Friday, October 31, 2014

The SCARIEST things...that happen to 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 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.

Friday, October 24, 2014

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? 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 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? 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.

Friday, October 17, 2014

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 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 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.

Friday, October 10, 2014

Selling #CRE? Seven things you MUST know

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 we are in can aggressively push pricing...even if the recent comps don't support it.

Friday, October 3, 2014

"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 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.