with a whole class of industrial construction with limited flexibility - special purpose. Many lay fallow for years. Those that secured residents prayed for their longevity lest they’d be stuck with a costly void.
 
Another one we see is a facility improved with food grade infrastructure as they are rarely morphed into anything else. Sure, the next guy might be able to use some cold or frozen space - but generally the floor drains, washable walls and the like end up in the scrap heap.
 
Buying a parcel with special purpose improvements becomes challenging for myriad reasons. Chances are the occupant uses the intricacies and so long as he’s in residence - you’re golden. If he bolts, you’re scrambling to replace his tenancy. You see, a substantial investment went in to the goodies - now you must pay to remove them. This assumes of course that what underpins is marketable. Frequently, it’s cheaper to scrape the whole thing and start new. We saw this on the countless aerospace campuses occupied by the lines of Boeing, McDonnel Douglas and Beckman. Built specifically for the use they housed - no one foresaw a time when a retool would be necessary. Why would they?
 
Rarely are sellers prepared to hear the downside and how this impacts the price a buyer may be willing to pay. In the case of the aforementioned campuses - owners had to realize the buildings had no value and all would be based upon the land underneath. A bitter pill indeed!
 
Now for the good news. If you’re fortunate to find one of these with a mammoth credit tenant and a long term lease - great upside is to be found. The bad news is if there’s a vacancy. However, because the location is so unique - there are no places to move. We refer to this as a “sticky” tenancy. The improvements cause the occupant to “stick” in place and not relocate.
 
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 will we Know When the Market Changes?

Much has been written lately about economic storm clouds massing on the horizon. If you doubt what I say, pick up any periodical, listen to talk radio or a network news broadcast and mentions of inflation, interest rate hikes, and the Fed’s remedies will abound. Akin to a desert monsoon that starts with a puff of clouds and morphs into something larger - everyone senses the deluge is coming but are uncertain how extreme the soaking will be. Full disclosure. Neither do I. 

 
Certainly, my years of experience and witness of several downturns can add credence. But, the reality is all are different in their causes. Take 1990-1994 as an example. Loose lending by savings and loans and their ultimate demise, over building, and Iraq’s invasion of Kuwait catalyzed the boom years of the late eighties to a screeching halt. 
 
How about 2008-2011? Easy money to unqualified home buyers coupled with another spate of massive construction starts was ill prepared for a pause in the music. Many were left without a chair as the financial markets froze and lending ceased. 
 
Today, the culprits are the pandemic which left us home bound and computer key happy, stimulus checks, and supply chain clogs. The classic case of too many dollars and too few goods took effect causing consumer prices to spike. Not since the Carter years have we seen inflation this high. 
 
Caught in the crossfire is real estate - commercial and housing. Housing has started to slow as buying power is directly impacted by pricier loans. Even though inventory of homes for sale is low - offerings are sitting around longer and the frenzied pace of January 2022 is a distant memory. 
 
So when will we know the commercial market is slowing? The following will provide some guidance. 
 
As I’ve mentioned, commercial real estate trends follow residential by 12 to 18 months. But we’ll sense a slowdown soon - if it’s coming. 
 
First, listings will languish. What flew off the shelves earlier in the year will take longer to lease or sell. Recall, our vacancy is at historic lows. So, this won’t happen next week. But, maybe an offering that generated multiple offers will settle for one or two. 
 
Next, owner motivation will shift. The longer a vacant building lays fallow, the more desire an owner will have to fill it. 
 
Pricing will stabilize and then decline. With occupants on the sideline, owners will be forced to deal. One way to do so is through a reduction in asking prices. 
 
As rents adjust, so will values. Recall, the price an investor will pay is a return on the lease check a tenant writes each month. A decline in this amount coupled with an upward move in capitalization rates causes the price per square foot to decrease.  

Believe me, I’m watching all of the above quite carefully. Just today - while guiding a tour - the conversation centered around “where are we going” as it pertained to our owner’s situation. Yep. An entirely different rhetoric was rampant a mere three months ago. 

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.

Random CRE Thoughts

Occasionally, it’s cathartic to empty the cache of our consciousness. Today is that day. As someone famous once opined - they’re only thoughts but they’re random and all mine. So with no further adieu, here goes!
 
Lee and Associates Summit. Last week we found ourselves at the Encore in Las Vegas for our annual soirée - AKA the Summit. Participants from all over North America and the UK attended. 2020 was scrapped entirely. 2021 was virtual. So this was the first time we’d been together since 2019. MUCH has changed - including a supercharged industrial market, an uncertain office environment, and a morphing retail experience. I should mention, our technology tools have also improved. Months of lockdown will do that to an industry.
 
Highlights from the industrial panel featuring professionals from the Rockefeller Group, Dermody, and Prologis follow. Institutional property owners are wary of inflation, a pending recession, and what impact both will have on cap rates. All agreed - industrial has been the darling and even if all of the new projects under construction laid fallow - our vacancy would still be skimpy - around 5.5%. Fuel conservation, automation, and taller and more efficient inventory is in our future. With the advent of self driving trucks - truck courts may be shorter.
 
Technology use in commercial real estate has lagged our residential counterparts. Since a house purchase is largely a consumer transaction vs a business deal - target rich social media sites are not as plentiful. Plus, we don’t share our available inventory and lease comps through a realty board clearinghouse. Therefore, we’ve been slower to adapt. We’ve witnessed a large consolidation of tech providers as evidenced by Lightboxes acquisition of ClientLook, Real Capital Markets, and Digital Map Products. Also, Buildout recently added Apto, Rethink CRM, and Prospect Now. No one dares to take on the big Gorilla - CoStar however. Some in the audience wondered if the broker would ultimately be ousted? Consensus was more money CSM be made selling to brokers vs replacing their role.
 
Who knows where we’ll be next year. Most agreed Las Vegas is tough to beat for its travel ease, entertainment, and massive convention know how. It is a tough schlep from the East however.
 
My foray into the Orange County office world. As readers know, my expertise centers upon manufacturing and logistics buildings and the family owned and operated companies that occupy them. I don’t seek office assignments, but occasionally they find me. Our current task is an offshoot of an industrial deal. You see, we were engaged to sublease a building’s warehouse. Planned was for the tenant to remain in the office portion. As our campaign unfolded - two groups emerged who wanted both - the warehouse and office portion of our offering. Now the operating group is considering a move into a suite of offices. Therefore, we toured eight suites in five buildings over the past week. The office world is changing to meet an evolving workforce. Open collaborative spaces are vanishing and returning to banks of private areas. After all, virtual meetings require privacy. Outdoor space is sought for respites, meetings, and functions. On-site amenities such as conference areas, fitness centers, and game rooms are cropping up. Corporate America is considering amenities in office buildings as a way to attract new workers and convince existing ones to return. Quite interesting turn of events, indeed.

 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.