Friday, April 24, 2015

Is your Commercial Real Estate UN-MARKETABLE?

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The typical industrial building contains several features such as its location, freeway proximity, favorable zoning, the size of the building, size of the lot, the amount of office space within the building, parking spaces, electrical service, fire sprinklers, ground level loading doors, dock hi loading doors, fenced parking or outside storage yards, warehouse clearance, truck turning radius, etc.

Occupants of industrial real estate will have some of these features as absolute requirements for their occupancy and some of the features will not matter.

Feature ladened commercial real estate coupled with your motivation to lease or sell your building will determine the speed with which your commercial real estate will attract a buyer or a tenant. 

I like to think of occupants as the universe of potential buyers and tenants. If your commercial real estate has EVERY FEATURE plus you are motivated to sell OR lease your building quickly, your commercial real estate will attract the largest percentage of the occupant universe. 

Your universe of potential occupants, with whom your commercial real estate resonates, retreats depending upon the lack of features. As an example, if you own a manufacturing building that contains an insufficient amount of electrical power, potential occupants will short circuit your building in favor of an electricity rich alternative. 

So with this context, what lack of features will cause your commercial real estate to be un-marketable in its present state? I have ordered these most to least. 

Deal motivation. If you ONLY offer your commercial real estate for LEASE and would not consider a SALE, you eliminate 40% of the this percentage of occupants ONLY wants to own their commercial real estate. 

Ceiling clearance. If you own a warehouse building that would find favor with a logistics company, that query would be quickly quelled if the height of the ceilings inside the building was 18 feet. Why? Because, the majority of warehouse occupants depends upon pallet stacking height to maximize their use of the space that they occupy.

Excess office space. Generally, manufacturing and warehouse-distribution occupants require a minimum amount of office space to house such functions as accounting, sales, clerical, executive, etc. If the amount of office space or the configuration of the offices is out of sync with the demand, your building will lay fallow. You see, the revenue from the operation is generated in areas other than the the back...where items are made, assembled, stored and shipped. 

Absence of loading. An industrial building that is greater than 20,000 sf will generally come equipped with grade level or ground level loading doors AND dock hi or truck hi loading doors. I've witnessed many instances where one of these loading options doesn't exist in an industrial building. From experience, I know that the missing loading will severely limit the number of occupants that will consider leasing or buying your building. 

Unrealistic owner. You may own the VERY best building in the market...feature full and open for business. But, the market is the market. If you are unrealistic in your expectations, and choose not to meet the market, you better have lots of staying power. 

Friday, April 17, 2015

As a Commercial Real Estate Owner, DON'T Fall Victim to Mayor PufNStuf!

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When I was a young man growing up in the 1960s...yes, I am that of the cool shows on TV was HR PufNStuf.

I didn't realize it at the time...because I was a sheltered youth growing up in Texarkana, Arkansas, where the Four States Fair and Rodeo was a BIG deal...that the show was linked to the cannabis culture of the 1960s and early 1970s.

I just thought that the Krofft's large NCAA mascot typed characters were neat and their genre became the KoolAid Pitcher, Mayor McCheese, and the Hamburglar.

What does any of this have to do with commercial real estate, you may ask...and you would be well advised to do so.

In commercial real estate we have a version of PufNStuf. This post is designed to explain the concept and provide some counsel on how to avoid it.

Just what is PufNStuf. PufNStuf is a method of inflating the recommended purchase price of a prospective listing in order to secure an exclusive engagement to sell or lease the piece of commercial real estate, the "puff". Once the engagement is secured, at the above market price, the activity in the market "stuffs" the true price down the unsuspecting owner's gullet. The broker blames the market for the variance in "ask" vs "reality" and the owner of the commercial real estate falls victim to a legalized "bait and switch".

Now, with full disclosure, sometimes a broker's intentions are not malicious. There are cases when a broker may recommend "pushing" the market to achieve a price in excess of the recent comparable sales. I have done this many times when I believed there was something unique in the offering OR if the market availabilities were scarce. In my opinion, that is what a skilled broker should do...recommend a course of action as dictated by the market trends.

How to avoid PufNStuff. We all believe that our children are the cutest and that our commercial real estate is somehow more valuable than other comparable buildings. PufNStuff plays to this emotion. My children ARE the cutest, by the way!

Consider these four things to avoid getting Puffed and Stuffed:

Be realistic. Your commercial real estate has an emotional appeal to you because you have owned it and may have operated a business from it. Understand that the market may not share your emotional attachment and will compare your offering to others in the market. Understand the trends. How many buildings, just like yours, have sold and are available? What were the salient reasons? Understand how the market may receive your building if your were to sell or lease it.

Ask your broker to justify his recommendations. If the comparable sales tell one story and your broker is recommending a price that is substantially higher than the market, ask him why. Listen to his response. The correct response would be that your building has unique amenities that buyers will value and that there is a shortage of buildings like yours on the market for sale. If he cannot justify his recommendations, you may be getting puffed!

Pay close attention to the activity you receive. Generally, you will receive a flurry of activity immediately after the building hits the market and the pent-up demand of the market reacts to the new listing. Chances are this activity will generate some tours. If lots of tours occur and there are no offers, chances are you are priced too high. Ask your broker to track down every single prospect that tours your building to discover what they liked and disliked about your building. You can learn loads from this type of feedback.

Rinse and repeat: Use the feedback in the market and your time horizon to adjust to the market conditions. Be swift to react as the commercial real estate market can move quickly.

Friday, April 10, 2015

Three BIG mistakes Commercial Real Estate Investors Make

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As a commercial real estate investor, you either occupy (with your business) the commercial real estate you own, you don't occupy (with your business) the commercial real estate you own, or you do both.

Today, I want to discuss the three BIGGEST mistakes that I have witnessed with investors that DON'T occupy the commercial real estate that they own.

They over leverage. Leverage is defined as the ratio of debt to equity. If your commercial real estate is leased and the tenant is paying a sufficient rent to exceed the monthly mortgage payments, also known as "debt service", the amount of debt vs. equity (leverage) is secondary. However, if the tenant vacates, the amount of leverage becomes a BIG deal! In order for you to receive a positive cash flow, you must find a new tenant that will pay rent in excess of your debt service. The more debt you have in relation to your equity, the higher the debt service becomes. With higher debt service, the resultant rent must be higher or you are forced to subsidize the difference. I have seen many investors who lease their building at the current market rates, incur debt based upon the rent amount, and then the tenant vacates unexpectedly. The investor is left with a building with no income and a huge payment...a formula for disaster! An investor should ALWAYS have a feel for the current market rents and how these market rents relate to the debt service he is paying. Regardless of what the current tenant is paying, if your debt service exceeds the current market rent, you are well advised to refinance or make some debt service reserves in case your tenant should vacate before his lease expiration.

They don't properly budget for turnover. Turnover is the loss of one tenant and the move-in of another tenant. The time between your current tenant vacating and your new tenant occupying is frequently underestimated by many investors. Additionally, your new tenant may require some free rent, some alterations to the existing office layout, or some refurbishment of the building. ALL of these items are expensive, so make sure you properly budget for them. A reserve account of one years rent is not excessive.

They try to time the market. Commercial real estate ownership is either a VERY short term play or a VERY long term hold. Investors who attempt to "time the market" frequently miss the mark and pay too much for their real estate or miscalculate their ability to exit the market. Decide, before you purchase commercial real estate, whether you intend to buy it, fix it, lease it and sell it quickly or whether you plan to pass the commercial real estate on to your grandchildren.

Friday, April 3, 2015

Should I OWN or LEASE my Commercial Real Estate?

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Commercial real estate comes in many, many flavors. There are warehouses and manufacturing buildings, commonly known as industrial buildings.

Office buildings are built as two story walk-ups, high rises, mid rises or if you add a bit of warehouse or manufacturing space to an office building it becomes flex space.

Retail spaces are located in neighborhood shopping centers, malls, power centers, or strips.

Institutional campuses such as colleges, hospitals and government buildings are classified as commercial real estate. 

Don't forget hotels, resorts, and motels, commonly known as hospitality. Have I forgotten any? I hope not.

As there are many types of commercial real estate, your occupancy of the real estate a bit simpler. You as an occupant of commercial real estate either own it or you lease it. Easy, right? Not so fast.

Some classes of commercial real estate lend themselves more toward tenants (leasing). As an example, few, if any regional mall occupants own their space, because the spaces are difficult to divide into smaller ownership interests. In order to own commercial real estate, the property must have a separate definable, transferable parcel. An easy rule is this. If the space has its own tax bill, it can generally be leased or owned by the occupant. 

If you occupy commercial real estate, how do you determine whether to own or to lease your space? As industrial real estate is my specialty, I will advise accordingly. However, the general rules cross all classes of commercial real estate (industrial, office, flex, retail, institutional, or hospitality) and are somewhat interchangeable. Your specific situation may vary so it is always a good idea to consult professionals before choosing an occupancy type.

In my experience, owners of commercial real estate generally have one or more of the following characteristics in common:

Closely held entity. Sometimes know as "mom and pop" companies, a closely held entity is a small C Corp, S corp or LLC that can benefit from the depreciation on the real property. Frequently, the owner of the business that occupies the building is also the owner of the building. The decision to own vs lease for a closely held entity revolves around paying rent to a third party or paying rent to yourself. Assuming the other factors below, align, ownership can be awesome! 

Stable space needs: owned real estate is more difficult to unravel if a company's space needs fluctuate  constantly. With a lease, if you outgrow the space, you sublease the space or wait for your lease to expire and walk away. If you own the building and owe a mortgage monthly, you are forced to sell or find a tenant that can pay you rent. 

Super specific facility needs: companies that must make large investments in their commercial real estate, such as heavy power distribution, dense office buildout, food processing equipment, freezer or cooler space, etc, will opt to own vs lease. To relocate these specific improvements is extremely costly! 

On the other hand, occupants that lease their commercial real estate would have in common:

Publicly traded companies: ownership and depreciation of commercial real estate lowers earnings and thus many publicly traded companies would prefer to lease their locations. 

Widely fluctuating space needs: as discussed above, moving is expensive, disruptive, and rarely achieves a speedy payback. To couple those reasons with an obligation to service a mortgage on a building you've outgrown, hampers the expansion of a fast growing company. 

Space that is a bit of a commodity. Logistics providers (warehousers and distributors) have many choices for buildings that suit their needs. Space is plentiful and interchangeable. Consequently, the space is a commodity vs a rarity. When their options are plentiful and interchangeable, a decision is made to lease.