Professional services are expensive! In many cases, hundreds of dollars an hour.
Generally, the level of experience is coupled with a high hourly fee structure. I am talking about consulting, tax, legal, banking, and wealth advice.
The more experienced your service provider is, the more you pay for her services - except with commercial real estate services.
Your commercial real estate service provider could have five minutes or fifty years of experience and you pay the same percentage of a sale or a lease if you hire him to sell or lease your building.
So aside from her experience, what are the overlooked reasons for hiring a commercial real estate broker?
The value of his network. Need a contractor to bid a tenant improvement - check! How about a consultant who will walk you through the maze of city requirements - check! What about a lender that can look past a couple of minor credit blemishes and get your loan done to purchase that building - check! Your commercial real estate professional can be a treasure trove of referrals for folks that can solve your problem.
His knowledge of the market. Two buildings of the same size appear in the comparable sale or lease set. One took five months to sell and the other was sold in thirty days. What was the difference? This is the type of market knowledge that can help you get your building leased or sold quickly.
Transactional expertise. Want to take your equity and accomplish a tax deferred exchange through chapter 1031 of the IRS code? How would you structure a lease with an option to purchase so that you are protected? If you award free rent to a prospective tenant, are you better served calling that concession "free" or "abated" rent? A professional can guide you through all of these variables and/or put you in touch with the professional service providers who can - see The Value of His Network.
Relationship with other commercial real estate professionals. Are you getting the true scoop on the interested parties that tour your building? How is your broker's reputation with his competition? Is your guy cooperative with his fellow brokers? Roughly 75% of all commercial real estate transactions are concluded with an owner rep AND an occupant rep. Make sure that your representative plays nicely with others.
Problem solving ability. Potential environmental contamination, city compliance issues, a building sprinkler system that is insufficient, seismic studies for your racking, building permits for new offices, a use of your building that requires a conditional use permit from the city, Americans with Disabilities Act conformance. ALL of these hurdles can stop a deal in its tracks if your professional is ill equipped to help you navigate the rapids. Make sure your provider is experienced in real problem solutions.
Friday, November 20, 2015
Thursday, October 22, 2015
How Commercial Real Estate Leasing Fees Are Computed and Paid
One of the biggest differences between commercial real estate agents and our residential brethren is that leasing commercial real estate is a big part of a commercial real estate broker's practice.
Generally, residential real estate agents sell houses. Certainly, they can lease houses as well but typically they specialize in selling them.
This post will provide an easy guide to how commercial real estate leasing fees are computed and who is responsible for paying them.
The fees (leasing commissions) work this way:
- Fees are paid by the owner of the building after the lease is signed.
- The tenant has no obligation to pay the fees. A misconception occurs, frequently, that somehow the rent that the tenant pays is inflated by the amount of the fee. The fee is included in the rent and the rent is determined by the market conditions. I suppose if no commercial real estate brokers existed then the rents would theoretically be cheaper but owners build fees into their rents as a cost of doing business.
- Generally, one half of the fee is paid at the lease signing and the other half is paid once the tenant moves in and starts paying rent.
- The fees are computed based upon the tem of the lease, the rent paid over the term, and the percentage that the owner has agreed to pay. As an example, 20,000 square foot building x $.60 per square foot in rent per month x 60 months = $720,000 x 6% = $43,200.
- The percentage of the lease consideration - total rent paid over the term of the lease - that the owner pays in fees varies by the product type - office, industrial, retail - and the market conditions that exist - tenant's or owner's market. In other words, if there are more buildings in the market than tenants to fill them, the owner may offer bonus fees to attract a tenant. We have seen this occur in the office space leasing realm in Southern California, recently.
- Generally, the owner’s representative takes half of the fee and the tenant’s representative takes the other half.
Ok, that is it. Simple, right! The hard part is finding a tenant. Oh, well, leave that up to the professionals - your commercial real estate broker.
Friday, September 18, 2015
Five BIGGEST Challenges to a Commercial Real Estate Deal
As I have commenced my 32nd year in the commercial real estate brokerage business, I have a great perspective on the challenges that confront owners and occupants of commercial real estate. I have categorized these challenges into the following five. In no particular order, here you go.
Governmental regulation. I have to laugh at the absurdity. If I didn't laugh, I would cry. Some beauties. A use that is allowed in a building by zoning right, yet a city demands a conditional use permit - an extra layer of permitting that requires a minimum of 120 days and over $5000 to process - just because. A manufacturing company - that will employ fifty people - required to secure a parking variance - even though the building has far more parking spaces than the fifty employees will consume. A trade school that will teach our youth to weld and repair air conditioning equipment that spent OVER A YEAR getting the proper permissions from the city. The absurdity has progressed to the point that I recommend that each of my occupant clients engage a person who can speak "government ease" when dealing with a governmental agency.
Shortage of available buildings. Frankly, this is as bad a market as I've EVER seen for occupants. There are simply not enough available buildings to fill the demand of growing companies. What exacerbates the problem is that the supply of new construction is non existent. Currently, 97.5 of every 100 buildings in Orange County, California is occupied. As I have written about extensively, what is left is a misfit toy - there is something functionally or financially wrong with the building or the building is occupied and the occupant cannot vacate because - yep - he has no place to move.
Unrealistic owners. The shortage of available buildings has caused owners of commercial real estate to puff our their chest and declare that their property is now worth so much more than the market can bear - why not, nothing else is available!
Unrealistic occupants. A great number of leases are expiring this year and next. These leases were transacted in the 2010-2012 era when we were entrenched in an occupant market. When these occupants must now renew a lease or seek a new home in an owner's market - there is a severe shock at how quickly things turned in the owner's favor.
Miscellaneous. Bank underwriting, environmental issues, office space that is not approved, Americans with Disabilities Act requirements, Energy bench-marking, high pile storage permits, seismic retrofitting...I have to stop before I throw up.
Governmental regulation. I have to laugh at the absurdity. If I didn't laugh, I would cry. Some beauties. A use that is allowed in a building by zoning right, yet a city demands a conditional use permit - an extra layer of permitting that requires a minimum of 120 days and over $5000 to process - just because. A manufacturing company - that will employ fifty people - required to secure a parking variance - even though the building has far more parking spaces than the fifty employees will consume. A trade school that will teach our youth to weld and repair air conditioning equipment that spent OVER A YEAR getting the proper permissions from the city. The absurdity has progressed to the point that I recommend that each of my occupant clients engage a person who can speak "government ease" when dealing with a governmental agency.
Shortage of available buildings. Frankly, this is as bad a market as I've EVER seen for occupants. There are simply not enough available buildings to fill the demand of growing companies. What exacerbates the problem is that the supply of new construction is non existent. Currently, 97.5 of every 100 buildings in Orange County, California is occupied. As I have written about extensively, what is left is a misfit toy - there is something functionally or financially wrong with the building or the building is occupied and the occupant cannot vacate because - yep - he has no place to move.
Unrealistic owners. The shortage of available buildings has caused owners of commercial real estate to puff our their chest and declare that their property is now worth so much more than the market can bear - why not, nothing else is available!
Unrealistic occupants. A great number of leases are expiring this year and next. These leases were transacted in the 2010-2012 era when we were entrenched in an occupant market. When these occupants must now renew a lease or seek a new home in an owner's market - there is a severe shock at how quickly things turned in the owner's favor.
Miscellaneous. Bank underwriting, environmental issues, office space that is not approved, Americans with Disabilities Act requirements, Energy bench-marking, high pile storage permits, seismic retrofitting...I have to stop before I throw up.
Friday, May 29, 2015
Five "MUST Address" Issues in a Commercial Real Estate Lease
Approximately 75% of my commercial real estate brokerage activity is in leasing and lease renegotiation...either on behalf of a landlord (owner) or tenant (occupant).
Congratulations! If you are reading this post you have secured a new home for your business and are now about to sign a commercial real estate lease and move in. But, before you reduce that pen to paper, you might want to consider a few of the issues below.
In my experience there are at least five "gotcha" issues that should be addressed in any commercial lease agreement. In my layman's opinion, The AIR 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 commercial real estate 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 that 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; occupant's 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. Ask: 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. Ask: I suggest there be a mechanism in the lease to specify that any expense that exceeds 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. Ask: I suggest that 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 at a fixed percentage increase annually or vary based upon the change that occurs in the Consumer Price Index or some other inflationary index. Ask: If a fixed increase cannot be negotiated, Caps and Floors are always suggested to hedge against a rampant inflationary increase.
Miscellaneous: Former and existing cabling removal, 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.
Congratulations! If you are reading this post you have secured a new home for your business and are now about to sign a commercial real estate lease and move in. But, before you reduce that pen to paper, you might want to consider a few of the issues below.
In my experience there are at least five "gotcha" issues that should be addressed in any commercial lease agreement. In my layman's opinion, The AIR 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 commercial real estate 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 that 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; occupant's 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. Ask: 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. Ask: I suggest there be a mechanism in the lease to specify that any expense that exceeds 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. Ask: I suggest that 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 at a fixed percentage increase annually or vary based upon the change that occurs in the Consumer Price Index or some other inflationary index. Ask: If a fixed increase cannot be negotiated, Caps and Floors are always suggested to hedge against a rampant inflationary increase.
Miscellaneous: Former and existing cabling removal, 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.
Friday, February 13, 2015
Should I accept an unsolicited offer for my commercial real estate?
A proposal to purchase your commercial real estate arrives in your email inbox at work or your mailbox at home...after all your tax bills are sent to your home...and that is probably how the offeror got your address.
Your property is not for sale, nor are you marketing the property for sale...but you are curious about the prospects of selling. So what should you do now?
I will make the assumption that you are remotely interested in the terms of the proposal (not necessarily that you are willing to sell).
My advice to you is contained within the following bullet points.
Before we address the question of whether you should accept the proposal, we need to understand a series of related issues about the proposal and the consequences to you of a sale.
Determine if the proposal is real. Some unscrupulous commercial real estate brokers will use the guise of a proposal from a dummy entity to determine if a property might be available for sale. Once they know you are a seller, they will busy themselves and find a real buyer. Others will send letters to property owners declaring their knowledge of a buyer that wants to buy your property (all the while with no understanding of your property).
Gauge the terms of the proposal vs the market conditions. An owner that I represent received an unsolicited offer on a property that he owns. The buyer offered a price in excess of the market value BUT asked for a fifteen month escrow and an option period of twelve months within the fifteen months to study the real estate. We discovered that the prospective buyer wanted to re zone the property to residential and the price that he offered was contingent upon receiving the zoning change. In essence, the lure of a high price was dramatically offset by the maybe of the zone change.
Assess the motivation and capability of the buyer. Why does the buyer want to buy your property? How will the buyer finance the purchase? What is the source of the buyer's equity? What else has the buyer bought recently? Will the buyer occupy the building as an owner occupant with his business? The answers to all of these questions should be thoroughly vetted.
Quantify the financial impact of selling your property. The sale of commercial real estate is expensive. There are real estate commissions (3-6% of the sale proceeds), federal income taxes (15-20% if held as a long term capital gain and 25-40% if not), state income taxes (in California up to 11%), ACA fees of 2.8% if in excess of $250,000, potential prepayment penalties of any outstanding loans against the property, escrow and title fees, and potentially others. Your CPA should run an after sale analysis of the proceeds you will receive. Sometimes, the after tax hit is too great to justify selling.
Consider what you will do with the proceeds of sale. Some sellers of commercial real estate affect like kind exchanges through a 1031 tax deferred exchange. Others simply pay the taxes and invest the net proceeds or pay off other debts. Regardless, you should consult your tax and legal professionals on the impact of either direction.
OK, so now we have done an admirable job of qualifying the unsolicited offer...the deal is real from a motivated entity, at market (or above) price and terms and you have decided that the after tax whack is manageable, and that you will use the net proceeds to pay off your beach house. Should you accept the offer?
My counsel to you, in today's environment, is that you should not accept an unsolicited offer. The market is so VERY active currently that you might be selling your property for far less than an actively marketed property will fetch.
The BEST way to achieve the highest selling price in the shortest period of time is by creating demand and competition. This can only be accomplished by listing the property for sale with a competent commercial real estate professional, creating a package, running a process, and marketing the property to ALL of the potential buyers in the market. Insist upon a fee sharing, freely cooperative listing team with other commercial real estate brokers...but get the property out there...you'll be amazed at the results!
Your property is not for sale, nor are you marketing the property for sale...but you are curious about the prospects of selling. So what should you do now?
I will make the assumption that you are remotely interested in the terms of the proposal (not necessarily that you are willing to sell).
My advice to you is contained within the following bullet points.
Before we address the question of whether you should accept the proposal, we need to understand a series of related issues about the proposal and the consequences to you of a sale.
Determine if the proposal is real. Some unscrupulous commercial real estate brokers will use the guise of a proposal from a dummy entity to determine if a property might be available for sale. Once they know you are a seller, they will busy themselves and find a real buyer. Others will send letters to property owners declaring their knowledge of a buyer that wants to buy your property (all the while with no understanding of your property).
Gauge the terms of the proposal vs the market conditions. An owner that I represent received an unsolicited offer on a property that he owns. The buyer offered a price in excess of the market value BUT asked for a fifteen month escrow and an option period of twelve months within the fifteen months to study the real estate. We discovered that the prospective buyer wanted to re zone the property to residential and the price that he offered was contingent upon receiving the zoning change. In essence, the lure of a high price was dramatically offset by the maybe of the zone change.
Assess the motivation and capability of the buyer. Why does the buyer want to buy your property? How will the buyer finance the purchase? What is the source of the buyer's equity? What else has the buyer bought recently? Will the buyer occupy the building as an owner occupant with his business? The answers to all of these questions should be thoroughly vetted.
Quantify the financial impact of selling your property. The sale of commercial real estate is expensive. There are real estate commissions (3-6% of the sale proceeds), federal income taxes (15-20% if held as a long term capital gain and 25-40% if not), state income taxes (in California up to 11%), ACA fees of 2.8% if in excess of $250,000, potential prepayment penalties of any outstanding loans against the property, escrow and title fees, and potentially others. Your CPA should run an after sale analysis of the proceeds you will receive. Sometimes, the after tax hit is too great to justify selling.
Consider what you will do with the proceeds of sale. Some sellers of commercial real estate affect like kind exchanges through a 1031 tax deferred exchange. Others simply pay the taxes and invest the net proceeds or pay off other debts. Regardless, you should consult your tax and legal professionals on the impact of either direction.
OK, so now we have done an admirable job of qualifying the unsolicited offer...the deal is real from a motivated entity, at market (or above) price and terms and you have decided that the after tax whack is manageable, and that you will use the net proceeds to pay off your beach house. Should you accept the offer?
My counsel to you, in today's environment, is that you should not accept an unsolicited offer. The market is so VERY active currently that you might be selling your property for far less than an actively marketed property will fetch.
The BEST way to achieve the highest selling price in the shortest period of time is by creating demand and competition. This can only be accomplished by listing the property for sale with a competent commercial real estate professional, creating a package, running a process, and marketing the property to ALL of the potential buyers in the market. Insist upon a fee sharing, freely cooperative listing team with other commercial real estate brokers...but get the property out there...you'll be amazed at the results!
Friday, January 30, 2015
Ways to FINANCE a Commercial Real Estate Purchase
I have written extensively recently about the HUGE increase in selling prices for commercial real estate in Orange County, California. Since the beginning of 2013 we have seen sales prices increase by a whopping Fifty Percent! It dawned on me that my readers might want to learn about the various ways to finance commercial real estate...which is the subject of this post.
As a buyer of commercial real estate you fall into one of three categories...an owner/occupant (your company will operate out of the building that you purchase), an investor (you don't occupy the building but purchase the building for the tenant's rent), or an owner/investor (you buy the building and partially occupy the building and have the balance as rental income). I will focus today on the financing options of the owner/occupant and the owner/investor.
Small Business Association loans: Also known as SBA loans, real property (not equipment or cash flow loans) loans through the SBA are generally one of two flavors...a 504 or 7A loan. The 504 loan is a fifty percent first loan from a bank and a forty percent second loan from the government (also known as a debenture). The 7A loan is a ninety percent government guaranteed bank loan. Each type of SBA loan (504 and 7A) has its advantages and disadvantages. The advantages include, small down payments (10%), fixed interest rates, ability to finance building improvements, and wide availability from a number of lending sources. The disadvantages are the origination fees, the prepayment penalties, the collateral and personal guarantees, and the cash flow and years in business requirements. If you would like to read about SBA loans in greater detail, you can click here.
Conventional financing: Once upon a time, before the preponderance of SBA financing, if you wanted to buy a building, you showed up at your local bank or savings and loan office and applied. What resulted was a loan of seventy five to eighty percent of the purchase price. Boom. Done. Not much as changed over the years...except of course, the savings and loans are extinct, there are fewer commercial banks, and the banks would prefer for you to originate an SBA loan because the bank's risk is less since the government is guaranteeing a portion of the loan. Hmmm, I guess a lot has changed.
Seller financing: We saw a lot more seller financing when the market interest rates bubbled above four to five percent and a borrower could not seek ninety percent financing through the SBA. There are few advantages for a buyer to seek seller financing, but if a seller of commercial real estate owns the property free and clear and is willing to finance the purchase, the buyer generally avoids the need for an appraisal and may also skirt certain origination fees.
Third party financing: Does your Aunt Barbara or Uncle Frank have a substantial nest egg earning close to zero percent in a certificate of deposit? Maybe they would like to loan you the money to buy a building for your company. They get a great return on their money and have the security of the building as collateral. Plus, you'll have something to talk about at Thanksgiving!
Purchase the building for cash: I've only seen this occur a couple of times in a career that commenced when Reagan was President, but it happens. The cool structure is to buy the building personally (or as an LLC), with personal cash, and lease the building to your company. Your company then pays you rent...Bingo!
As a buyer of commercial real estate you fall into one of three categories...an owner/occupant (your company will operate out of the building that you purchase), an investor (you don't occupy the building but purchase the building for the tenant's rent), or an owner/investor (you buy the building and partially occupy the building and have the balance as rental income). I will focus today on the financing options of the owner/occupant and the owner/investor.
Small Business Association loans: Also known as SBA loans, real property (not equipment or cash flow loans) loans through the SBA are generally one of two flavors...a 504 or 7A loan. The 504 loan is a fifty percent first loan from a bank and a forty percent second loan from the government (also known as a debenture). The 7A loan is a ninety percent government guaranteed bank loan. Each type of SBA loan (504 and 7A) has its advantages and disadvantages. The advantages include, small down payments (10%), fixed interest rates, ability to finance building improvements, and wide availability from a number of lending sources. The disadvantages are the origination fees, the prepayment penalties, the collateral and personal guarantees, and the cash flow and years in business requirements. If you would like to read about SBA loans in greater detail, you can click here.
Conventional financing: Once upon a time, before the preponderance of SBA financing, if you wanted to buy a building, you showed up at your local bank or savings and loan office and applied. What resulted was a loan of seventy five to eighty percent of the purchase price. Boom. Done. Not much as changed over the years...except of course, the savings and loans are extinct, there are fewer commercial banks, and the banks would prefer for you to originate an SBA loan because the bank's risk is less since the government is guaranteeing a portion of the loan. Hmmm, I guess a lot has changed.
Seller financing: We saw a lot more seller financing when the market interest rates bubbled above four to five percent and a borrower could not seek ninety percent financing through the SBA. There are few advantages for a buyer to seek seller financing, but if a seller of commercial real estate owns the property free and clear and is willing to finance the purchase, the buyer generally avoids the need for an appraisal and may also skirt certain origination fees.
Third party financing: Does your Aunt Barbara or Uncle Frank have a substantial nest egg earning close to zero percent in a certificate of deposit? Maybe they would like to loan you the money to buy a building for your company. They get a great return on their money and have the security of the building as collateral. Plus, you'll have something to talk about at Thanksgiving!
Purchase the building for cash: I've only seen this occur a couple of times in a career that commenced when Reagan was President, but it happens. The cool structure is to buy the building personally (or as an LLC), with personal cash, and lease the building to your company. Your company then pays you rent...Bingo!
Friday, October 24, 2014
Company MERGED or ACQUIRED? Don't forget your #CRE
I publish a weekly video series entitled Tuesday Traffic Tips. These short, informative videos are geared toward commercial real estate brokers...brokerage advice to my colleagues in the business.
This week, my tip revolved around mergers and acquisitions and the resulting commercial real estate activity. As I've encountered several commercial real estate situations recently that were initiated by a merger, an acquisition, or a disposition, I believed it was time to reduce a few of these situations to a post so that my owner and occupant clients might benefit from the advice I've given.
Before, I delve into the world of M and A...not to be confused with MMA (although sometimes selling your company can feel like cage fighting)...let me digress.
I provide Location Advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I've been involved with a number of deals stemming from "excess" real estate in my four decades of brokerage. This should qualify me as some sort of an expert...if I can remember why...
Back to M and A...
Someone very wise once postulated...A merger is like a marriage, an acquisition is like the arrival of a new baby and a disposition is like a divorce...of sorts. In all of these instances, a new way of doing business emerges and some excess occurs. If you doubt, for a moment, what I am saying...consider your commercial real estate.
When a merger with another company, division or operating unit is affected, there generally is a surplus of the physical plants from which the operations are conducted.
If you acquire a competitor; their customers, billing, shipment schedules, culture, and facilities must be morphed into your existing company.
A disposition of your business can result in the assignment of an existing commercial real estate lease or the origination of a new commercial real estate lease in the case of an owner occupied building (owner of the business and the real estate).
Below are some specific examples (and suggestions) of the role commercial real estate can play in a merger, acquisition, or disposition.
Disposition of the business with long or short term leased commercial real estate. If a long term lease (longer than two years) is in place, chances are that the purchaser of your business considered the location and the remaining term of the lease. If the purchaser opts to occupy the location, generally, an assignment of the lease obligation should be requested. Any options to extend are personal and typically cannot be assigned, however. Also check and see if any personal guarantees of the lease's performance can be vacated. Generally owners of locations want as much security as possible in the performance of the lease, however, if the purchasing entity has a larger net worth, sometimes owners will vacate previous personal guarantees. If the purchaser does not intend to occupy the location, you as the occupant must deal with a term of lease that must be satisfied...without the benefit of a business to generate income. Some owners are happy to work with an occupant that is paying a rate substantially below market. This hasn't been the case for several years as lease rates have declined. Please address the lease term (and the responsibility for it) in your letter of intent.
If a short term lease (two years or fewer) is in place, this can be tricky if the owner of the location believes that the occupant (you or the business you are buying) has such an investment (distributed power, AQMD permits, ISO 9002 permits, paint spray booths, offices, freezer/cooler space, conveyor systems, etc.) in the location that moving would be too costly. The owner may attempt to negotiate a higher than market rate assuming that a move would be too costly. Be well advised to determine the buyer's desire to stay in the location and attempt to negotiate an extension. Otherwise, your buyer may negotiate a lower price for your business based upon the uncertainty of the occupancy.
Merger of two entities: We saw a great deal of this activity in the latter part of the last decade through bank consolidation. Remember when one bank merged with or was acquired by another and you would find a Wells Fargo branch next to a Wachovia branch in the same retail center?...now common ownership. A bunch of excess real estate was created and had to be purged from the market. Refer to the previous paragraph for some suggestions on how to dispose of the excess commercial real estate.
Acquisition in another market: I have a client who acquired a company in Arizona with three locations. The decision was made to keep all three locations in Arizona but there was much work to do in renewing leases, upgrading the locations, and assigning the leases to the new entity.
Strategic or PE acquisition of the business and commercial real estate: On two recent occasions, I have encountered a company that was sold...one to a strategic buyer and one company sold to a private equity group. In both cases the real estate was acquired with the operating company. In neither case was the strategic buyer or the private equity group in the business of owning commercial real estate. Also, in both cases, moving the operating company into another location would have been costly, disruptive, and inefficient. So what was the solution? In both cases, the new business owners (the strategic buyer and PE buyer) sold the commercial real estate to an arm's length commercial real estate investor along with a lease back of the commercial real estate. The operating companies stayed put, the new owners disposed of an asset (the unwanted commercial real estate) and defrayed the cost of the acquisitions.
Disposition of the business with owned commercial real estate: Frequently, in closely held businesses, owning your location can make a great deal of sense. You fix your location costs and you control the occupant (it is your company), you benefit from the location's appreciation, and there are some potential tax benefits individually. I explained in great detail the characteristics of a company that should own its location in a previous post. You can click here if you are interested in learning more about those characteristics. When you sell the business that occupies the location (even if the purchaser of your business signs a lease with you), the question you ask should be, would I want to own this location if it were vacant? Remember when you were the occupant and the owner, the dynamic is different than being the owner but not the occupant. You are now an investor who must compete with many other investors for your tenant's occupancy...are you prepared for that potential risk? As explained in a previous post, the cost of originating a new lease is staggering. If the answer is no, then there are steps that you can take to minimize the risk of owning a vacant building. First, analyze your location's monthly carrying costs...debt service, taxes, insurance, common area maintenance, miscellaneous maintenance, etc. (You should maintain a 9-12 month cash reserve of this total amount). Second, determine how marketable the vacant location is. A location advisor familiar with the current market can provide this for you. How many vacant locations similar to yours exist? What is the current appetite (including market time) for such a location? What is the current vacancy rate for locations such as yours?...like yours specifically...not a market wide vacancy of all locations. How special purpose is my location? Third, determine what the location is worth to an arm's length investor with the new lease. This amount less any debt owed against the location and less any closing costs of sale (net of any taxes) determines the proceeds that can be deployed into an alternate investment. If you choose to deploy the funds into another real estate investment, the gain may be tax deferred if the upleg purchase meets certain criteria. You may be wondering why you would sell one piece of real estate only to buy another? The simple answer is to lessen the risk. By selling a special purpose single tenant location and investing in a general purpose multi tenant location, the management is greater but the downside is more manageable...ala selling stock in a single company and buying a mutual fund of many companies.
This week, my tip revolved around mergers and acquisitions and the resulting commercial real estate activity. As I've encountered several commercial real estate situations recently that were initiated by a merger, an acquisition, or a disposition, I believed it was time to reduce a few of these situations to a post so that my owner and occupant clients might benefit from the advice I've given.
Before, I delve into the world of M and A...not to be confused with MMA (although sometimes selling your company can feel like cage fighting)...let me digress.
I provide Location Advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I've been involved with a number of deals stemming from "excess" real estate in my four decades of brokerage. This should qualify me as some sort of an expert...if I can remember why...
Back to M and A...
Someone very wise once postulated...A merger is like a marriage, an acquisition is like the arrival of a new baby and a disposition is like a divorce...of sorts. In all of these instances, a new way of doing business emerges and some excess occurs. If you doubt, for a moment, what I am saying...consider your commercial real estate.
When a merger with another company, division or operating unit is affected, there generally is a surplus of the physical plants from which the operations are conducted.
If you acquire a competitor; their customers, billing, shipment schedules, culture, and facilities must be morphed into your existing company.
A disposition of your business can result in the assignment of an existing commercial real estate lease or the origination of a new commercial real estate lease in the case of an owner occupied building (owner of the business and the real estate).
Below are some specific examples (and suggestions) of the role commercial real estate can play in a merger, acquisition, or disposition.
Disposition of the business with long or short term leased commercial real estate. If a long term lease (longer than two years) is in place, chances are that the purchaser of your business considered the location and the remaining term of the lease. If the purchaser opts to occupy the location, generally, an assignment of the lease obligation should be requested. Any options to extend are personal and typically cannot be assigned, however. Also check and see if any personal guarantees of the lease's performance can be vacated. Generally owners of locations want as much security as possible in the performance of the lease, however, if the purchasing entity has a larger net worth, sometimes owners will vacate previous personal guarantees. If the purchaser does not intend to occupy the location, you as the occupant must deal with a term of lease that must be satisfied...without the benefit of a business to generate income. Some owners are happy to work with an occupant that is paying a rate substantially below market. This hasn't been the case for several years as lease rates have declined. Please address the lease term (and the responsibility for it) in your letter of intent.
If a short term lease (two years or fewer) is in place, this can be tricky if the owner of the location believes that the occupant (you or the business you are buying) has such an investment (distributed power, AQMD permits, ISO 9002 permits, paint spray booths, offices, freezer/cooler space, conveyor systems, etc.) in the location that moving would be too costly. The owner may attempt to negotiate a higher than market rate assuming that a move would be too costly. Be well advised to determine the buyer's desire to stay in the location and attempt to negotiate an extension. Otherwise, your buyer may negotiate a lower price for your business based upon the uncertainty of the occupancy.
Merger of two entities: We saw a great deal of this activity in the latter part of the last decade through bank consolidation. Remember when one bank merged with or was acquired by another and you would find a Wells Fargo branch next to a Wachovia branch in the same retail center?...now common ownership. A bunch of excess real estate was created and had to be purged from the market. Refer to the previous paragraph for some suggestions on how to dispose of the excess commercial real estate.
Acquisition in another market: I have a client who acquired a company in Arizona with three locations. The decision was made to keep all three locations in Arizona but there was much work to do in renewing leases, upgrading the locations, and assigning the leases to the new entity.
Strategic or PE acquisition of the business and commercial real estate: On two recent occasions, I have encountered a company that was sold...one to a strategic buyer and one company sold to a private equity group. In both cases the real estate was acquired with the operating company. In neither case was the strategic buyer or the private equity group in the business of owning commercial real estate. Also, in both cases, moving the operating company into another location would have been costly, disruptive, and inefficient. So what was the solution? In both cases, the new business owners (the strategic buyer and PE buyer) sold the commercial real estate to an arm's length commercial real estate investor along with a lease back of the commercial real estate. The operating companies stayed put, the new owners disposed of an asset (the unwanted commercial real estate) and defrayed the cost of the acquisitions.
Disposition of the business with owned commercial real estate: Frequently, in closely held businesses, owning your location can make a great deal of sense. You fix your location costs and you control the occupant (it is your company), you benefit from the location's appreciation, and there are some potential tax benefits individually. I explained in great detail the characteristics of a company that should own its location in a previous post. You can click here if you are interested in learning more about those characteristics. When you sell the business that occupies the location (even if the purchaser of your business signs a lease with you), the question you ask should be, would I want to own this location if it were vacant? Remember when you were the occupant and the owner, the dynamic is different than being the owner but not the occupant. You are now an investor who must compete with many other investors for your tenant's occupancy...are you prepared for that potential risk? As explained in a previous post, the cost of originating a new lease is staggering. If the answer is no, then there are steps that you can take to minimize the risk of owning a vacant building. First, analyze your location's monthly carrying costs...debt service, taxes, insurance, common area maintenance, miscellaneous maintenance, etc. (You should maintain a 9-12 month cash reserve of this total amount). Second, determine how marketable the vacant location is. A location advisor familiar with the current market can provide this for you. How many vacant locations similar to yours exist? What is the current appetite (including market time) for such a location? What is the current vacancy rate for locations such as yours?...like yours specifically...not a market wide vacancy of all locations. How special purpose is my location? Third, determine what the location is worth to an arm's length investor with the new lease. This amount less any debt owed against the location and less any closing costs of sale (net of any taxes) determines the proceeds that can be deployed into an alternate investment. If you choose to deploy the funds into another real estate investment, the gain may be tax deferred if the upleg purchase meets certain criteria. You may be wondering why you would sell one piece of real estate only to buy another? The simple answer is to lessen the risk. By selling a special purpose single tenant location and investing in a general purpose multi tenant location, the management is greater but the downside is more manageable...ala selling stock in a single company and buying a mutual fund of many companies.
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