Negotiating The BEST Deal

Last week, we spent some time discussing the morphing industrial market and its impact upon pricing. To review, north Orange County - especially in large logistics boxes - approaching an imbalance weighted upon those who occupy. Supply exceeds demand. Only time will tell if price drops will spur demand - also known an elasticity. 
 
With that backdrop, today I’d like to offer some suggestions if you find your company heading out to make a deal - either a purchase but especially a lease. 
 
Know the market. Let’s say your requirement is 100 to 150,000 ft.² of logistics space in North Orange County. You should be keenly aware of everything that currently exists or will become available during your search time. By this, I mean, what tenants will vacate spaces that you could backfill. Coupled with an understanding of the available inventory is knowledge of the transactions that have recently occurred. By the way, transactions occur as sales, direct leases, subleases, and renewals. Sales are a matter of public record - their terms are easy to determine. Direct leases and subleases are more difficult to track because no deed is recorded. Renewal deals are the most difficult to review as frequently renewal deals occur between an owner and his occupant. These are typically not marketed and therefore difficult to gauge. It is imperative that you engage a commercial real estate professional, who really understands the marketplace in which your requirement will compete. Another factor with which you should be aware is the type of owner holding title to the property. An institutional property owner such as a pension fund advisor or a real estate investment trust will likely have more guard rails around the terms and conditions under which they can negotiate. A private owner may be more flexible in agreeing to favorable terms. Regardless, you must understand the owner’s motivations in order to secure the best possible sale price or lease rate and terms.
 
Know your capabilities. Things such as how long you will be able to commit to the space, what variances from the typical amenities will you require, what is the timing of your present lease expiration, do you own a facility that must be sold prior to transacting, is there anything unique about your use of the building that might cause a timing delay, and other questions should be seriously considered with carefully thought out answers. We recently represented a tenant who was able to sign a 10 year lease, use the improvements in the building largely as they existed and had a lease that expired with enough time to enable the building to become market ready. We were an ideal match for the owner. Had any of these components been lacking, our requirement would not have been as favorable. 
 
Understand your strong suit. If your company is ready to move upon closing a sale or signing a lease, and the building you are pursuing is vacant, you are potentially golden. However, the converse could be true if you are ready to make a deal yet the building won’t be available for another nine months. As you can see, something would have to change with this set of circumstances. Either you would have to delay possession or the owner would have to figure out a way to make the building available sooner. Is your company financially strong? In this rapidly changing market, credit is king. The last thing an owner wants to do these days is sign a long-term commitment with a financially shaky occupant. Turnover is expensive and owners want to avoid this at all cost. 
 
Be aware of your blind spot. If all of the interest in a particular piece of property were laid side-by-side, how does your interest compare? By this I mean, do you require bank financing in order to complete the deal? Is board approval a part of your process? Is there anything particular about your requirement, which could add time to your ability to say yes? Will a hefty legal review of all of the documents ensue upon the handshake? How does the purchasing or leasing entity look financially? Let’s say you want the very best purchase price available yet are hamstrung because of your need to procure financing. This adds an uncertainty to the transaction which may cause a seller to go a different direction. Of course, this assumes there are other potential purchasers. If your sense is you are his only alternative, you may be able to get a great price and the timeframe needed to close the deal. Certainty of clothes these days is more important than the very highest price. Consequently, structure your deal accordingly.
 
Don’t get greedy. The biggest mistake I see occupants make in this rapidly changing market, is trying to take advantage of an owner. Owners of commercial real estate are generally sophisticated entities with tons of market expertise. It’s safe to assume they’re acutely aware of their situation. If you are trying to extract the best sales price, lead with data. By understanding the owners exit strategy - lease up and sell or hold long-term, you can chart the course to completion. Using the lease up and hold exit, an owner will have to procure a tenant for his building before selling it to an investor. Therefore, understanding the rental market - rate, concessions and terms - you have a starting point. Once a tenant is in place, what is the market capitalization rate for this income. Assume $21.60 NNN annually and a 6% cap. The resulting price per square foot value would be $360 ($21.60 / .06). But the tenant is not there yet. So, it would be reasonable to expect some origination costs should be subtracted. After all, to procure the tenant will require some free rent, potential modifications to the building such as lighting or dock levelers, and brokerage fees. To compute this cost requires assumptions. Overestimate and the greed enters the picture. 
 
Thus, negotiating the best deal in today’s industrial real estate market requires thorough market knowledge, a clear understanding of your capabilities, and strategic negotiation. By focusing on data-driven decisions and avoiding greed, you can secure favorable terms in a challenging market.
 
 
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.
 

Price Reductions

Our industrial market in Southern California is rapidly morphing into a buyer’s/tenant’s market. By that I mean, a supply of available buildings which exceeds demand and a softening of prices. We’re seeing this especially in the large logistics spaces constructed in the last building craze. At their peak, rents topped $2.10 per square foot triple net for these concrete caverns. On a 100,000 sf building, that’s $210,000 per month plus an additional $40,000 for operating expenses. In context, these rents for a seemingly lower and lesser use - industrial - than an office building eclipsed the price paid for a suite of office space. 
 
Prior to June 2022, these boxes were devoured by hungry occupants before construction was completed. Now they sit. In some cases for months. Those deals that have transacted are much less than the halcyon days of two years ago. Now a credit worthy tenant can expect to pay $1.75-$1.85 triple net for the same address which commanded 17% higher numbers not that long ago. 
 
What about the sale market? In north Orange County - Anaheim, Placentia, Brea, Orange, Yourba Linda, Fullerton and la Habra - we’ve also seen softening. However, not to the extent rents have decreased. The inland areas tell a different story. 
 
Factors Contributing to the Shift:
1. Increased Supply: The recent building boom has resulted in an oversupply of large logistics spaces. These buildings, once in high demand, are now struggling to find tenants. This surplus is driving down rental rates as owners compete for a shrinking pool of occupants.
2. Economic Uncertainty: Economic factors, including inflation and rising operational costs, have made businesses more cautious about expanding their industrial footprints. Companies are re-evaluating their space needs and, in many cases, opting for smaller or more flexible leasing arrangements.
3. Changes in Consumer Behavior: The rapid shift towards e-commerce during the pandemic has now stabilized. As consumer behavior normalizes, the frantic demand for massive warehouse spaces to accommodate inventory surges has waned.
4. Financing Challenges: Higher interest rates and tighter lending conditions have made financing new acquisitions and developments more challenging. This has tempered the pace of new investments and developments in the industrial sector.
 
Opportunities for Tenants and Buyers:
1. Bargaining Power: With a glut of available spaces, tenants have greater bargaining power. They can negotiate more favorable lease terms, including lower rents, longer rent-free periods, and tenant improvement allowances.
2. Strategic Acquisitions: For buyers, especially those with readily available capital, this market presents opportunities to acquire properties at more reasonable prices. Investors can capitalize on distressed assets or properties that have been sitting vacant.
3. Long-Term Planning: Businesses can take advantage of the current market conditions to secure space for future growth at attractive rates. Locking in long-term leases now can provide stability and cost savings in the years to come.
 
Challenges Ahead:
1. Vacancy Rates: High vacancy rates can strain property owners who rely on rental income to meet their financial obligations. This could lead to increased property turnover and potential distress sales.
2. Maintenance Costs: Maintaining large, vacant industrial properties can be costly. Owners must continue to invest in upkeep to attract potential tenants, even as rental income declines.
3. Market Uncertainty: Continued economic uncertainty and potential regulatory changes could further impact the industrial real estate market. Stakeholders need to stay informed and adaptable to navigate these challenges.
 
Conclusion:
The Southern California industrial real estate market is undergoing a significant transition into a buyer’s/tenant’s market. While this shift presents challenges for property owners, it also offers opportunities for tenants and buyers to secure favorable terms and strategic investments. By understanding the factors driving this change and staying adaptable, stakeholders can navigate the evolving landscape and capitalize on new opportunities.
 
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.
 

Midwest Meanderings

Our travels took us to the upper Midwest to witness the nuptials of our dear friend’s daughter. We found ourselves in the land of Lincoln - Illinois and Wisconsin. 
 
You may be wondering what a trip to the Midwest has to do with Southern California commercial real estate. Please indulge me as I recap a few lessons learned. 
 
One of the most striking aspects of our visit was the strong sense of community and local support in the Midwest. Small towns thrive on mutual support and engagement, from local businesses to community events. In Southern California, fostering a similar sense of community within commercial developments can lead to more vibrant projects. Investing in local events, supporting small businesses, and creating spaces where people can connect can enhance the value and appeal of commercial real estate.
 
The Midwest is known for its unpredictable weather and the resilience of its people. This adaptability is a valuable lesson for commercial real estate in Southern California. As we face challenges such as economic fluctuations, environmental concerns, and changing market demands, the ability to adapt and remain resilient is crucial. Incorporating flexible design elements and sustainable practices into commercial projects can help buildings withstand various challenges and remain valuable assets over time.
 
Illinois and Wisconsin boast a rich heritage, with a blend of historical landmarks and modern innovations. Similarly, in Southern California, balancing preservation with progress is key. Renovating historical buildings to meet modern standards or integrating innovative technologies into new developments can create unique and appealing commercial spaces. Embracing both heritage and innovation can attract diverse tenants and visitors.
 
During our travels, we noticed the importance of efficient transportation and accessibility. Whether it was the well-connected highways or the ease of navigating small towns, getting around was convenient. In Southern California, prioritizing transportation infrastructure and accessibility within commercial developments can significantly impact their success. Ensuring easy access for customers, employees, and goods can enhance the overall functionality and attractiveness of a property.
 
Lastly, our trip was a reminder of the power of personal connections. The warmth and hospitality we experienced highlighted the importance of building strong relationships, whether in business or personal life. In commercial real estate, nurturing relationships with clients, partners, and the community can lead to long-term success. Personal connections often translate to trust, loyalty, and opportunities for growth.
 
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.
 

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.