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!