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.