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.
 

What to expect for the balance of the year with commercial real estate.

As I write this column there are approximately nine months remaining in 2023. Yes. The year is slipping by quickly. And now with the tax deadline postponed until October - the landmark signaling “it’s time to get rolling” each year has vanished. The first three months of 2023 have been curious. Overall, the amount of industrial activity has waned. Certainly compared to Q1 of 22 but also compared with the last half of the year as interest rate hikes, inflationary pressures, and global turmoil created uncertainty. So what am I watching and what should we expect for the last gestation period of 2023? 
 
The Federal Reserve. Our central bank is in a real quandary. On the one hand, inflation has proved stubborn - due primarily to consumer spending, the cost of shelter, and services. On the other hand, if the Fed resumes its aggressive rate march up the ladder, it risks causing other bank failures. As well, a pause could be an indication they’re concerned about breaking something else which could further shake confidence. Two weeks ago, I was in the camp expecting a 50 basis point bump. Now, I believe we’ll see a 25 basis points. This will increase the Fed Funds Rate 4.83%. In January of last year it was .58%. Will we reach a 6% target as anticipated this year? Unlikely at the point. But with the fluidity with which we saw events unfold over the past week - it wouldn’t shock me.
 
Class A industrial leasing activity. Our market is delivering more class A industrial inventory than ever since we began tracking such things in 1990. Fueled by a low cost of money, large global manufacturers making a decision to sell their aging campuses, and rabid developer appetites with an institutional credit card and desire for returns - we saw such name brands as Kimberly Clark, Boeing, Beckman, Kraft Heinz, National Oilwell Varco, Schneider Foods, Ricoh, and others hit the exit ramp. Resulting has been an array of beautiful new logistics spaces with all the new amenities of upgraded warehouse fire suppression, super high stacking capabilities, and marvelous truck maneuvering. Just over 2,700,000 square feet of new addresses are open for business and seeking residents. Goodman’s development in Fullerton - on the old Kimberly Clark site and been noteworthy. Delivering first in an otherwise crowded waiting room and with size ranges not normally found in North Orange County - 100% of the 1,600,000 square feet have been leased with recognized names such as Sprouts, Samsung, and Bandai. Very successful! What remains to be born are a number of buildings of essentially the same size range - 120,000-200,000 square feet. I believe we’ll see some lease rate softening in order to get all the buildings absorbed.
 
Office building defaults. A perfect storm is brewing. First, our hybrid working environment has cratered high rise occupancy. Second, office deals are expensive to originate. Once downtime, rent concessions, beneficial occupancy, tenant improvements, and broker commission bonuses are computed - roughly half the income an owner will receive is pre-spent. Next, our stock of office buildings in Orange County is aging and many don’t provide the modern experience many office tenants are seeking. In order to retrofit these vintage spaces is extremely expensive. Plus, the investment doesn’t guarantee a higher level of occupancy or higher rent. Finally, we’re in an unfavorable interest rate environment that is filled with lenders unwilling to loan on office space. My sense is some owners will opt to hand over the keys to the lender vs investing a ton of money to bolster leasing activity.
 
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.
 

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

As we dawned 2022, yield on ten year treasuries was 1.73%. Also referred to as T-bills - the rate today is 3.4%. Last week the rate eclipsed 4% for the first time since last October. But prior to that, rates had stubbornly refused to budge north of 4%. During the Federal Reserve’s loosening in the pandemic - rates on ten year treasuries were below single digits. That’s right! In mid 2020, if you agreed to tie up your money for ten years - until maturity - you’d receive a paltry .52%. Let’s say you were quite cautious, risk averse, but wanted some return on your cash and bought a pile of these government issues. If you planned to redeem the bonds in 2030 - no problem. The return would be there, along with your principal amount. Let’s say for example you parked $100,000 in this manner. You could expect your investment to yield $520 per year for its duration. But. What would happen if you needed the principal before the maturity date of 2030? You could sell the bonds on the market. But at a steep discount. How much, you may be wondering? Using the yield of 3.4% today, your principal would be worth $15,294! That’s a hit of close to 85%. This very over simplified example is partially what caused Silicon Valley Bank to fail and be seized by federal regulators. When the run on deposits occurred last week - the bank was forced to take a loss on its bond portfolio in order to cash out investors. Bonds move inversely. As the price of a bond increases its yield decreases and vice versa. Capitalization rates on real estate behave in a similar fashion. As cap rates increase - the value of the underlying property decreases.
 
So. To the question above - what impact a bank failure might have on commercial real estate - here goes.
 
The Federal Reserve may not raise rates as aggressively as it planned. When the federal reserve started its march toward a federal funds rate target of 6% - in an effort to lower inflation to 2% - a series of .75% rate hikes ensued. These .75% rate increases morphed into .25% rate increases early this year as inflation showed signs of easing. We’ve now experienced a couple of months of strong jobs numbers paired with increased wages and a resilient consumer who refuses to stop spending. Before the bank shenanigans of last week, many believed a .5% increase was in the works for the March Federal Reserve meeting. However, because of the rapid increase in the Fed Funds rate - remember we’ve gone from a half a percent to 4.5% in less than a year - some believe we could avoid an increase altogether.
 
Borrowing costs may increase. If depositors believe certain banks are riskier than others, they’ll demand a greater return on their money for the added risk. Read. Higher depository costs. If failures cause a revamp of banking regulations - similar to what we experienced in 2008 - reserve requirements might increase. The impact of these two mean fewer, more expensive dollars to lend.
 
Investor activity may slow. We saw a dramatic decline in institutional investor activity in the second half of 2022. Left were private capital investors. Historically, this investor genre will pay less than institutions. Primarily because they borrow money to affect the buy. A classic disconnect is now occurring between buyers and sellers. Unless there is distress on behalf of a seller and/or tax motivation on behalf of buyers the dance ends before the band tunes up. I don’t see this ending soon.
 
Cap rates may be higher. Expect higher cap rates because of all of the above. Keep in mind. A year ago 3.75%-4.25% cap rates were the norm. Traditionally reserved for the bondable absolute net investments - such as Amazon on a ten year lease with 4% annual rent hikes - capital, seeking return, was pouring in to anything with a truck door. Many eschewed long term leases in favor of shorter terms where a rent pop could be sooner realized. Now. The government will pay you 4.2% for a two year treasury backed by the full faith an credit of the United States. Sure. You don’t get the appreciation or depreciation of a real property investment but the risk is minimal. 
 
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.
 

Is NOW a good time to sell?

With the uncertainty that permeates the media these days, many may be wondering if now is a good time to sell their commercial real estate. After all, interest rates are roughly double what they were just a year ago, rabid investor appetites have moderated, world turmoil persists and there is in again some rumbling we could recede later this year? Remember, you heard it here first in January - I believe we’ll avoid a recession - but I digress. To the question de jure. Is now a good time to sell? My answer is - it depends. Allow me to expand. 
 
In the universe of sellers there exist three types - equity, non-equity, and distress. Daylight appears between the market price  of a property and any debt owed in an equity situation. The reverse is the case in a non-equity circumstance. However, not all non-equity sellers are in distress and some distress sellers still have equity. 
 
Equity seller. A property owner with equity views their situation as a “I don’t have to sell”. But. Is their equity earning the type of return it should? I spoke to a private investor last week. He’s owned and operated an industrial property since he bought it in 1998. He owes very little - which means a large pool of equity resides. He’s facing a maturing mortgage. He can refi the underlying debt, pull out some cash and the property will still cash flow - provide income after the mortgage is serviced. But is that the right move? With the rampant appreciation experienced since he acquired the property and only moderate rent growth - the return on his equity is skimpy. When I explained what sort of return could be achieved by selling today and redeploying his equity via a tax deferred exchange - he was intrigued. He can’t sell for early 2022 pricing but won’t have to buy at 2022 pricing either. There is a trade off. Sellers who occupy buildings with their companies generally are guided by business motivations - vs real estate market conditions. Specifically, if more space is needed and the residence will become excess - a selling decision might be made. Because the proceeds will be funneled into the next buy - less emphasis is placed on extracting the highest dollar amount - and more on certainty of close. 
 
Non-equity seller. Those that purchased in late 2021 and early 2022 with 90% small business administration financing could presently be a non-equity owner. With the price softening this year coupled with maximum leverage from last year - chances are no equity remains. An aggressive loan repayment or a rampant run up in pricing can remedy the imbalance. Given this scenario - I’d suggest holding unless some distress appeared.  
 
A seller in distress - equity or non-equity. In the non-equity example above, should loan repayment be required, distress emerges. Now this owner may find his only recourse is to sell - at the best price attainable. Certainly, refinancing the debt could be an option but with no equity - lender alternatives will be limited to non-existent. Because this is a forced sale of sorts - market conditions are secondary. The seller must do the best he can under the circumstances. 
 
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.
 
 

Are Sale-Leasebacks still viable?

Our practice centers around family owned and operated manufacturing and logistics businesses experiencing a transition. Recently, I wrote about common transitions small businesses experience. Included among these were - dissolution of a partnership, sale of a business, acquiring a competitor, or the unfortunate circumstances of the death of a principal, divorce or some other distress within the enterprise. 
 
As reviewed, all of these transitions come with their own brand of commercial real estate solution. As an example, when a competing company is acquired - two cultures must be forged into one - akin to a blended household. As you can appreciate, this can cause some drama. As the operations are morphed - so must the locations from which they occur. Frequently, redundancy is experienced. Specifically, two buildings within the same submarket - where only one is needed. Consequently, one must be jettisoned. 
 
But, let’s examine the flip side - the seller of the acquired competitor. When the sale of a business happens, the addresses from which the trades are plyed are either owned by the principal selling or leased by said principal. In the circumstance mentioned above where two facilities are within the same geography, two different strategies are employed. If the redundancy is leased and a decision is made to abandon the building - we can sublease, pay double rent until the term boils off, or default - never recommended. If owned - now without an occupant - we can sell the empty building or lease it and hold on or possibly sell the leased location to an investor. 
 
But how about the chosen building - the one selected to carry forth the business of the company and not deemed excess. Then what? A building owner finds herself in position to assign the lease agreement if appropriate, or sell or lease the building to the acquiring group. 
 
All of the above scenarios contemplate the moves made AFTER the business sale. But are there maneuvers before such a liquidation? Certainly. And I’ll spend the balance of my words describing one such arrangement - the sale-leaseback. If you’re unfamiliar, a sale-leaseback allows the owner of the location to liquidate the real estate while allowing the occupying company to remain in residence under a long term lease arrangement. 
 
We were fortunate last year to complete five sale-leasebacks. Four of the five were done in anticipation of a sale of the occupying companies. In one case a principal’s death caused disruption and the need to quickly restructure and liquidate for the heirs - who had no desire to own a company or the real estate it occupied. In the other three - the principal was in his late seventies, had experienced a business downturn from the pandemic, but wanted to capture the appreciation of the real estate today in anticipation of a business sale in a couple of years. 
 
So, why do this prior to a company’s sale? After all, rent will no longer be received by the seller. In our experience, the reasons that follow are typical. 
 
A market rent is established from which a company’s value is derived. 
 
Real estate values ebb and flow. Taking advantage of a hot market can make sense. 
 
A marketable lease can be structured - with appropriate lease rate, terms, increases, and maintenance responsibilities. 
 
You may be wondering. Does selling real estate prior to a company sale affect the company buyer pool? It indeed can and this should be carefully considered before such a strategy is completed. How you may wonder? As mentioned above - a buyer with similar locations my view a long term lease as a liability. This occurs frequently when a strategic player emerges - a group in the same industry. 
 
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.
 

CRE Brokers Defined

I delivered a presentation to a sales team of material handling specialists last week. Why you may wonder? I would share with you two reasons. First, I’ve transacted nineteen deals with the president since 2009 all over the western United States - we’ve grown together. This was one way of giving back to an organization that’s  been very kind to me. Secondly, we work closely with their sales team in assisting us execute deals. The better they understand our world - we both benefit. 
 
Some of you reading this column are commercial real estate practitioners. Others of you own or lease commercial real estate and pick up tidbits along the way. Still others  may be considering the field as a career or a way to supplement your income. Regardless, of your vantage point, I believe you’ll find value in todays topic. 
 
Let’s center the column on three of the four topics discussed - CRE brokers defined, how we’re paid, why you should care. 
 
CRE brokers defined. Said simply, commercial real estate brokers assist owners and occupants of commercial real estate in finding buyers or tenants for vacant buildings in the case of owners, or finding a place to relocate in the case of occupants. Commercial real estate companies are generally local, regional, national, or global, determined by the reach of their brokerage. These firms service a geography through their network of agents. Additionally, most firms find their agents on either or both sides of the transaction - representing the owner and/or the occupant. “Dual representation” describes an agent on both sides of the deal and is a much larger subject I’ll reserve for another day. However, there are companies who specialize in tenant or buyer rep. As a service provider seeking relationships with us - all of these elements are important to understand. 
 
How we’re paid. Full commission, no salaries or bonuses and only when we transact. Yep. We can spend days, weeks, months or years on initiatives that never pay us. Unlike those with salaries or hourly service providers such as CPAs or attorneys - our profession “eats what it grows” so they say. 
 
So what, you may be wondering. We enter through the C suite in many cases deal with the president, CEO, CFO, or the COO. This gives commercial real estate practitioners a view from the top, as opposed to some service providers who must begin with a warehouse manager, or a purchasing agent. Because we start in the C-Suite, our engagement is recommended from the boss, and in most instances we don’t have to compete.
 
We are the arbiters of change. Generally, the involvement of a commercial real estate broker is preceded by some sort of a transition. Whether it’s a death, a divorce, a massive debt that must be repaid, some distress, a dissolution of a partnership, or a disposition of the company - our job is to assist a company navigating these transitions. 
 
We are upstream from most relocation decisions. By this I mean, we must network with trusted advisers, so that we are in proper position once a transition occurs. Business attorneys, CPAs, commercial, insurance, brokers, investment, bankers, business, bankers, and wealth advisors are all professions. That will see a transaction before we do. But, we are in front of all those that must rely upon a transaction to occur such as contractors, escrow, agents, architects, and the like. 
 
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.