5 Commercial Real Estate Lessons Learned in 2014...and how you can benefit!

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As 2014 draws to a close, I thought it would be beneficial to my clients and future clients to recap the five commercial real estate lessons I have learned in 2014.

I will recount these in no particular Letterman-onian order BUT will color each lesson with a real world example...or three.

This year marked my thirtieth in the business...how did that happen? I could've written about thirty lessons, but would probably have forgotten...as age has a way of softening our memories. Five seemed like the correct amount.

So, without further ado, here goes:

Whatever you believe the time frame to be...double...or triple it! As I have written about countless times, the only two things that we have to sell, as commercial real estate brokers, are time and information. The time frame I reference above is different...I reference the time frames that the deal dictates...city approval, loan approval, lease approval, building completion, construction time etc.. We were told this year by a lender that a loan would be approved in sixty days...120 days later...crickets. A conditional use permit in the city of Santa Ana was to be perfected in 120 days...it's been seven months (210 days for those of you counting at home) and we are not conditionally permitted. A new project slated to achieve occupancy in October just got finaled yesterday. Be mindful of this at the beginning of the negotiations...not in the middle of the deal when you need an extension of time.

Mergers and acquisitions create commercial real estate needs. When companies get married or divorced, frequently there is excess commercial real estate, or at a minimum, a change in the ownership or operation of the commercial real estate. I have experienced countless examples this year of the disruption that a merger or acquisition can create.  One rather painful circumstance has delayed the merger of two printing operations. Factor in the change in your commercial real estate when contemplating a sale of your business or the purchase of a competitor.

Greed is not good. We are deeply entrenched in an owner's market today, as previously penned . On four separate occasions this year, I have procured above market offers for clients who own commercial real estate. In three of the four cases, the offers were rejected or countered at higher prices. Mind you, our values today have eclipsed 2007 levels (the previous Mt. Everest of pricing). With some storm clouds on the horizon, currently, with the decline in oil prices, junk bonds, and big bank derivative exposure, I certainly hope these commercial real estate owners aren't kicking themselves a year from now! If you plan to be a seller within the next three to five years...NOW , may be the time.

I still have to pay my dues. Even though I 've been doing this since Reagan's first term, I still must hit the streets, prove my metal, and roll up my sleeves to make a deal. The business has not gotten any easier with technology...just more ways to contact folks. Find the expert that will REALLY work for you...we are out there.

Let the market be the good or bad guy. I can level with my owners or occupants. I can give them the benefit of my expertise and view of the future...based upon my witness of the past. BUT, they are STILL the client and sometimes we must let the market do our dirty work. The market is neutral...be realistic in your expectations.

I hope that your 2014 was phenomenal! I wish all of you a VERY merry Christmas and a prosperous 2015.

Until next year, my BEST to you!

My #CRE ROOF is LEAKING...now what?

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As SoCal braces for STORM WATCH 2014 and we receive some MUCH NEEDED RAINFALL, owners throughout Orange County, California can hear the collective screams of HELP from their occupants as seemingly water tight roof membranes start to leak.

One of the most common questions, we are asked by occupants of industrial/commercial real estate is, "who is responsible for the roof?" As I sit in my dry office penning this post, it is pouring down rain in SoCal. I felt the post was timely.

So let's dig in, shall we? Please understand that this post is a laymen's interpretation of the mechanics of roof responsibility and is not intended to be legal advice. I am not an attorney, nor do I play one on TV.

Before the water comes pouring into your office or warehouse from the latest downpour, do yourself a favor, grab a copy of your lease (if you have one) and take a look at a couple of areas.

First, take a look at the heading across the top of the first page. There you should find reference to "Net" or "Gross". This is an important distinction, as the main difference between the two leases is the roof responsibility. The vast majority of leases in Southern California are on a form known as an AIR form and could read something like this..."AIR Commercial Real Estate Association Standard Industrial/Commercial Single-Tenant Lease--Net". Generally, in a Gross lease the owner is responsible for the roof and in a Net lease the occupant is responsible. There are some specifics, however, that should be understood.

Next, take a look at a paragraph entitled Maintenance and Repairs. In the AIR leases, the paragraph is 7 on page 5 and 6.

Responsibility for the roof on an industrial/commercial building is specifically broken down into three categories...maintenance, repair, and replacement. You should read how your specific lease deals with each item.

Maintenance: Most leases (and definitely the AIR forms) specify which party maintains the roof and call for the maintainer to have a service contract for the maintenance. Many maintenance contracts include an annual visit for removing debris from the roof and making sure that the downspouts are clear. Sometimes roof leaks occur when ponding builds at the downspouts because they are clogged. The puddle sits at the low point of the roof, weakens the membrane and leaks occur. Another culprit is the area around roof penetrations (such as HVAC units) that are not properly masticked. When the mastic becomes dry and cracked, the material loses it flexibility and water can seep through. A normal maintenance visit can shore up these issues and prevent leaks during the rainy season...when we have a rainy season!

Repair: Once again, most leases outline which party is on the hook to repair a roof if repairs are needed. In the case of a Gross lease, the owner performs the repairs and in a Net lease the repairs are the occupants to perform except to the extent that the repairs exceed 50% of the price to replace the roof.

Replacement: In a Gross lease the owner is responsible to replace the roof at his sole cost and expense. In the case of a Net lease, the owner is generally also responsible but only when the cost of repair exceeds 50% of the cost to replace. Within the AIR language, the owner replaces the roof, at her expense, and then amortizes the cost over 12 years.

So, in the case of a Gross lease, blow up your owner's phone. In a Net lease, HELP is all you. Call a roofer!

Orange County, California #TopWorkPlaces...CRE and beyond!

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Last night, I had the privilege of attending a gala hosted by our local periodical...the Orange County Register! Honored were the 100 Top Work Places in Orange County, California in the small, medium and large company categories. My firm, Lee and Associates, with our three Orange County offices and approximately 100 agents is considered a small company but a Top one! Steve Churm did a brilliant job with his emcee duties and was assisted in his efforts by Donna Wares and others.

What struck me as interesting was the number of Top firms within real estate and health care. Of the nine companies honored (top three in large, medium, and small firms) as a Top Work Place, SEVEN were involved in real estate or healthcare! The only manufacturing company to receive an honorable mention was Van's. Scanning the list of the Top 100, did reveal some notable manufacturers...Exsilio, Behr, MicroVention, Trace 3, Fluidmaster, and Hybrid Apparel among others. I am pleased to call Exsilio and Microvention, clients!

So here, by category, are the honorees:

Large Firms (500+ employees):

1. Evergreen Realty
2. New American Funding
3. Montage Laguna Beach

Honorable mentions to Solid Landings Behavioral Health and Vans

Medium Firms (100-499 employees)

1. Surterre Properties
2. The New Home Company
3. Sea Crest Home Health and Hospice

Honorable mentions to John Patterson's OC Auto and Zillow

Small Firms (35-99 employees)

1. Pacific Hospitalists Associates
2. SureFire CPR
3. Mattson Resources

Honorable mentions to Payoff, Inc. and Zumasys, Inc.

I cannot wait until next year! Thanks again to the Orange County Register!

Orange County #CRE, 8 Things You MUST Know

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Orange County, California Industrial has seen a resurgence like none since the early part of the decade of the two thousands! Currently, 97 of every 100 industrial buildings are occupied in Orange County. This is the LOWEST vacancy factor that I can recall since vacancy factors were first computed back in the mid eighties. If you doubt for a moment that the above is true, ask any occupant broker about the imbalance that exists, and you will get an earful! Orange County, California is deeply entrenched in an owner's market. So much has changed since the post recession occupant market evaporated in 2013 that I thought a recap of the current trends was in order.

Vacancy: As mentioned above, vacancy for industrial space is at a fifty year low. Underwriting a new loan or investment deal requires a deduct of 5% for vacancy...but the percentage is no longer justified! You now get penalized as an owner for a vacancy that is not supported in the market.

Sales Prices: Sales prices for occupant owned industrial buildings have hopped 50% since the beginning of 2013...50%! That is staggering. Our industrial values have now eclipsed 2007/08 levels before the world came to an end in the fourth quarter of 2008. The reasons are a simple case study in Econ 101...supply and demand. We have too little supply to meet the demand.

Lease Rates: Lease rates are starting to move up as well, albeit not to the degree of sales price increases. Fueling the rental rate increases are companies searching for expansion space to buy. When a suitable alternative cannot be found, these companies resort to leasing. Additionally, because of the low vacancy, many expanding companies are forced to renew leases at their present locations and figure out a way to band aid for their growth by adding offices, creative material handling, or outsourcing a function. Renewals of existing leases have caused the available inventory to shrink.

Capitalization Rates: Orange County industrial cap rates are hovering around 5%. Credit of the tenant, size of the building, price per square foot, length of the lease, lease rate compared to market can all affect capitalization rates positively or negatively, BUT a five year lease at a market lease rate for a 50,000 sf building with local credit should trade for a 5-5.5% cap.

Mergers and Acquisitions: We have witnessed a tremendous amount of merger and acquisition activity in the past two years in Orange County. Comparable to the activity we have experienced in the industrial investment sale arena, capital is plentiful and seeking returns.

New Construction: Several new industrial projects have dotted the Orange County landscape. Western Realco and Panattoni Development have been the most active with four new projects in Brea and Anaheim between them. Western Realco has developed excess land acquired from Harte Hanks and Suzuki. Panattoni is reshaping the former Boeing Campus with new state of the art freestanding buildings. All of the new developments are achieving tremendous activity at record prices with three of the four projects sold out prior to completion.

Interest Rates: Eisenhower era interest rates, that your grandparents would envy, continue to drive owner occupant purchase activity. Even with all time high purchase prices, an occupant can invest 10% of the purchase price and achieve a debt service comparable (or slightly higher) to a market lease rate. I've been predicting a rate hike for two years. It hasn't materialized. That's why I stopped playing blackjack.

The Next 12 Months: Continued lease rate growth, a leveling of sales prices, a small rise in interest rates...unless something catastrophic occurs...in which case, your call...

5 Reasons you SHOULD operate from multiple #CRE locations

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I have written exhaustively and taped videos on the reasons that companies relocate. Without a doubt, the number one reason that I see which forces a relocation is...operating from more than one space. There is no question that operating in numerous physical locations (not different markets, btw) is inefficient, costly, and counter productive...but it occurs many times to house a fast growing company as it muscles out of its existing confines.

I found myself yesterday advising an occupant to consider operating out of two locations as a solution to his growth projections...which spurred my thinking. Just when does that strategy make sense? In other words, when SHOULD an occupant consider operating out of multiple locations?

The reasons, in no particular order are enumerated below:

There ARE no other alternatives. Currently (example above), we have an occupant that we represent in the plastic injection molding business. Their current facility has 600 amps of power. They just bought a  machine that draws 590 amps of power at start up. Upgrading the power panel will cost $100,000...a cost he is unwilling to bear in someone else's building. Additionally, he wants to be within fifteen minute of home. With 97 of every 100 buildings occupied in Orange County, we are REALLY struggling to find expansion space. We may have to lease a secondary building temporarily to stem the flow until a long term solution can be located.

The real estate structure WON'T allow any other way to grow. I have seen this countless times when an occupant owns his building OR the occupant has substantially improved a leased location to the point where moving becomes cost prohibitive. If this situation occurs, growth may be accommodated by leasing overflow space close by.

The operation is easily segmented. Several years ago we represented a packaging distribution company in their search for a building to house sales, design, engineering, and distribution. They wanted to own. The sales and design portion of their business catered to a high end clientele...so image was important. We struggled to find the right fit of image and function since we were trying to find a class A office location for the design portion bolted onto a warehouse for the distribution piece. We solved the problem by selling them an office building close to home for sales, design, and engineering and leased them warehouse space for the distribution component.

An acquisition of a competitor. If a competitor is acquired, generally there is excess real estate. I wrote about this a couple of weeks ago. You can read that post here. We advise blending the cultures first and then figure out the real estate equation.

A portion of the operation MUST be segmented. Paint booths, H-2 rooms, fiberglass operation, plating machinery, foundries, etc. can ALL benefit from being separated from the entire operation.

So there you have it! Everything is not ALWAYS as it seems and sometimes operating out of multiple locations can make sense.

The SCARIEST things...that happen to occupants...in a #CRE deal

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In honor of Halloween and an idea foisted upon me by one of our crack staff members, Lisa Congdon, this post will delve into the scary things can happen to commercial real estate occupants during a commercial real estate transaction. Before we venture into the dark side of deals past, let me set the stage for you by outlining my credentials...

I provide Location Advice for owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. This is my 31st Halloween as a real estate broker. I've witnessed PLENTY of scary things, which should qualify me as some sort of an expert. We will go with that anyway.

So, here goes, in no particular order:
The building inspection that you relied upon misses something. We sold a building a few years ago. During the due diligence period, our buyer left the country and asked my partner and me to engage a building inspector in his absence...which we did. The inspection proposal was addressed to us and the inspection commenced, a report was generated and based upon the findings (there were no issues identified), the buyer closed the sale deal upon his return. About a month after he closed escrow, we received a call from his attorney. The building inspector had overlooked the fact that the building had NO AIR CONDITIONING! Fortunately the building inspector made good and paid for the air-conditioning to be replaced.

Your lender suddenly changes the rules. Recently, we entered escrow on a building (I represented the buyer). We had negotiated a sixty day loan contingency with the seller (at the bank's request). As we approached our loan approval deadline, the bank decided that they wouldn't close until the buyer received BUILDING PERMITS for the buyer's tenant improvements...which meant at least a 120 day approval delay. Fortunately, the seller cooperated and granted us an extension. The deal closed (albeit several months after the original closing date).

The building you are buying appraises for less than the contract price. This happened with EVERY deal between 2009-2011 that I was involved in (or so it seemed!). We solved this in one of three ways; price reduction, increase in down payment, or a combination of the two. What I learned during these trying times was that setting the proper expectations was critically important. I was careful to point out to all concerned that our agreed upon price was SUBJECT TO appraisal...and if the building didn't appraise, we would have to discuss a solution.

You cannot possibly achieve city permitting for your use...by your projected move in. We are seeing this issue a lot these days as it appears that ALL governmental agencies must grant your occupancy's approval. My best counsel is to ANTICIPATE the hurdles that your use will encounter and structure the transaction accordingly. As an example, if you know your use will require a high pile storage permit, communicate this to the owner of the building early and be prepared to discuss the steps needed to get your permit...which will make your request credible.

We experience September 2008 again. I will NEVER forget the day the music stopped...banks stopped lending, buyers couldn't buy and sellers couldn't sell because, overnight their buildings were worth half of the value before. Here is my formula for survival.

You discover a MAJOR un disclosed issue...structural, environmental, financial. If you discover the issue during due diligence, you generally have the ability to cancel the transaction without penalty. Once your contingencies are waived, you can generally cancel with penalty. If you discover the major issue after you become the owner or tenant, you should consult a good real estate attorney as warranty rules and recourse against an owner vary by state.

You realize that you have the right building...but the wrong broker. I currently represent an owner who had a falling out with his previous broker. You, as the occupant or owner, can choose who you want to represent you...period. If you discover that you are obligated to PAY your previous broker (you signed a lease and he repped you and you want to renew) you can still choose other representation...although it might cost you a bit more.

Company MERGED or ACQUIRED? Don't forget your #CRE

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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.

10 DEADLY errors that #CRE occupants make

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As I have traveled these commercial real estate roads for over four decades, what follows are the 10 deadly errors that I have seen occupants make when buying or leasing commercial real estate.

As an aside, 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. That qualifies me as some sort of an expert...if I can only remember why.

Buying when you should lease: Your business is outstripping its building capacity almost daily, you want to build the business to a point and sell the business, you are sinking every bit of operating capital into the businesses growth, you cannot adequately predict your space needs for next month...much less next year...hmmm, why are you looking to OWN? I outlined a number of the pitfalls in this recent post.

Leasing when you should own: You have been in business for over five years, your space needs are static, the interest rates are historically low, you have enough idle cash for a down payment, the cost to own vs the cost to lease is comparable...what am I missing? YOU SHOULD OWN! I recently penned a post on this subject entitled Reasons you SHOULDN'T lease #CRE

Leasing more space than you need: Somehow that growth spurt NEVER occurs and you end up with way more space than you need...which means your precious profit dollars are consumed in that space.

Committing to a short term lease in a down market: You are petrified that the business won't survive and therefore you can't commit to a lease term in excess of a couple of years...even though the deal is the BEST ever! You then kick yourself that you didn't lock up the terms for ten years when renewal time comes and the market has shifted back to the owner's favor. A work around could be a short term lease with a fixed rate option to renew. An owner will generally not agree to such an arrangement in an up market but may in a down market to secure your tenancy. Conversely, an out clause could be negotiated.

Committing to a long term lease in an up market: I have a client who signed a ten year lease in 2008 (right before the world ended). Fortunately, I didn't represent him at the time or he might be a former client. Anyway, he now pays a substantially over market lease rate for his space.

Waiting too long to consider your alternatives: How much time do you need?...A minimum of one year. If you have eclipsed this time frame, you may still be OK, but if you want to move and there is some complexity to the operation...plan on hustling to make it happen.

Assuming your owner will not "broker up" at renewal time: Believe me, if you assume that, come renewal time, your owner will not be well informed on market conditions, current lease rates and terms, and the most recent comparable leases transactions...you are sorely mistaken. You owe it to yourself and your company to have representation during your lease renewal.

Not weighing ALL of your alternatives: Staying in your existing location, moving, changing the operation to outsource a function. ALL should be considered.

Believing that if one broker is good, three will be better: The opposite is actually true. If you have three service providers providing the same service, what suffers is the service to you. Because you have not loyally chosen a representative, the representative has no loyalty to you. Therefore, you will see ONLY the most likely alternatives for your requirement...but not much else.

Not competitively bidding your financing: I cannot tell you the number of times, one of my clients (when I ask them who is providing their financing) tells me "my bank". This can go VERY well or more commonly VERY badly. Remember, unlike commercial real estate service providers, lenders sell money...at a price...the interest rate. You owe it to yourself to get a second and maybe a third opinion before allowing your bank to do your loan.

Selling #CRE? Seven things you MUST know

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This post was inspired by an article I read recently in our local rag. The emphasis was on residential but I believe there is a commercial real estate application as well. Before, I get to the good stuff, how about a little context?

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 advised thousands of owners over the years which should qualify me as an expert du jour.

So to the good stuff (seven things you MUST know before you sell or lease your building), I promised...

Is NOW a good time to sell or lease commercial real estate. I was approached in 2009 (probably the bottom of our market in SoCal) by a friend and client of mine. He owned three commercial real estate assets that he purchased in 2001. All were multi tenant projects with reasonable occupancy BUT with over market rents. His desire was to sell the three buildings as a package and re-invest the sale proceeds into distressed buildings. I explained to him that this was an AWFUL time to sell because the over market rents would be marked to the lower market rents and he would be lucky to sell the three for the price he paid eight years before. He appreciated our candor and listed the buildings with us for LEASE and LEASE RENEWALS. Recently we have advised the owner that NOW is a GREAT time to sell and he is pondering.

How is my broker received in the market. Before you hire a broker to market your commercial real estate, ask him for the names and numbers of his three biggest competitors. Call these folks and ask them, "what do you think of ________"? LISTEN. This is critical. You don't want a broker with a shady reputation representing your commercial real estate to the market.

What is the market's perception of my building. Ask this question during the interview process when hiring a broker to sell or lease your commercial real estate AND after you list the building for sale or lease. LISTEN. The market can tell you things that your broker may be fearful of telling you.

Where is the occupant of the building going to go. We have had two situations recently (I represented the buyers) of occupants who couldn't find replacement space because the market is so tight. Even if you have cancellation clauses in your lease with the occupant, if he can't find a place to move, guess what, he won't move!

What are the three most recent COMPS that REALLY compare to my building. Anyone can cite general deal points...price, financing, buyer or tenant...BUT what about things like, how long was the building on the market? What, if any pricing adjustments were made during the marketing? Where was the buyer's previous location? Did the buyer or tenant grow into the space or was it a downsize? Why was this particular building chosen...power, yard, price, lease renewal of an existing occupant, option to buy exercised, etc.? Why was this COMP chose as a comparable to my building?

Are there any "headwinds" looming that I should consider. How would you have felt in June 2012 if your broker had ill advised you of the impending tax law changes. In effect, you would receive approximately 8% less if you closed in January of 2013 vs December of 2012. I'm guessing you have been more that 8% upset!

How many buildings JUST LIKE MINE are available. AND how many, just like mine have leased or sold in the past year. This quick analytic will let you know how many "weeks of business" are on the market and will help you gauge marketing time. if it appears that you are in a seller's environment...as we are in SoCal...you can aggressively push pricing...even if the recent comps don't support it.

"How to" handle OTHER #CRE leasing issues

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This week we concluded a rather complicated "shuffle" of an existing tenant and a suitor within a multi tenant project. I believed the journey was blog worthy.

We represent(ed) the owner of the project, handle the new leasing, renewal of the existing tenants, and "other" leasing issues.

My partner, marketing associate and I work in close conjunction with a professional property management firm, Essex Realty Management.

Essex collects the rents, pays the bills, deals with repairs and maintenance on the property and prepares the year end accounting.

Ownership: The ownership is a seven member LLC that must approve any new leases, renewals, or "other" leasing issues. Currently, the managing member of the LLC is recovering from a lung transplant so we are seeking approval from designated family members.

Is that complicated enough?...stay tuned!

Before I forget, 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 love the "other" leasing issues that occasionally arise as they add a challenge to a somewhat mundane leasing assignment. The below qualifies as "other".

OK, now the "other leasing issue" I promised before the break...

The existing tenant:
An existing tenant within the project

• Had a space full of special purpose improvements and equipment, all of which were tenant created and funded
• A little over two years remaining on an over market lease obligation, and
• A brand new location that she purchased...before settling with our owner on the remaining term of the lease...in effect she now had two spaces for one business

The good news is that she also had a suitor, in a similar business, who wanted to buy the special purpose improvements and equipment in the space. Her business deal (the improvements and equipment sale) with the suitor depended on a new lease or an assignment of her existing location's lease...easy right? Ummmm, not really.

The challenge:

• The existing tenant wanted out of the lease, with no recourse, at the rate she was paying.
• The suitor wanted a new five year lease at the market rate (approximately $.35 psf below the rent the exiting tenant paid).
• The owner was unwilling to do a market deal today because he had a tenant obligated to pay rent for an additional 26 months...a classic stand-off.

The solution: We did three things...

• We wrote a new five year lease with the suitor at a market rate.
• We convinced the existing tenant to pay the difference between her rent and the new rent for the balance of her term in a lump sum we called a termination fee.
• Because the new lease and termination were subject to the business deal closing, we made a demand to escrow that all of the monies due the owner would be due at closing AND in the event the business deal didn't close, the old lease was still in effect.

A win for everyone: The suitor got his new five year lease, the existing tenant relieved herself of the excess location and the owner was made whole and got three years of additional term.

What EVERY #CRE owner wants to know

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I was asked recently to attend a meeting with a property owner by a broker associate of mine. I kindly accepted and was grateful that my associate asked for my involvement.

The owner will soon have a vacant space in a building that he owns and occupies. The owner would like to attract a tenant to his building as quickly as possible to avoid a lengthy interruption in his income stream.

Our discussion with the owner struck me as important for ALL owners of commercial real estate to know...thus the genesis of this post. Please stand by for a word from our sponsor...

I provide Location Advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease industrial buildings for a living and have since Reagan was President (his first term). I have advised numerous owners over the years but have rarely written about the owner advice that I give. I believe this is a post worth reading...for ALL owners.

So what is TRULY important to an owner of commercial real estate?

What is my property worth. Any broker should be able to emphatically tell you this. If there is any hemming and hawing, the danger Will Rogers lights should flash. Qualifiers are OK..."given a reasonable marketing time, I believe the building is worth X" OR "if you paint and carpet the offices, we should lease the building for Y."

How is the market: Your broker should be conversant with the overall market in which your building competes, the trends up or down and the prospects for the next six months. Such as, "there is a new project being completed down the street which will add X number of square feet to the market and none of the space is pre-sold."

What specific buildings are competition to mine. The broker should be able to tell you specifically, including addresses, amenities, ownership structure, and motivation.

How many similar buildings are on the market. In our case, there were four. GREAT NEWS for our owner, but this can be a bellwether as to how long your building may sit with no income.

What are the three most recent comparable transactions and how do they compare to my building. Names, dates, terms, EVERYTHING about the deal. Most importantly, HOW does the comp compare to YOUR building...other than square footage? We believe that our owner may have an issue with his building's fire suppression system, which could limit stacking height in the warehouse. NOW is the time to understand these issues.

What are your brokerage qualifications. Tenure, specialty, reputation, area, expertise, references...ALL should be provided. Ask your broker what how his competition would describe him or her.

How much do bill for your services: SPECIFICALLY outlined

How will you find a tenant or buyer for my building. Your broker should employ a good mix of new world (video virtual tours, social media and internet canvassing) vs. old world (brochures, multiple listing services, mailers, cold calls, and signs) marketing techniques.

How long can I expect the vacancy to last. Included in the COMPS and AVAILS list should be an understanding of the marketing time (vacancy) of each deal.

I believe you will agree that ALL of these items are necessary to understand and EVERY owner wants to know.

The MOST important thing in a #CRE purchase

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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?

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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!

I signed a #CRE lease, BUT I want out...now what?

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Your company was just purchased and the operation will be rolled into another location...check!

Or, you've out stripped the capacity of your location but you have time remaining on an existing lease...check!

Or, you have decided to shutter the operation, and outsource the manufacturing to China...but your lease expires a year from now...check!

Or, you decide to take advantage of  historically low interest rates and buy a commercial real estate location...but there is that landlord who wants to receive her rent for the next two years...check!

ALL of these scenarios and more can cause the need for a lease termination. But, just how do you accomplish this? This post is designed to give you some helpful suggestions to extract yourself from a lease obligation.

But first, the obligatories...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 encountered many occupants with the issues above over the past four decades. I believe this qualifies me a some sort of a guru...right?

OK, let's go to work and find a solution for that un-needed lease term!

Ask yourself these questions:

How much time remains on your lease? If the term remaining on your lease is less than two years, be prepared for your owner to use your remaining term as a "free" marketing time. The owner has the luxury of rent payments while searching for a replacement tenant or buyer.

What type of entity owns your location? A private individual may be a bit more flexible than an institutional owner such as a pension fund advisor or a REIT.

Where is your rental rate in relation to the current market? If your rate is above market, plan on subsidizing payments on the remaining term...if a replacement tenant can be found. If your rate is below market, your remaining term could provide a good alternative for a fast growing company concerned about a long term lease.

How does your lease treat assignment or subleasing? Most commercial leases allow for subleasing or assignment. Rarely is there a removal of your obligation, however. This means that if you sublease or assign the remaining term, you may still be liable for the payment of rent if the sub tenant defaults.

If your are moving to a bigger location, what is the rent amount monthly? If you are doubling or tripling in size, one month of rent in the old location could be a fraction of the monthly rent in the new location. IE: Old location rent is $5000 per month. New location rent is $15,000 per month. There are nine months of term remaining in the old location or $45,000. If you negotiate three months of rent abatement in the new location, you avoid a double payment.

How long would your building take to lease? Any competent commercial real estate broker can answer this for you. The answer to this question will have bearing upon a lease buyout.

Can some portion of the operation stay in the location through the term? I just sold a building to a company with 15 months remaining on a lease term. Rather than try to sublease the space or negotiate a buyout, my client elected to open another related operation in the space.

Are any of your neighbors crowded and in need of space? A fast growing neighbor can consume your space with a moment's notice...AND thank you!

Once these answers are clearly understood, you have some options:

Negotiate a buyout: I generally will suggest that an occupant call his owner and discuss the reason that the space is no longer needed. I suggest that the occupant ask the owner if she would consider a buyout of the remaining term and if so, for how much? Depending upon an up trending or down trending market, the owner response will vary. Assuming 12 to 18 months of term remain, an owner will generally compute the marketing time to find a new tenant, lease concessions (free rent and improvements), brokerage fees, and the variance of the current rental rate to market. All of these factors form the basis of a buyout offer. You can read this post on a recent buyout negotiation we successfully conducted.

Sublease or assign the space: If more than two years remain on your lease, unless you are dramatically below market, most owners will not consider a buyout of the remaining obligation. You then must find a replacement tenant to live out the remainder of your lease term. You can either do this yourself, hire someone like me, or ask the owner to do it.

Cease payment: I have NEVER recommended this but it is an alternative.

Live out the term: In the example above, my client loved the old location so he created a business operation to house the space and live out the remaining term.

I signed a #CRE lease for a new location...now what?

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You, on behalf of your manufacturing or distribution company just signed a commercial real estate lease for a new location...congratulations!

Many believe that the deal is now done (including many in my profession), we can move-in, cue the band, alert the media...and let's get the party started...hmmm, not so fast as there are a multitude of issues to address...some seen and some unseen and not the least of which is the physical move!

This post is designed to provide a list of items to consider....after the lease is signed. Before we delve into the list, let me pause for the formalities...

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. That qualifies me as some sort of an expert...I believe?

The list below is intended to be a list of issues to consider as opposed to an "end all be all" moving checklist...which if I published would make your eyes bleed.

Inspection of the building: Normally, this step is accomplished prior to signing the lease, in case there are latent issues that the landlord should handle prior to occupancy. In the off chance that this was not done, you may still be OK as the lease that you signed should contain a provision for an inspection to be conducted within the first thirty days post lease signing. Generally, the owner must fix anything that is broken. ADA upgrades are typically an exception to the owner's responsibility. I would recommend you engage someone to do two things...inspect ALL of the systems within the building...fire system*, truck doors, plumbing, electrical, roof, HVAC, etc. AND prepare a report including images of the condition of the building pre move in. You will be able to use the report when you move out of the building to recall this condition. *Take a look at the most recent fire sprinkler certification and make sure that is up to date. If not, request that this be done.

Warranties on the building systems: I will assume that your lease provides a mechanism for the owner of the building to make things right if any repairs to the above referenced systems are needed. In Southern California, assuming you signed an AIR lease, this warranty is 30 days for non HVAC items and six months for Heating, Ventilating and Air Conditioning. Use the report I recommended that you create and place the owner on notice to accomplish whatever repairs are needed.

Permits and licenses: Once again, I will assume that the necessary permits and licenses were obtained prior to lease execution...or at least some serious due diligence was accomplished on what was needed. If not, shame on someone! Please don't just move in to a building without talking about your use with the city to make sure the zoning is correct for the use, no special permitting is needed for high pile storage, storage rack permitting (in SoCal seismic testing is needed for new rack installs). You also should consider machinery that will be moved and any UL rating that may be needed.

The physical move: I would highly recommend that you engage a moving and storage company familiar with moving  your operation. Some careful vetting and planning here can really save you time and aggravation.

Lease administration: Most location advisors will prepare a lease abstract of the key dates of options to renew, options to purchase, rent amounts and rent increases. I would suggest making two copies of your lease and place one in your top desk drawer or in an easily accessed digital file for ease of reference and the other with your payable department. Make sure the lease is signed by all parties...sounds silly but I've encountered many situations where the occupant is never given a fully executed lease copy. Also, make sure you know where to send your rent check and whether your new owner prefers direct deposit vs. mailing a check.

The transition: Where practical, I recommend having a face to face meeting with the owner. Chances are, your negotiations were conducted through commercial real estate brokers or attorneys and you never have met the owner. Make sure you exchange name, address, and contact information...email and mobile phone. Who will tell your customers and suppliers that you moved? How will you deal with plant shut downs and production interruptions? When and how will you tell your employees that you are moving?

Planning your next move: Wait a minute...I JUST MOVED! Precisely. There is no better time to reflect on the move, what you will do at lease expiration, what went well...what didn't go well, etc.

My #CRE lease expires in 18 months...now what?

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Unless you own your commercial real estate location, you will face a lease expiration.

If your company does a series of short term leases...twenty four to thirty six months...this expiration will seem to occur overnight!

If your company takes a longer view of your lease obligations...five to ten years...then your lease term will eclipse or straddle many market peaks and valleys.

Regardless, of your company's attitude about the length of your leases, you will face an expiration.

How and when you plan your direction at lease expiration time is the purpose of this post.

...but first, allow me to 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 have advised a multitude of companies large and small on new leases, lease renewals, and lease cancellations. This qualifies me as some sort of an expert...if I can only remember...

As with any business strategy, an appropriate lease expiration strategy can save you time, money, and aggravation. I would suggest following the steps below, when you are 18 months from expiration:

Gather ALL of the important information: Find your lease. Make a copy. Put it on your desk. Vow to read it. You are interested specifically in any options to renew, rights of first refusal to purchase, rights of first offer to purchase, expansion rights, hold-over clauses, termination rights, commercial real estate brokers that were involved in the transaction, etc. Well in advance of your lease expiration (18 months) is a GREAT time to gather this information.

Engage great help: If a broker represented you in the original lease, there may be clauses contained  whereby she is owed a fee in the event you renew your lease...even if no option to renew exists. Check this out! Regardless of your experience (good or bad) with the brokerage representation, a fee may be owed by the owner of the location for any expansion or renewal. If the experience was good...no issue...engage that broker to assist you in mapping the renewal strategy...after all, she will be paid. If the experience wasn't so great, you can opt for other representation...BUT, the owner will still owe the previous broker a fee...therefore any brokerage help you engage will be a cost that you, as the occupant, will bear. The extra $ could be worth it! If you dealt directly with an owner to construct your lease...DANGER, Will Rodgers! Please engage a commercial real estate broker to assist you in negotiating a renewal.

Analyze your current operation: Chances are, when you leased your present location, certain business realities existed...customer locations, manufacturing processes, methods of shipment for raw materials and finished goods, hours of operation, number of employees, dollar volume of business, etc. How have these realities evolved since your lease originated? If you were told that you couldn't renew...how would that affect your operation? Would you face significant improvement cost in a new location? Would moving costs be excessive? If so, you might be better served owning a location...depending on other factors in the market...avails, interest rates, etc.

Take a look at your crystal ball of future business: What is your best estimate of your business in 18 months from today? How does the location mesh with the crystal ball? How long can the location efficiently house the operation...past the 18 months?

Assess the commercial real estate market conditions: Ask your broker/partner to assess the market for you as if you were moving locations today. With the same criteria as your present location, how many avails are in the market? What are the three most recent lease comparables? Is the market up or down trending? Is your present lease rate above or below market? Ask that your broker/advisor send you an updated list of avails and comps each month for the next six months.

Be realistic: If you are paying a rate above market, weigh the difference (between the market rate and your rate) vs. your cost to move. As an example, if  you are $.15 per square foot above market, you occupy 20,000 sf and your cost to move is $50,000...your incremental cost is $.07 per square foot over a three year lease. ($50,000/36/20,000). Conversely, If your lease rate is below market, understand that you may be strapped with a rent increase come renewal time. There are ways to stem this increase which will be a topic for a future blog.

Figure out the BEST time to approach your property owner: During 2009-2011, we discovered that many occupants were well above market in the rates that they were paying. The whole idea of a blend and extend evolved. The mechanics of a blend and extend were that additional term was committed to today in return for a reduction in rent. Occupants were happy to commit to the term past their original expiration, in return for a cost savings today. Owners were happy to avoid a costly vacancy in 18 months...WIN WIN. If your rate is below the current market rate, this doesn't work as the owner will wait for the expiration to extract more rent.

Build #CRE and they will come? Seven reasons they won't...

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Early in my commercial real estate career, which now spans four decades, I received an objection from buyers. It went something like this...why should I pay X amount for the building? I'll just buy a piece of land and build it myself...it's bound to be cheaper. Hmmm, maybe they are right, I thought. I learned early on that I better be well versed in the "replacement cost" argument.

Please indulge me and I will explain why building your own building rarely (if ever) makes sense...even if you want to lure the Chicago Black Sox.

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. Some expertise is intrinsic...if I can exorcise it...

What buyers of commercial real estate (who believe they can build cheaper than buy existing) often overlook is as follows:

Land prices: Remember if you want to build a 20,000 sf industrial building with a normal parking ratio...two spaces of parking for every 1000 sf of building, you will need to purchase an acre (an acre is 43,560 square feet) to an acre and a half of land...or approximately double the building square footage. This building to land relationship is referred to as a coverage ratio or an FAR (floor to area ratio).  Rarely will a city allow a coverage ratio, for an industrial building of greater that 50%. If you pay $20 per square foot for the land, at 50% coverage, the cost of land under building is $40 per square foot. The smaller the land parcel the more valuable...thus the price per square foot will be higher. A production developer who buys ten acres and builds ten, 20,000 square foot buildings will pay less per square foot for his land. You will pay more for your land.

Soft costs: Architectural, engineering, off-site improvements (curbs, gutters, utilities), on site improvements (demolition, clearing) will add 20-25% to the total project cost. These costs are overlooked or under estimated.

Entitlements: City approval for the development. Catch 22 here. You don't want to invest in a parcel of land that you can't improve BUT rarely will land sellers tie up their property while you endeavor to receive permission to build. If you begin with a raw piece of land this can take a year or two.

Time value of money: Entitlements and construction time can easily eclipse two years or more. Rarely does an occupant have that much time to plan for a move or the foresight to predict their building needs. During this time, a great deal of money is tied up in the land purchase.

Financing: Typically, the land will have to paid for in cash, a construction loan originated and replaced with permanent financing once the project is completed. Consequently, there are loan points, fees, interest carry, and interest rate risk (if rates are rising during the construction) for ALL of the loans...construction and permanent. You will pay twice as much to originate financing (because you have two loans) than simply buying an existing building. Loans are more expensive.

Economies of scale: You are building ONE building. A production developer is building ten. Who do you suppose if going to drive cheaper construction costs? Additionally, some costs are fixed regardless of the square footage being built...a water main to the project, as an example. The more square footage that can be prorated, the cheaper the price per square foot of buildings.

Market forces: When you buy an existing building, you have the market forces to your advantage. The more buildings available, the more competitive prices will be. If you are building your own building, you cannot take advantage of market forces.

Does it ever make sense to build your own building vs buy existing? Certainly...but only if your use of a building is special purpose (cold storage, data processing, warehouse clearance in excess of forty feet, etc.) and there are NO buildings available in the desired area, OR if your existing location includes some excess land which is not improved and can be developed with no cost associated with the land, OR if you are a general contractor, architect, or engineer and can provide your services wholesale.

Otherwise, don't build it they will not come (SPOILER ALERT...they didn't in the movie either).

Reasons that you SHOULDN'T lease #CRE

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Last week I recounted the tale of my client that phoned and asked if he should buy the building that he occupied. If you missed the post and would like to read it now, please press here. The post was one of the most widely read of all time...thanks mom and dad for reading...Anyway, the wide readership spurred today's post...reasons that you shouldn't LEASE commercial real estate. Before I jump into the anti leasing realm, let me digress. I'll catch you in two and two (thanks to Chuck Woolery).

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. My expertise is questionable...but oh well...

Back to the question of leasing.

I recently met with a client of mine. The purpose of our meeting was to discuss his upcoming lease expiration and some direction on a renewal...at least that is the way the meeting began. As we delved into the subject, it became painfully apparent to me that this client should OWN a building. So what were the "tip offs" in this client's case.

Age: The client is 42. He plans to continue his current business until his son is through college (approximately 15 years). He can retire the debt in the time until his son graduates and own the real estate free and clear.

Stabilty: The client has been in business for fifteen years and his business has grown each year.

Size requirements: The client has occupied his exiting location for five years and prior to that another five years in a previous space...all about the same size.

Wealth objectives: The client is looking for some investment diversity and believes commercial real estate should be an integral part of his plan.

Historically low interest rates: He knows that we only go up from here and if he can lock in a low rate today, he freezes his NNN occupancy costs for 20-25 years...if he decides to stay in business that long.

In short, this client should definitely OWN vs. LEASE today.

Are there other reasons that a company should NOT lease?...certainly.

Special purpose building: If the occupant has a substantial investment in processes, office space, or other immovable improvements, try to own the real estate...you don't want to be at the mercy of an owner that will extract a value for your inability to move.

Ownership structure: Closely held works best and if the ownership has few owners.  As we discussed last week, publicly traded companies typically DO LEASE as they don't want the negative effect from depreciation on earnings.

If your business is home based: My wife Carla runs her business out of our house. Our kids are grown and gone so we have ample space for the business. The additional overhead, for a location, is impossible to justify...maybe someday!

If you can outsource the need for the location: You shouldn't lease a building if you can outsource the function. Remember, there are other costs in addition to rent to consider...utilities, tenant improvements, fixturization, etc.

 

So there you have the alternate view and now you know the reasons NOT own and the reasons NOT to lease.

Reasons that you SHOULDN'T own #CRE

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I received a call today from an old client of mine...in my advancing years, many of my clients are "old" clients. The question that he posed was "should I buy the building that I occupy?" My response to him was simple...I don't believe so.

You may be scratching your head about now...this guy sells buildings for a living...why would he recommend that someone NOT buy a building?

Indulge me for a moment while we hear from our sponsors...

I provide Location Advice to owners and to occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I have sold and leased hundreds of thousands of square feet over the years...as well as, talked a few folks out of buying or leasing. This qualifies me as some sort of an expert...if I can only remember why...

OK, so back to buying a building.

The reasons, that I used to form my recommendation not to buy today, were:

His age: My client is 58. Certainly not ready for the old folks home but closer to retirement than not. Unless he were to pay cash for the building, the loan would not be fully retired until well after he is.

The time in the market cycle: We are at the top. Unless the hold was for another twenty years, I doubt the building will be worth more than it is today.

The physical amenities of the building: Old, tired, and needing some stuff (similar to his broker)...roof, HVAC, parking lot, etc. Under his lease arrangement, and superior brokerage advice :), the current owner is responsible for all of these expenses.

His exit strategy for the business. He plans to sell the company that occupies the leased building within five years. When asked if he would want to own the building vacant...his answer was no.

As I thought about the reasons that this client should avoid purchasing and opt for leasing, other reasons (for not buying) popped into my greying head:

If you are a publicly traded company: Depreciation becomes an issue as it reduces earnings...bad for share prices.

If you expect to outgrow your location within 3-5 years: You will then face a liquidity event...either leasing or selling the building that you just purchased...and outgrew.

If the location that you occupy is a commodity: Meaning plentiful in the market...ie: bulk distribution space. The more of this space in the market, the cheaper it will be to lease.

If the company (your company) that occupies the building you're buying is less than three years old: Chances are the company has not established a profit pattern and may find it difficult to obtain financing.

If your company has a pressing need for operating capital: The last place your want your money if you need it for hiring, equipment, and growing the business in in an illiquid asset such as a building.

If the debt service on the building you're considering buying exceeds NNN market rents by 20%: The tax benefits will never make this purchase worthwhile...and you can't count on appreciation to bail you out...think 2008.

I really believe that my client appreciated the candor...after all, that is how he became an old client.