Advice I’m Giving These Days

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Much of my time is spent counseling family owned and operated manufacturing and logistics providers. My role is one of a trusted advisor. Ironic in this approach - is I’m not paid like other advisors - CPAs and attorneys. Their services are billed by the hour. Commercial real estate professionals are paid to transact. No deal, no paycheck. Many have asked why I have approached the business this way for nearly four decades. To me it’s simple. If I focus on the payday rather than the advice - I become a commodity. If a premium is placed upon my counsel a relationship is formed. I become less transactional and more oriented toward the long term. Fortunately, some companies I encounter need to immediately lease or buy a location or find an occupant for a vacant one. But many times I’ll spend years grooming before my brokerage services are employed. So what advice am I giving these days. Please indulge me as I share a few examples.
 
Carefully watch the market - pricing finding support and resistance. As discussed previously, since the halcyon days of 2021 and early 2022 where space was being gobbled like a pizza on grad night - the leasing and selling pace has slowed. There’s no better example than what’s occurring in Class A industrial offerings. In 2021, any new construction brought to market was pre-leased prior to completion. Once the walls were tilted, the activity commenced. Once the roof was on, the lease was signed. Now we have several concrete boxes awaiting a resident. Many more will follow this year. Interesting is the activity in “less than class A inventory”. Aging buildings suffering from substandard warehouse fire protection, compromised loading, or ceiling heights which don’t allow for maximum stacking are finding favor because they’re 25% cheaper than their Class A cousins. Advice: The fish are there - you just have to go a little deeper. Read. Lower asking rates.
 
How to deal with MASSIVE rent increases. Tenants are choking on the massive rent increases landlords are proposing and which have occurred over the past three years. This may sound contrary to the previous paragraph. You may be thinking “hmmm. I thought he said rents are coming down”. Both are true. Here’s how. Let’s say you leased a 100,000 square foot facility in 2018. The prevailing rates during that time were around $1.00-$1.25 per square foot. For easy math, that’s $100,000 per month in rent. Most leases have annual rent escalators built in. In 2018 we were writing deals with 2.5%-3% annual bumps. So. That $100,000 you paid initially, became $112,550 or $1.12 per square foot for the fifth year of your lease. The last flurry of deals happened at over $2.00 per square foot or $200,000 per month - a whopping 77% increase! If you’re facing renewal time - you encounter those crazy new rates. But now inventory is sitting. No one is dealing at those $2.00 rates. They’re compromising by leasing a location with fewer amenities - because they can. In 2021 they weren’t available. Now they are. Advice: So don’t jump at that first offer your owner makes. Understand things will further soften until all this new stock is filled.
 
If you sell the engine, you’re left with the vehicle. For those operators we counsel who made a decision to own - vs rent - the location from which their company operates - a different challenge emerges. We see countless examples of the real estate value eclipsing the worth of the enterprise. The most extreme case we’ve witnessed was ten fold. Yes. The address that houses the operation is worth ten times more than the business. Wow! Orbiting in conjunction we find the operation has its rent subsidized. A real conundrum exists here. Part of the benefit of owning the building from which your business operates is you can charge any rental rate you want - within reason. The lease payments are deducted by the business as an ordinary business expense and the owner of the building receives monthly payments. These lease payments are a ding on profit. If the rents are subsidized - not at full market value - an unreal picture of the business’s profitability is painted. Should these rents be “marked to market”, the value of the enterprise declines because the multiple of the EBIDA returns a smaller amount. By the same token, if the business is not paying full market rental value, then the value of the real estate is understated. So what’s a mother to do? Advice: Ratchet up that rent.! If the company can’t afford it, maybe it’s time to seek cheaper quarters.
 
Excess space is challenging today. If you find yourself with space you don’t need, you have four alternatives to rid yourself of the excess. You can approach the owner of your building and ask him to let you out of your lease, you could propose a buyout of the remaining obligation of your lease, you could find a sub tenant who will take over your lease, or - and we never recommend this alternative - you could simply stop paying rent and cause your lease to go into default. Because many of the leases written over the past two years are over market today - alternative one is a non-starter. Most find the amount needed to buy out their remaining obligation is too hefty. Unless you’re an unfair dealer, four is out. So subleasing is left. Advice: Your goal should be to minimize the amount of time you continue to pay rent. In other words, find a replacement as soon as you can. Understand you are limited in what you can offer to the market in the way of tenant improvements and a term exceeding that of your of your lease. The best way to make a sublease space attractive to a perspective occupant is to trim the rate by 25 to 30% and hit the market with shock and awe.
 
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.
 

Key Things To Do In 2023

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Last week I shared my forecast for the balance of 2023. Discussed were my view on where interest rates might be headed and their impact upon our industrial market, class A industrial absorption, the possibility of a recession, and finally politics. My mom always suggested I not discuss politics or religion in an open forum - but alas, politics touches so many areas of our profession - sometimes venturing in is necessary. Today, however, no politics, but a review of a few things you - as an owner or an occupant of commercial real estate - should consider as the days shorten and the “ber” months unfold. 

Property taxes. One of the first lessons I learned when I became a real estate practitioner is how property taxes work in California. By the way, each state is different. Proposition 13 in 1978 set the course for how California currently handles levies on real property. Simply, 1% of the assessed value is computed to form the amount each parcel owner will pay in the fiscal year. Fiscal years run from July 1 to June 30 - therefore stemming parts of two calendar annuals. Assessments generally arrive to parcel holders in mid summer. Unless the parcel traded hands or improvements - requiring building permits - were made, the math is simple. Law requires a 2% increase. A sale will reset the assessment to the amount of the transaction and improvements increase the assessed amount dollar for dollar. Then. The first half taxes July 1-December 31 - are due November 1 and are late December 10. Second half - January 1-June 30 - are due February 1 and are late April 10. The nemonic device No Darn Fooling Around has been employed by real estate professionals for decades as a date reminder. 

Your landlord - if you lease - will do one of several things with the tax bill on your rented premises. If you operate under a triple net lease arrangement - she’ll send you the bill when it’s received and expect you to pay it. Or, she’ll pay it and expect reimbursement. Or, she’ll collect an estimate of the annual amount on a monthly basis and pay when received. Under a gross lease, she’ll pay the bill and expect reimbursement for the increased amount over the first year of your lease. Don’t know the base amount? Simply visit the Orange County tax assessors web site. You can easily research past years. 

Understanding the mechanism of property tax computation can potentially save you dollars. So keep this column as a guide. By the way, you should be able to question - and require proof - of any property tax increase. 

The fall is a great time to check on insurance coverages, building system repairs, and upcoming key dates. As you’ve read, insurance carriers are bolting our state. Those that remain behind - with a lack of competition - are jacking up rates. This can affect coverage on your premises as well as your operation’s liability. Do yourself a solid and schedule a visit with your insurance provider. You’ll be happy you did. With the dog days of summer behind us and shorter, wetter days ahead, now’s a good time to have your roof inspected and any repairs performed. Also, if your location is equipped with a well for truck high loading - check the sump pump lest you have a water feature after the first major rainfall. Finally, take a look at the key dates of your lease - expiration, options, rights to terminate or refusal to purchase, or any upcoming rent increases. 

You’re now equipped to complete the year and head into 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.

Last Four Months of 2023

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Happy Labor Day! It’s now September. That time in SoCal when Christmas decorations take the place of lawn furniture in Home Depot. College football has just begun yet we’re expecting St. Nick to return the next kick off. Fall is my favorite time of year, however - cooler temps, changing leaves, shorter days, and all of the holidays that follow - Labor Day, Halloween, Thanksgiving, Christmas and News Year’s Eve. Travels for the summer are over, kids are back in school, and hopefully no more hurricanes will mass in the Pacific. Now to the balance of the year. What the next four months have in store for commercial real estate owners and occupants is the subject of this column. 
 
Watch interest rates. Borrowing for houses just eclipsed 7%. Historically average but so much higher than the sub 3% rates we witnessed in 2021. What’s followed is a lack of available houses for sale as folks with cheap loans don’t want to sell and new buyers can’t afford today’s prices financed at the higher rates. Sure. Commercial real estate borrowing is also impacted but another element evolves from high rates - small businesses ability to finance growth through acquiring competitors, buying equipment and leasing larger quarters. Our Federal Reserve seems bent upon taming inflation and causing unemployment to rise in the process. Higher interest rates - when business expansion is quelled - can create uncertainty among business owners. 
 
Class A Industrial absorption. Amid the resounding echoes of new construction, there's a curious absence - a noticeable lack of tenants ready to move in and occupy these freshly minted spaces. The question looms, why? Conditions that once fueled the previous industrial boom have evolved into a new breed of challenges. Gone are the days of localized manufacturers and logistics providers securing their own spaces with owner-occupied financing. Instead, our market has produced spaces that align with the needs of large-scale tenants. And therein lies a conundrum - the needs of these tenants hinge on a degree of certainty, a stable backdrop before they commit, amplifying the vacancy issue. We’ve overbuilt the high end of the market. Someone will have to concede to lower lease rates in order to attract a tenant. Once this happens, others will follow as a new paradigm will emerge. 
 
Recession. I predicted in January we’d avoid a recession as the resilience of the consumer would steer us past a downturn. So far, I’m correct. What lies ahead in the next four months of 2023 will be interesting to watch. So far unemployment is low, wages are higher, and folks are spending money on services such as travel. Most would agree the consumer racking up too much credit card debt in the process. As this debt is recalibrated into higher monthly payments because of higher rates - fewer dollars are available to throttle consumption. 
 
Politics. We have a long list of Republican hopefuls, an indicted frontrunner and months before the primaries. On a global level, war still rages in Ukraine, China stealthily observes, and record heat, rain, and storms rage like no other time Incan remember. The list of contenders will thin and we’ll be safely past storm season. 2024 will bring the promise of an election year. 
 
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.
 

Hilary and CRE

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On Wednesday of last week, the first reports of a tropical storm brewing off the coast of Baja were filed. Over the next few days, the storm gained intensity and at its peak had winds allowing it to claim Category 4 status - one below the largest breed, a Cat 5. Catastrophic flooding, crippling winds and record rainfall were predicted to hit SoCal as the first storm of its kind to make landfall in 84 years barreled toward our coast. As I write this column, Hurricane Hilary is headed up through Northern California, Oregon and Idaho and fortunately not leaving much destruction in its wake. Sure we had some flooding in the Inland mountains and valleys but for the most part very little wind or rain in Orange County. I’ve definitely witnessed more torrential downpours during El Niño storms. 
 
You may be wondering what a freak hurricane has to do with commercial real estate? Indulge me as I draw a few parallels. 
 
Resilience and Preparedness. Just as communities and individuals need to prepare for hurricanes and other natural disasters, businesses also need to have contingency plans and strategies in place to withstand unexpected challenges. Is your manufacturing business able to sustain a power outage? Do you have an alternate shipping provider if UPS or FedEx were to strike? 
 
Location Matters. The path of a hurricane is critical in determining its impact, and similarly, the location of a commercial property can greatly influence its success. Proximity to employees, suppliers, and customers are critical. Businesses must carefully choose their real estate locations to ensure accessibility, exposure, and the ability to weather economic storms.
 
Risk Assessment and Mitigation. Analyzing the potential risks of a hurricane, such as flooding and wind damage track along with the need for businesses to assess risks associated with their real estate. Are you covered in the event of a cyber attack? With so many carriers leaving California, have you had a recent chat with yours to insure your coverage is secure?
 
Adaptation and Recovery. After a hurricane, communities and businesses must adapt to new conditions and work towards recovery. Similarly, commercial real estate ventures might need to adapt to changing market dynamics, technology trends, or shifts in tenant needs.
 
Infrastructure and Facilities Management. Hurricanes can damage infrastructure, and businesses must invest in repairs and maintenance to keep their operations running. I received a call last month from a client seeking referral to a roofer. Mind you, he had no idea we’d have rain in August. He just realized the best time to prepare for roof leaks is before you have one. 
 
Community Impact. Hurricanes impact not only individual properties but also the broader community. Similarly, the state of commercial real estate in a region can affect the local economy and vice versa. Vacancy in a regional mall or a dark big box retailer - such as the one near our house - cause tenants to seek other addresses. 
 
Economic Resurgence. After a hurricane, communities often work together to rebuild and revitalize. This mirrors the collaborative efforts that can occur in the aftermath of economic downturns or changes in the commercial real estate market. I recall an investor telling me in 2010 that we were entering the best buying cycle of a lifetime - and he was correct!
 
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.
 

Evidence the Industrial Market Is Changing

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I’d like to flash back for a moment to three years ago. Recall, we were past the darkest days of the pandemic - at least we believed - and headed for freedom. Freedom from our keyboards and the stifling confines of our converted home offices. Commutes to our brick and mortar locations awaited us. Whether we plied our trades in a concrete tilt up manufacturing building, a suite of offices in a high rise or a retail store front - homes away from homes were returning. At least we believe so. Nature had another variant in mind and although Delta was less virulent it was much more contagious. Our staycations continued until the virus found fewer hosts. 
 
During this hiatus, industrial manufacturing and logistics thrived, office floundered and retail shifted to blue vans delivering to our residences. 
 
Now. Three years hence, the class of commercial real estate - buildings used for manufacturing and shipping - is showing signs of a slowdown. So what pray tell are the warning flags that signal said pause? Indulge me as I review a few of them. 
 
More Sublease Space. Three years ago, excess industrial space was non-existent. Fast forward to today, and it's become a common buzzword in the industrial market. It's like finding uncharted territory on a map that was once thought to be fully explored. The increase in sublease space is more than just square footage; it's a sign that the landscape of demand is shifting. Companies that once occupied these spaces are now reevaluating their real estate needs. The surplus of sublease options indicates a change in how businesses perceive their workspace requirements. It's like a reverse game of musical chairs. 
 
Longer Time on Market. Remember the days when a property would hit the market, and within the blink of an eye, it was off again? Or, it never officially hit? Well, those days seem to be fading. Properties are lingering, waiting for someone to come knocking. The extended time on the market isn't just a numerical value; it's a reflection of uncertainty. It's as if potential occupants are standing at a crossroads, evaluating their next move cautiously.
 
Increased Broker Incentives. Brokers used to be like matchmakers, introducing tenants to their perfect property. Now, it's almost as if they've donned a new hat – that of a negotiator. Broker incentives have become a sign of the times. Trips, bonus fees, touring currency are making their way back. They're the conversation starter, the bargaining chip that landlords put on the table to sweeten the deal. It's not just about securing a tenant; it's about convincing them that this space is worth their commitment. The increase in broker incentives is like a neon sign flashing, "Flexibility is the new black." It's an acknowledgment that the market has changed, and everyone needs to adapt to keep the dance floor crowded.
 
More Tenant Concessions. Concessions, such as free rent, moving allowances, special purpose tenant improvements, et al, used to be rare, reserved for special occasions. Now, they're being offered like party favors at the end of a celebration. It's not just about the property itself anymore; it's about what comes with it. Companies aren't just looking for four walls and a roof; they're looking for a partnership. Tenant concessions are a handshake that says, "We're in this together." Landlords are bending, flexing, and shaping their offerings to accommodate the evolving needs of their tenants. It's like watching a jigsaw puzzle being put together, piece by piece, until a harmonious picture emerges.
 
Softening in Asking Rates. The asking rate used to be a non-negotiable declaration, a line in the sand that set the tone for negotiations. Today, it's more like a starting point, a foundation that can be molded and shaped. The softening in asking rates isn't a sign of weakness; it's a sign of realism. Landlords are acknowledging that the script has changed. It's not just about what they think their property is worth; it's about what tenants are willing to pay. The softening in asking rates is like a bridge connecting two sides, a compromise that ensures both parties can find common ground.
 
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.
 

Alaska Journey

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Another state got notched into our travel belt this week as we concluded a cruise to Alaska. In a word - amazing! Ketchikan, Sitka, and Juneau were on our agenda. Photos do not do justice to the rugged wilderness of the 49th addition to our union. Hopefully, my words can. 
 
As we traversed the Endicott Arm and threaded through the Tracey Arms-Fjord, several chunks of blue ice were encountered. Akin to a punch bowl at the end of a party, these bobbing blue behemoths bathe in the icy waters - having parted from the mothership Dawes glacier and now headed for the freedom of open waters. I couldn’t help recall a comparison I once made to an iceberg and its similarity to a commercial real estate transaction. 
 
As occupants of commercial real estate, you focus upon a couple of things – the space and possibly the lease payment or monthly debt service. The space: Does it lay out well for your operation? Are there enough private offices for a collaborative work environment? Does the power into the building adequately support all machinery and equipment? Can you afford the monthly payments? If these boxes are checked, boom! You’re golden, right? Maybe not so rapido, my friends. If you focus on the space and the payments, you’re only seeing the tip of the iceberg. Similar to Dawes glacier, more than 80 percent of the transaction’s issues are lurking beneath the surface and can destroy your occupancy if not properly anticipated.
 
As the commercial real estate comparisons continued, I learned on this trip is the undeniable significance of location. In Alaska, remote and inaccessible areas are abundant, offering breathtaking beauty but also posing challenges for development. Similarly, in commercial real estate, the value of a property is often tied to its location, accessibility, and proximity to key amenities and transportation hubs. Just as Alaska's hidden gems require strategic planning to unlock their potential, commercial properties in prime locations can hold the key to successful investments.
 
The rugged terrain of Alaska prompted me to contemplate the importance of due diligence in commercial real estate transactions. Just as I carefully planned my hiking routes to ensure safety and efficiency, investors must thoroughly research properties, assess risks, and conduct comprehensive financial analyses before making decisions. Understanding the lay of the land, figuratively and literally, is crucial to avoid pitfalls and maximize returns.
 
Finally, the sense of adventure and discovery that accompanied me throughout my Alaskan expedition mirrors the excitement and reward in the world of commercial real estate. Exploring new markets, uncovering hidden potential in properties, and forging successful deals can be as thrilling as discovering an uncharted trail or an untouched wilderness.
 
My journey through Southeast Alaska left an indelible impression on my soul, and it also opened my eyes to the valuable lessons that can be applied to the dynamic world of commercial real estate. Whether it's embracing the significance of location, conducting thorough due diligence, or simply enjoying the thrill of exploration, this trip has enriched my understanding of both Alaska's wonders and the intricacies of commercial real estate.
 
So, fellow adventurers, as you set out on your own ventures in the realm of commercial real estate, remember to embrace the spirit of Alaska - wild, resilient, and full of untapped potential. 
 
Happy exploring and investing!
 
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.
 

Journey Along the Strait. Where History Meets Real Estate

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Greetings from the Strait of Juan de Fuca! As I traverse the picturesque towns bordering this historically significant waterway, I can't help but marvel at the unique blend of past and present that shapes the landscapes around me. From Sequim's lavender fields to the quaint charm of Whidbey Island, and from the rugged beauty of Port Angeles to the Victorian allure of Port Townsend, each place has its story to tell.
 
As I stand on the shores of the strait, it strikes me that this is not just any body of water. Unlike the Bering Strait or the Strait of Gibraltar, the Strait of Juan de Fuca holds a distinct peculiarity - it serves as the international boundary between Canada and the United States. In 1787, the maritime fur trader Charles William Barkley named it after Juan de Fuca, the Greek navigator who embarked on a Spanish expedition in 1592 to seek the legendary Strait of Anián.
 
But you may be wondering, what on earth does all of this have to do with commercial real estate? Bear with me as I weave the threads of history, geography, and property together.
 
The towns that line the Strait of Juan de Fuca have witnessed a rich tapestry of events, with maritime trade being a common theme in their stories. The influx of traders and settlers in the past laid the groundwork for the thriving communities we see today. Sequim, known for its lavender farms and breathtaking landscapes, has seen a surge in tourism, leading to growing demand for commercial properties like boutique hotels, quaint cafes, and craft shops that cater to visitors seeking a slice of tranquility. That’s what lured us here as my wife visited Sequim a few years ago to dye cloth. 
 
Whidbey Island, with its idyllic surroundings and artistic vibe, has also become a magnet for tourists and creative minds alike. The real estate market here has adapted to the influx of artists, writers, and nature enthusiasts, with charming studios, workshops, and eco-friendly accommodations becoming the new norm.
 
In Port Angeles, where the Olympic Mountains meet the sea, the maritime history is still palpable. While the shipping industry has evolved, the waterfront properties have retained their allure. With breathtaking views of the strait and the nearby islands, developers are keen on creating modern commercial spaces that respect the town's history and unique setting.
 
Port Townsend's well-preserved Victorian architecture takes us back in time, but the real estate market here is far from stagnant. The town's heritage buildings have found new life as boutique shops, galleries, and restaurants, each property contributing to the vibrant local economy.
 
Seattle, the urban heartbeat of the region, showcases a different facet of commercial real estate. As a bustling metropolis, the city boasts an array of high-rise office buildings, tech hubs, and commercial centers. I’ve not seen the number of cranes rising from down below in any major city recently. The economic ties between Seattle and neighboring Canadian cities have further fueled cross-border investments, making the region a melting pot of cultures and business ventures.
 
Next week, as we sail towards Alaska on the Quantum of the Seas, the significance of the Strait of Juan de Fuca becomes clearer. Its history has shaped the present, and that includes the world of commercial real estate. From quaint towns preserving their past while embracing the future, to vibrant cities that thrive on innovation and international connections, the strait's influence reverberates through the properties that shape these communities.
 
So, the next time you set foot in a historic building turned modern commercial space or enjoy a relaxing retreat by the water, take a moment to appreciate the hidden stories woven into the fabric of the place. History may be in the past, but its echoes are forever present in the towns and properties along the Strait of Juan de Fuca.
 
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.