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.

The MOST important thing in a #CRE purchase

We are immersed in a seller's market in Southern California...AKA, we are close to the end...because buyers are committing to CRAZY numbers for industrial buildings.

An imbalance between available inventory and buyer demand has sent the prices of well appointed (and even misfit toys) buildings past the pre-recession highs. Rents have not quite followed suit, but soon will, as buyers cannot find anything to buy...need to grow...and will lease instead of losing business.

So what do market conditions in my patch of the world have to do with the MOST important thing in a commercial real estate deal? Allow me to digress and meet you on the other side...

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 have witnessed three price peaks in that period of time...and the resultant price busts...which qualifies me as an expert to discuss the market today...I believe.

So, back to the MOST important thing in a commercial real estate purchase:

Location: We have all heard that the three most important aspects of real estate are location, location, location. Although this has merit, I don't believe that location is the most important thing in a commercial real estate purchase. As an example, if the prime area for appreciation is an hour's drive from your home, what do you gain?...other than a commute in and out of the office of two hours per day. What if the location places your business farther from your customer base or your key employees, thus increasing the cost of your operation? As you can see, location is not the most important thing.

Function: Certainly if you are occupying the building that you buy, the function must conform to your use and the size must mirror your growth projections. The real estate must have ample power for your operation, generous loading and freeway proximity for your logistics, and sufficient sprinkler capacity and clear height for your warehousing. The office space within the building must be adequate to comfortably house your staff. The function must work...but at what expense?

Investment Metrics: If you are buying a piece of commercial real estate strictly for investment purposes, several factors should be considered...capitalization rate, current rental rate that the tenant pays, stability of the income stream, price of the building, general lease-ability, etc. In a moment you will discover the MOST important.

Financing: The interest rate and terms at which a commercial real estate purchase is made can cure a lot of ills, but is it the MOST important item in a purchase? Imagine if you achieved a 2% interest rate but the rate could increase at will. We saw an awful lot of prime rate adjustables in the early nineties that when adjusted crippled the borrowers. What if the loan comes with an enormous pre-payment penalty that will hamstring your ability to sell the building?

Pricing: Some would offer that if commercial real estate is purchased at the right basis (price), then any deficiency with the real estate can be overcome. Really? What if the reason for the pricing is functional obsolescence? A building fifty miles from civilization is going to trade for a much cheaper price than one in the heart of the central business district. There is generally a reason why something is cheap. The best alternative for your business may be a building right next door...but you will probably pay a premium.

Ok, so what is MOST important?

The answer is they ALL are the MOST important! In my experience the stars must align...AKA, all of the reasons must point to go in order for a purchase transaction to occur. Just like the pre-launch scene in the movie Apollo 13, you MUST be go for launch.

Should your company consider a #CRE sale/leaseback?

In 2003, when California was in a world of hurt with worker's comp rates, employers leaving the state, driver's licenses for illegals (which all lead to Governor Gray Davis being terminated by the Terminator), we saw a huge amount of sale/leaseback activity from national corporate occupants.

Aquatics-Lasco Bathware, Akzo Nobel, Johnson Controls, Smurfit Stone, Parker Hannifin, Illinois Tool Works, Limbach...and many others sold manufacturing locations in Southern California and leased them back from the owners. Why, you may be wondering? Provide me your forbearance, while we hear from our sponsor, and I will explain my views...

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 have been involved with many of the deals listed above which should qualify me as an expert of sorts...if I can only remember...

The two main reasons in 2003-2005 that many national (multi location) companies sold their locations and leased back, were real estate values and the business climate in Southern California. By selling the locations when the market was at its value peak and leasing back for a three to five year time frame, the companies maxed the real estate equity and could decide at the lease expiration whether to stay in California or consolidate into another location. Some stayed, but many left.

In my opinion, another perfect storm is approaching that could portend another round of sale/leasebacks...this time from closely held owners of real estate.

So, what are the reasons that a company should consider a sale/leaseback?

Values: Commercial real estate values have eclipsed all time highs in Southern California and there is a real imbalance between available properties and demand for available properties...AKA an owner's market.

Equity is needed for business expansion: When a bank won't loan money to an expanding business and there is equity in the company's real estate, a sale and lease back can provide much needed expansion capital...at today's capitalization rate...and avoid moving the company out of the location.

An acquisition: I was just asked to prepare a broker opinion of value for a company that acquired another. Along with the business purchase was the real estate that housed the operation. The company is not in the real estate business and leases their other locations. A sale/leaseback would allow the company to sell the real estate, take the proceeds and defray the acquisition cost and leave the operating unit in tact in the real estate with a lease.

A business transition within five years: If a business and location owner foresees a sale of the business within the next five years, now could be a great time to dispose of the real estate (while values are high) and lease back. The business sale (in five years) then would not be encumbered by the location. Certainly, if the new owner of the business wants to remain in the location, a lease with the new building owner can be affected.

A flight to quality: I worked with a national company a few years ago that sold and leased back for five years. Their belief was that values had peaked and their desire was for a more upscale location within five years. The structure allowed the company to achieve its goals. By the way, the company couldn't have planned the timing ANY better...a sale in 2005 (high for sales) and a new lease in 2010 (low for leases)...BINGO!

The good ole days in #CRE...circa 1985...AKA where is my Delorean?

I am pleased to say that I just closed the sale of an industrial building in 30 days! My guy waived contingencies in two weeks...including city approval of his use and operation, secured financing from his savings and loan at 9.5%, and will move in next week!...this post from 1985!

Man, those were the days...am I sounding old?

I have to admit I got a bit jaded this week as I attended yet another seminar on AB 1103...California's weak attempt to benchmark energy uses across commercial real estate sectors. I pondered how the "deal process" has morphed in the last thirty years. More on that in a moment.

As a disclaimer, 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. As I have sold or leased hundreds of industrial buildings over four decades...and can compare the differences...I am qualified as an expert...if I can only remember why...

So back to the deal environment and how the process has changed in the past thirty years...

Thanks to the regulatory environment that ALL California real estate brokers must adhere to these days, the number of newly minted legal professionals, the Savings and Loan industry imploding, three ugly recessions...1991-93, 2000-2001, and 2008-2009 , changes in the property tax laws (prop 13), gross imbalances of revenue intake and outflow in our cities, etc., our sprint to closing a commercial real estate deal has many new "hurdles" to hump...and many new costs to bear. By the way, ALL of these have surfaced in the last three decades.

Non binding Letters of Intent: A binding offer has evolved into a "we will consider if we want to but only if the consideration will not adversely affect anyone or if it does we can change our mind...and only a lease or a PSA will bind us unless we have a great lawyer and we didn't really mean it and can get a judge to see it our way..."

Phase I, II, and III environmental reports: These broke on the scene in the mid 1980s and add $2500-??? depending upon the phase and extent of enviro contamination (including regional issues). Like leaving home without an American Express card...lenders won't lend without them.

AQMD credits: Frankly, I still don't understand these. If I ever do business with a company needing a spray booth of any sort, I immediately refer them to my expert.

Title 24: HVAC calcs that affect any new office space construction...just wait...this is about to ramp  up to a whole new level thanks to AB 1103.

Seismic upgrades: I get this. We don't want a building falling into a heap when the Earth moves.

Appraisal review boards: Banks and/or brokers used to have a say in the appraiser they chose...that was abused, values sky rocketed...unjustifiably...we now cannot provide any input and neither can the lender as they must follow the recommendations of the appraisal review board. If you get a bad appraisal (less than value)...prepare for a war.

Natural Hazard Disclosures: We need to protect California's business operators from the threat of a flood...mind you Southern California gets approximately 9 inches of rain a year...Texas can get that in two hours...

Americans with Disabilities Act: Once again, I get this one. The problem is no one seems to understand what is required, who is responsible, and what it costs...and oh yeah, no one polices this at the city level...hmmm.

Conditional Use Permits: Visit the counter at a city, check the zoning, is the use permitted?...cool!...ummm, not so fast I recently visited my fair city of Orange, California, checked the zoning, the use was permitted in the zone..and was told I needed a CUP...which costs $3-$5000 and 120 days. Why? because the city was considering changing the zoning in the future and the use wouldn't comply with the new zoning.

High pile storage permits: You can't just rent a building, stack your stuff and do business. You must now comply with the type of stuff you store, in what quantity, at what height, etc. Have your fire consultant's number on speed dial!

Racking permits: About a $10,000 price tag and a 30 day lead time...

Occupancy permits: You can't just move in and operate your business...even if you're an approved use in the zone...and doing everything to code.

UL machinery ratings: Gotta have the tag OR you gotta get one...to the tune of $2500 per machine

AB 1103: The new law enacted in in the mid 2000s...but yet to be fully implemented (because no one understands how to implement it) seemingly has a good purpose...to reduce energy consumption...until you read the fine print. Energy companies are under a mandate to produce 33% of their consumables by the year 2016...now one understands that the energy lobbies are pushing the regs down to the end user.

A buyer of an industrial building is now forced to engage a specialized consultant to advise them on all of the above...some are lender requirements...ala, enviro reports...at a significant cost, BTW!

So what are the takeaways assuming you don't have a Delorean and a wild haired professor with a time machine?

• Understand what is required...and the timing of each requirement
• Properly prepare owners and occupants so that expectations are managed
• Have several consultants in your database that you can refer to your owners and occupants.

Five #CRE secrets...your broker won't tell you

I want to broach a subject today which is painful for me...the five things most commercial real estate brokers won't tell you. 

The reason this subject is painful is because I LOVE our industry...most everything about it...the people, the pace, the financial rewards, the freedom and flexibility...and most of all...helping business owners achieve their dreams with commercial real estate.

However, I have witnessed...as we all have... some practices that are scary and self serving which I will discuss below.

As a disclaimer, 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 have dealt with hundreds of CRE practioners, trained new associates, and operated within the industry for thirty years...there is some expertise bubbling below the surface that I want to un-cork.

In a Letterman-tonian format...here goes!

I believe you could avoid a move if you did a few things differently: We are paid to move companies and fill spaces or through companies relocating into those spaces. I wrote about this last week...moving sucks...it is expensive, disruptive and rarely achieves the efficiency that is sought. Do you and your client a favor...discuss ways that a move can be AVOIDED...first...before striking out to find a new location.

 I don't believe that buying a building is in your company's best interest: $$$ Dollar signs cloud our judgement here! We make so much more selling vs leasing. If someone tells us that they want to buy...very few of us will challenge that desire...even if we know that buying might be counter productive.

 I have not fully researched a building before we tour: This drives me CRAZY! So many in our industry will not preview a location before touring...maybe because of the above?...you got me, they will not discuss the owner's motivation with the listing broker, will not check on zoning, etc. An inordinate amount of time is wasted! Hint: Don't take a client through a building that you have not previewed...you will save yourself a lot of agony and improve your professionalism.

I have made touring your property as difficult as possible: Vacant buildings used to be sooo easy to tour...we all had a lock box key that fit the standard lock box and our industry used the lox boxes universally. If you could not reach the listing broker, you could simply drive by the building...if it was vacant, the likelihood was high that a lock box was on the front door...bitchin! You could preview, take your client through...all very painlessly. The world has changed! We now must call for touring instructions...which vary by broker. Many listing brokers insist upon meeting us at the building to preview and to tour...a royal pain in the ass! NET, NET cooperation is discouraged. Hint: Candidly, the opposite approach should be taken...MAKE IT EASY!...your owners will benefit!

Your property is dramatically over priced: Some CRE brokers will inflate the asking price of a listing! Shock..the horror, the humanities! This practice probably bugs me the most...I get that we want to achieve the most $$$ for our owners...but please...is that 1960s vintage, low clear, under powered piece of junk worth more than a class A, beautifully appointed, well located alternative...c'mon.
Hint: Level with your owner. Explain that his expectations are out of line with the market and that a higher than reasonable asking price will actually deter any interest and cause the property to sit...maybe for months.

OK...rant rage over. You get the idea. Please do us all a favor... don't be that guy...