Capital Markets - Institutional Investors

Commercial real estate ownership is divided into those that use it for their operations and those who rely upon the occupant to pay rent - also referred to as investors. Sure. There is a subset of occupant investors - those who own the building from which their business operates. But today’s column focuses upon another type of investor - the institutional investor. 
 
First, a bit of background on the characteristics of this genre. Generally, the institutional investor sources its capital through other people. You may be thinking, ok. My neighbor encouraged me to invest alongside him in acquiring a neighborhood shopping center. Is he an institutional investor? The answer is no. The “other people” mentioned refers to large buckets of money - the capital markets - amassed by pension funds, life insurance companies, and the stock market. If you’re a teacher, a police officer, a fire fighter or work in city hall, a portion of your paycheck is deducted. These dollars flow into funds which are then invested in stocks, bonds, and yes - commercial real estate. Those annual premiums paid to insure your life must be deployed into vehicles that earn a return. Once again, commercial real estate. Finally, you may have heard of a real estate investment trust or REIT. Publicly traded versions of REITs find money through the stock market. Prologis and Rexford are examples of REITs that develop, purchase, own, and manage commercial real estate. And more specifically, industrial. 
 
So, with that explanation as a backdrop, what are institutional investors experiencing these days? 
 
Capital for industrial purchases is returning. After a period of caution, capital is once again flowing into industrial real estate. Institutional investors are seeing renewed interest from their funding sources, driven by the stability and long-term growth potential of the industrial sector. Remember, investment activity came to a screeching halt two years ago as the Fed started its tightening pilot to tame decades high inflation. 
 
Demand for coastal gateways is increasing. Coastal gateway markets, such as those in California, are experiencing heightened demand. These markets are crucial for import/export activities and provide strategic advantages for distribution and logistics operations.
 
The leasing picture has become clearer. With the economic uncertainties of the past few years beginning to settle, leasing is becoming more predictable. Institutional investors now have a better understanding of market dynamics and tenant demand, allowing for more informed decision-making.
 
Interest rates are declining. After a period of rising interest rates, we’re seeing a trend towards stabilization and even slight declines. This shift makes financing more attractive and affordable, spurring increased activity in property acquisitions and developments.
 
Expectations for rent growth. Institutional investors are optimistic about future rent growth. Factors such as limited supply of industrial space, growing e-commerce demand, and strategic locations near major transportation hubs are expected to drive rents upward.
 
In conclusion, institutional investors play a significant role in the commercial real estate market, especially in the industrial sector. With capital returning, increased demand for strategic locations, clearer leasing dynamics, favorable interest rates, and expectations for rent growth, the future looks promising for these major market players. Understanding their impact helps us all appreciate the broader trends shaping the commercial real estate market today.
 
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.
 

SIOR Meanderings

From SIOR.com - “For more than 80 years, the Society of Industrial and Office Realtors® (SIOR) has been the leading global professional office and industrial real estate association, and continues to move the industry and our members' business forward as we drive the future of Commercial Real Estate. With 3,900 members in over 50 countries, SIOR represents today's most knowledgeable, experienced, ethical, and successful commercial real estate brokerage specialists.” 
 
I’ve been a proud member of this organization since 2018. The semi-annual conferences are epic, the destinations are glorious, the education is unparalleled, and the networking unsurpassed! We returned from this spring’s gathering last week and I’ve now had time to decompress and reflect on what I learned. This column will share some insights. 
 
Industrial breakout. I spent time with industrial real estate brokers from around the United States and the world. Monday afternoon’s conversation was quite eye-opening. Discussed was occupant’s use of Automated Storage and Retrieval Systems - ASRS. These high-tech inventory management arrangements cause a modern logistics provider to be more efficient, timely, and they require fewer employees. Many in the cold storage space are utilizing an ASRS to more strategically manage their inventories. In one instance, an occupant called AmeriCold constructs their new buildings around such a system and in many cases, they stretch 150 feet in height. To put this in context, that is approximately twelve stories high, and roughly four times the height of the modern concrete behemoths we see being erected in the Inland Empire.
 
Data centers, which power artificial intelligence are springing up around the United States, as well as chip manufacturing fabs as they referred to. The underlying challenge of both industrial real estate applications is the acute need for power.developers of these buildings seek power first and communities that can provide the power as opposed to the cost of land under which the building is constructed. A new concept called mini grids are appearing around the United States. These systems are encapsulated power serving a specific site with the juice generated by solar, wind, or other forms of renewable energy.
 
Industrial roundtable.  We heard from agents representing Mexico, Tampa, Florida, Atlanta, Georgia, Charlotte, North Carolina, Nashville, Tennessee, Dallas, Texas, Houston, Texas, Rotterdam, the Netherlands, Toronto, Canada, Laredo, Texas, Columbus, Ohio, Indianapolis, Indiana, and Los Angeles, California. Curiously absent from this round up was anyone from the middle part of the west such as Denver, Salt Lake City, and Phoenix. Certain themes were repeated. Much like Southern California - large scale inventory between 100,000 and 500,000 ft.² has been dramatically over built and therefore more supply than demand exists. In buildings larger than 500,000 ft.², a shortage exists. And there is still quite a demand for large boxes. The most robust size range nationally are buildings under 50,000 ft.². Most mentioned power and the lack of a sustainable source to be an existing in future challenge. All of the markets have experienced occupant demand waning as a result of inflation, higher borrowing rates, and the de-inventory after the Covid pandemic. The representative from Los Angeles, California opined that we are at the bottom in terms of rental rates as rents have decreased 30 to 40%. He echoed that 800,000 ft.² and larger is a hot size range as well as buildings below 50,000 ft.². The Los Angeles ports are doing a record amount of business. Third Party Logistics operators - 3PLs - are renegotiating leases that they originated in 2020, 2021, and 2022. Finally some local insurance carriers are requiring electrical panels be replaced in order to lessen the possibility of fire.
 
It’s very interesting to hear about the successes and struggles of other SIOR brokers around the United States. I’ll look forward, with great interest, to our fall conference which will be a home game as it will be based in Hollywood California. 
 
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 Can The Southeast Teach Us About Commercial Real Estate

Semi-annually, an organization called Society of Industrial and Office Realtors - SIOR - gathers to compare notes on what’s happening around the country. This year’s soirée is in Florida and begins today. I’ll have more on this year’s spring conference in next week’s column. However, having not seen places like Savannah, Charleston, and Hilton Head - we decided to get our wanderlust on and cover some turf. The weather cooperated beautifully as did the bugs. I’ve rarely seen such beauty in the architecture and countryside or encountered such a nice group of people. We’ll be back!
 
You may be wondering what a sojourn to the southeast has to do with commercial real estate? Only these. 
 
The Southeastern region of the United States - including Florida, Georgia, and South Carolina, boasts a diverse economy, significant population growth, and varied market conditions. For instance:
 
Population Growth. The Southeast has been experiencing rapid population growth, driving demand for various types of commercial real estate, such as retail spaces, office buildings, and residential developments. The deep water ports in Savannah and Charleston receive and distribute goods from around the globe
 
Economic Diversity. From technology hubs like Atlanta to tourism-driven markets like Orlando, the Southeast showcases a diverse range of industries. Augusta, Georgia has become a cyber security hub. These economic drivers can provide demand for all sectors of our industry - office, retail and industrial spaces. 
 
Infrastructure Development. The Southeast has seen significant infrastructure investments, including new highways, airports, and ports. These developments cause a need for industrial and logistics properties.
 
Resilience to Natural Disasters. The region's resilience to hurricanes and other natural disasters has prompted innovations in building design and construction techniques, which can inform risk management strategies for commercial real estate investors.
 
Regulatory Environment. The regulatory environment varies across states in the Southeast, impacting zoning laws, tax incentives, and development regulations. Florida has no state income tax and other states provide incentives for relocating a business here. Understanding these nuances is crucial. 
 
Overall, studying the Southeast's commercial real estate market can provide valuable lessons in adapting to demographic shifts, economic trends, and regulatory changes that affect the 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.
 

Top Ten Killers of Commercial Real Estate Deals

Today I must get my David Letterman on and discuss the top 10 reasons commercial real estate deals fail to close. As I have discussed in this column, ad nauseam, commercial real estate transactions are simply leases or purchases. We differ from our residential brethren, in that a large percentage of our transaction volume is comprised of leases. Specifically, some agents ply their entire trade negotiating leases either in renewal, direct, or sublease fashion. These professionals are known as “tenant rep” brokers because the majority of their work is on the occupant side of the table. Notably, as interest rates have risen over the past year and a half, we’ve witnessed a reduction in sales to the benefit of leases. Fortunately, a commercial occupant has a choice! Also, present in the industrial arena this year is a plethora of sublease business - an occupant no longer needs the space from which they operate and must locate a surrogate to fulfill their obligation. 
 
Today, I’ll illuminate the top ten reasons these deals - sales and leases - fail to consummate. 
 
Financing Issues. Difficulties in securing financing or unexpected changes in lending terms can jeopardize a deal. Issues such as insufficient funds, a spike in interest rates, or stringent lending requirements can lead to deal termination.
 
Due Diligence Concerns. Discoveries made during the due diligence process - that free look period occupants have to study a property - such as environmental issues, zoning violations, or property defects, can cause buyers to walk away from the deal or renegotiate terms.
 
Title Problems. Title defects, unresolved liens, or disputes over property ownership can delay or derail a commercial real estate transaction.
 
Appraisal Shortfalls. If the property appraises for less than the agreed-upon purchase price, buyers may struggle to secure financing or may seek to renegotiate the deal terms.
 
Environmental Issues. Environmental contamination or concerns about potential liabilities related to hazardous materials on the property can complicate or prevent a sale or lease from closing.
 
Legal Challenges. Legal disputes, such as zoning violations, boundary squabbles, or recorded lease agreements, can delay or derail a commercial real estate transaction.
 
Market Volatility. Changes in market conditions, such as uncertainty, shifts in supply and demand, fluctuations in interest rates, or economic downturns, can impact deal viability and cause parties to reconsider their positions.
 
Renegotiation Attempts. One party may attempt to renegotiate deal terms after an agreement has been reached, leading to a stand off and potential deal collapse if both parties cannot come to a satisfactory resolution. We’ll typically see this after an occupant has completed their due diligence and found an issue. 
 
Contingencies. Contingencies outlined in the purchase agreement, such as the sale of another property or obtaining necessary permits, may not be met within the specified timeframe, leading to a cratered deal.
 
Buyer or Seller Cold Feet: Sometimes, one party may simply have a change of heart or lose confidence in the deal for personal or business reasons, leading to deal cancellation. We once had a buy requirement pause because he contracted Covid-19. This caused him to re-think his entire life and business. 
 
And. Not among the top ten but certainly a thing. Sometimes, you just don’t see it coming! But boom, there it is. The death of a principal, collapse of the financial system - 2008, a pandemic - 2020, or a company is sold during your negotiations. Yes! We’ve seen all of these. 
 
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.
 

Occupant Mistakes

Occupants of commercial real estate, also referred to as users or occupiers fall into two categories - tenants or owners. To draw a finer distinction - both are tenants - however one genre pays rent to an unrelated third party, a landlord and the other pays rent to a related owner of the building. Most common in the second type, is a real estate ownership structured as a limited liability company, LLC, and the occupier a corporation. 
 
Today, I want to focus upon some common mistakes I witness occupants make in their commercial real estate decisions. 
 
No agreements. Too frequently, I see this with occupants whose building ownership is synonymous with that of the operation. A building is purchased, many times with debt, and a mortgage payment is originated. Additionally, property taxes, insurance, and maintenance are incurred. Resulting is a payment - rent - which ownership charges the resident. Unfortunately, the payment has no relation to a market rent for a comparable building. The owner has her costs covered and believes everything is golden. Unfortunately, a subsidy - charging the company less than market - devalues the operation. If a market rent was charged, a deduction in profit results. Conversely, billing too much places undo strain upon the occupant and ready sources of capital are consumed. This can limit the ability to hire, buy machinery, and grow sales. 
 
Once a satisfactory market rent is determined, it’s critical to have a written agreement between the parties - outlining the rent, expenses, term, increases, and options. 
 
I once had a client forced to move because no written agreement existed between the owner and occupant. Unbeknownst to the occupant, the owner had deeded small portions of the building ownership to various entities, such as ex-wives, charities, ex-girlfriends, and the like. When the owner met his untimely demise, the occupant - who was also a small owner of the building - found himself without an agreement and many different factions wanting their equity. A trustee was appointed to sort out the mess. The trustee’s only course of action was to sell the building and force the tenant to relocate. Extreme, but it can happen.
 
Extension rights. Extension rights fall in to numerous categories including options to renew a lease term, options to purchase the building, options to terminate the lease, options to take additional space, rights of first refusal to purchase and lease, as well as rights of first refusal and rights of first offer to purchase the real estate. Clearly, these understandings must be in writing in order to avoid conflict. However, one of the problems I see is the agreements are too vague. As an example, maybe an occupant has the option to renew the term of their lease for five years upon the expiration of the original lease term. If the language simply says - and occupant can stay for an additional five years at a mutually agreeable rate, disagreements can occur -  because no mechanism exists to determine a fair rental rate. Therefore, it’s important for options to not only be in writing, but also have clear definitions as to how rents and purchase prices are to be calculated. I’m involved in one such exercise currently where the language is very specific. If the landlord and tenant cannot agree upon a rate, each appoints, an arbiter to make an independent evaluation of the market. If those two arbiters cannot come to an agreement, a third arbiter is appointed by the previous two and her determination is final. This is a cumbersome process, but one which will avoid any disagreement. Finally, make sure the market lease rate or market purchase price is based upon comparable buildings within a comparable sub-market with similar amenities. In other words, it’s unfair to compare a 4000 square-foot address in the Irvine Spectrum to a 100,000 square-foot building in Santa Fe Springs.
 
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 Thoughts

Ahh, springtime. Longer days, warmer temps, flowers abloom, the crack of the bat on opening day of MLB, NCAA final four, and the Masters golf tournament. You may be wondering how I have time to make any deals with all the sports happening this time of year. It’s tough. But in light of the screen time I’m spending, my thoughts these days are random. 

 
Please stay tuned as I run through a few thoughts I have clouding my consciousness. Someone famous once said - they’re only opinions, but they’re all mine”. 
 
Seller/buyer disconnect. I wrote an entire column on this topic last week. If you missed it, you can catch it online.
 
Not terribly long ago, we were immersed in a seller’s market. Occupant demand outstripped supply and sellers were bullish. Multiple offers were the norm. Asking prices were abandoned for the dreaded TBD in case pricing was pegged too low and money was left on the table. The amount of buyer activity determined the ultimate strike price. In order to compete in this frenzy, occupants were forced to shorten due diligence periods, jettison financing contingencies, and seemingly overpay. A listing translated into a guaranteed paycheck. 
 
My how the world has changed in two short years. The only thing keeping sales prices relatively stable is a lack of availabilities. 
 
Impact of our Presidential election. I get asked quite often what to expect if Mr. Trump is elected vs Mr. Biden. Generally, a republican administration can portend tax cuts, an increase in defense spending, loosening of government regulations, and the appurtenant boom in the economy. To the extent this boom causes prices to rise - interest rates must be hiked in order to cool the fever. 
 
Counter to this would be a democratic administration with higher taxes, cuts in defense, more regulation, and a weakening economy.   
 
Yes. I’m oversimplifying. I can hear the detractors screaming - we have a democrat in office and the economy is just fine. In our most recent republican tenure, government debt increased dramatically. So the above are only generalities. 
 
Bottom line. Who knows? 
 
What’s happening with our economy? Speaking of said economy, what’s up? Consumer confidence is high, over 300,000 jobs were added in March, labor participation rate is now close to two thirds. If the economy is in the doldrums - why are employers adding so many jobs? Granted a big portion of the new employment is in the service industry where folks are spending money to dine out, take trips and buy experiences. Meanwhile, we expected a declining interest rate market this year as we anticipated the Federal Reserve would start the march down with inflation coming to heel. As of this writing, our benchmark ten year treasuries are topping 4.4% - bad for borrowers, good for savers. Retailers in the beauty trade are taking their lumps as well. 
 
Bottom line. Who knows. 
 
Springtime spells new beginnings. Another year and another batch of things to ponder. Should be an eventful balance of 2024. 
 
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.
 

Education of Buyers and Sellers As The Market Adjusts

In order for a real estate transaction to close - whether it is a lease or a sale - a properly motivated buyer and seller must be present. By this I mean you need an owner ready to make the next deal and an occupant who’s kicked the tires and is prepared to sign. Ideally, these motivations mesh into a synchronicity that is melodious. 
 
Currently, in our Southern California industrial real estate market we have a mismatch of expectations. Owners tend to remember how things were in early 2022 when occupant demand was robust, inventory was scarce, and interest rates were affordable. Folks who lease and buy these buildings perceive the opposite - a downturn in their business (less need for space), more addresses sitting vacant for longer, and borrowing costs that have doubled. A standoff akin to an old west gunfight has ensued. Fortunately, no one will be bodily harmed in said showdown. However, owners late to the fight may suffer financial losses. 
 
Today, I’d like to discuss our biggest task as commercial real estate brokers. That is educating owners and occupants to current market conditions. 
 
Understanding Market Dynamics. To grasp the current state of affairs, we need to delve into the factors shaping the industrial real estate market in Southern California. In the recent boom, investors favored constructing large warehouses for logistics operators, who primarily lease these spaces. Initially, the demand surged as online shopping soared, prompting distributors to expand their inventory storage. However, as the frenzy settled, warehouses across all submarkets now sit vacant, competing for tenants. While reducing rental rates seems a logical solution, constraints like promised returns to investors or fixed cost structures complicate matters.
 
Challenges Faced by Owners. Owners are grappling with the challenge of reconciling past experiences with present realities. Many are holding onto outdated expectations, hoping for a return to the heyday of early 2022. However, failing to acknowledge the shifts in demand, supply, and financing could lead to missed opportunities and financial losses.
 
Perspective of Occupants. Occupants, on the other hand, are feeling the impact of changing market conditions firsthand. With businesses adapting to new norms and uncertainties, the need for commercial space has shifted. This shift in demand has implications for leasing and purchasing decisions, as occupants navigate a landscape fraught with uncertainties.
 
The Broker's Role in Education. As brokers, our role extends beyond facilitating transactions; we are educators and advisors. Providing owners and occupants with comprehensive market insights, backed by data and analysis, is essential for setting realistic expectations and making informed decisions. By bridging the gap in understanding, we empower our clients to navigate market shifts with confidence.
 
Building Synchronicity and Moving Forward. Ultimately, success in commercial real estate hinges on collaboration and adaptability. By fostering open communication and collaboration between owners and occupants, we can work towards mutually beneficial outcomes. Embracing flexibility and adaptability allows us to navigate market shifts and seize opportunities as they arise, paving the way for continued success in an ever-changing landscape.
 
Education of owners and occupants is key to success in commercial real estate. By equipping buyers and sellers with the knowledge and insights needed to weather market shifts, we can bridge the gap in expectations and reach agreement. I’ve often opined - “allow the market to be the bad guy”. If I tell an owner - here’s how it is, I’m asking that reliance’s be placed upon my experience and credibility. I could be wrong. However, if we engage in a process of discovery - the market is sending the feedback. 
 
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.