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.
Showing posts with label rent increases. Show all posts
Showing posts with label rent increases. Show all posts
Friday, October 14, 2022
Friday, August 12, 2022
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.
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 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.
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.
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.
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.
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