Friday, July 31, 2015

DON'T Overprice a Commercial Real Estate Listing...Here is WHY

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If I had a dollar for every time an owner of commercial real estate proclaimed, "We can always lower the price - but we certainly cannot raise the price", - well, you know the rest.

OK, fair enough, I get it. I might take the same approach when selling my own real estate. The purpose of this post, however, is to dispel the two myths mentioned above - that you can always lower the price but you cannot raise the price.

The background: Recently, I posted about how price is determined in a commercial real estate deal. If you missed the post, shame on you, but you can quickly get caught up by reading here.

Your commercial real estate is only worth the price that a ready, willing, and able buyer with proper motivation is willing to pay you and that you are willing to accept - period. Let's break that down. Ready, willing, and able - a buyer or tenant that is in the market today or in the near future, that can use the building amenities that are being offered and that has the financial capabilities to lease or buy your commercial real estate, check! Proper motivation - a reasonable period of time with which to search for a location, a building that is readily available, no extenuating circumstances that would limit the number of building availabilities that can be considered, check! That you are willing to accept - aha, this is where the whole idea of overpricing takes root - your motivation, check!

A high asking price: A common misconception arises when an asking price is too high for the market. An owner believes that the ready willing, and able buyers or tenants will simply offer on an overpriced listing. The reality is that the ready, willing, and able buyers and tenants perceive that the expectations are too far apart and will not offer for fear of offending the owner or simply that offering on an overpriced listing is a waste of time - there is no chance that the two parties could agree to a reasonable price.

A low asking price: A low asking price for commercial real estate communicates motivation and a realistic idea of what the market will bear. Many times a low asking price will generate so much activity that the price is actually "bid up" over the original ask. If you have ever been on the owner's side of a bidding war, it is quite appealing - for a buyer or tenant, not so much!

Lowering a high asking price: If you have ignored the pleas of your commercial real estate advisor and have over priced your commercial real estate, chances are you have not received many, if any offers. Now you endeavor to lower the asking price. This move creates all manner of activity within the brokerage community - the owner is getting more realistic - or worse, is desperate! Akin to that pair of shoes at your favorite retailer - if you just wait long enough, the price will come down again.

The moral: Be realistic about what features your building contains compared to your competition. Make sure you understand three metrics - recent comps, current avails, up or down trending pricing. Keenly assess your staying power - how long can you afford to feed a vacant building? Price accordingly, rinse and repeat!

Friday, July 24, 2015

Commercial Real Estate Cube Space? So What?

Image Attribution: Raymond Handling Solutions
The Preview: As I previewed several buildings for a client tourrecently, I encountered an occupied building that was on the market for lease. This is common. When an owner is notified by his occupant that the occupant will vacate at the end of his lease, the owner's recourse is to market the space - during the remaining time of the lease - while the building is still occupied. 

The Debrief: As the occupant showed me around, we discussed the occupant's moving plans - timing, new space needs, reason for the move, etc. I will generally do this - that is, debrief with the occupant - as I need to know if the space WILL in fact be available OR if the owner and occupant are playing cat and mouse in an effort to effect a lease renewal. 

Does he need to move: What struck me as odd was the way in which the occupant utilized the space. Let me set the stage for you. 35,000 square feet of warehouse space with an interior clearance of 32 feet and fire sprinklers within the warehouse that would allow the occupant to stack his product to the rafters - but this guy was not using racks and was stacking his product on the floor of the warehouse on pallets. The floor space was consumed. But, what about ALL of the space between the top of his floor stacks and the ceiling - the "cube space" - LOST! 

It's a BIG Deal: Now, here is why this was a big deal. Presumably, this occupant had lived there for three to five of the preceding years. He had paid rent for the square footage of the building - remember the 35,000 square feet - for ALL that time. Because he didn't stack his product to the ceiling, he was, in effect, paying for much more space than he needed. When I asked him why he didn't store his products in racks - thus utilizing the cube space - his answer was, "he didn't want to go through the permitting expense of installing racks". Hmmm, so he would prefer to pay for three times more space than he needed? Certainly made no sense to me! I calculated what leasing the excess space cost him on an annual basis - it was on the order of $100,000! That will buy lots of racking and permits. Heck, he might be able to buy a new forklift as well. 

The Moral: So here is the moral. If you believe you are out of space, look up. With a bit of material handling creativity, you can find space you never knew existed - in the cube!

Friday, July 17, 2015

The PERFECT Commercial Real Estate Investment

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I have my younger brother, John to thank for this post's inspiration.

You see, my brother has a computer repair, maintenance, and installation company in Texarkana, Arkansas. The business started as a hobby with a bit of supplemental income but has now become a terrific revenue generator and space hog. John's garage, living and dining room can no longer sufficiently house his burgeoning business so it is time to look for a location.

Enter older brother. Although I won't assist John in his site selection in Arkansas...the commute would kill me...even by SoCal standards, I was able to provide some helpful counsel on the PERFECT commercial real estate investment.

John is considering a commercial real estate investment that he will partially occupy and rent out the balance for income.

So just what should a new investor in commercial real estate consider when analyzing a deal. In my opinion, these six factors should be considered.

The income stream: The tenant(s), the rent that is collected...not contracted, the relationship of the rent to market rents...higher or lower, the tenant(s) business, the vacancy in the market, the credit worthiness of the tenancy, the length of the remaining leases, the taxes, insurance, maintenance, tenant improvement costs...ALL form the income model of a commercial real estate investment. In my opinion, the income stream is the MOST important consideration in a commercial real estate purchase. The reason is simple, if there is no income, there is no investment! Sure, he can buy an empty building and lease it, but that is a whole different kettle of fish. Be prepared to invest a significant amount of your future rental income originating a new lease. You can read more about that here.

Purchase price: I recommended that John have a complete understanding of the price and how the price related to market comparable sales. You definitely want to purchase commercial real estate below the latest round of comps...even if the market is increasing. The price you pay determines your property tax assessment forever and your ability to fill a vacancy in the future also depends upon your basis...the price that you pay. Always try to buy below replacement cost if possible.

Capitalization (Cap) Rate: I walked John through a simple computation of the cap rate for a commercial real estate investment. Take the gross income (the rent that the tenant(s) pays) and subtract the expenses. This yields a net operating income. Divide the net operating income by the purchase price and voila, you have the cap rate. Notice that I mentioned cap rate third on the list. This is not by accident, as I believe too many commercial real estate investors place too much emphasis on this metric...see Income Stream. What can appear as a great return (cap rate) will evaporate if the tenant cannot pay the rent. The opposite would be true of a dramatically under market rent. The return (cap rate) would look measly. But, if you can move those rents to market, a great investment may bloom.

Financing: I advised John to pay cash vs. leverage the purchase with new financing. Many would disagree with me, but he's my kid brother and I want him to send me a Christmas gift. If he does decide to get a loan...the term, interest rate, recourse or non recourse nature of the loan, amortization, and pre-payment penalty should ALL be vetted.

Exit: Is the plan to pass the property to his heirs (hold it forever) or lease the vacancy and sell the building? I told John to always have an escape route in case the investment should not unfold the way you planned it. As an example this escape hatch could be selling the building to the occupant.

Those things you don't think about: Reserves for vacancy and improvement costs, structure of the purchase...due diligence and closing, lease documents, condition of the property, environmental issues, zoning and use restrictions, pool of potential occupants, etc. You just never know when one of these snakes will bite be prepared.

So good luck in your foray into commercial real estate, baby bro! And remember us little people that helped you along the way...

Friday, July 10, 2015

How is Price Determined in a Commercial Real Estate Deal?

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Price. That monetary value that an owner of commercial real estate places upon his building. Just how is the pricing in a deal determined? That question is the topic of today's post.

Simply explained, the price or lease rate is a function of what a ready, willing, and able buyer or tenant will pay and what an owner is willing to accept.

But, we must begin with an asking price, in order to attract a ready, willing and able buyer or tenant, correct? So, how is an asking price determined?

From my experience, dating back to three pieced suits and wide lapels, asking prices are derived from several factors:

Location. A well located, freeway proximate building will command a higher asking price than one that is buried in a business park in a residential development. The ready pool of potential occupants will also factor in to pricing as the building may provide an easy expansion for a neighboring business. Ready sources of raw materials for manufacturing companies or easy logistics for warehousing companies can enhance a building's location - and thus an asking price.

Amenities. If your building has the bells and whistles that occupants demand, the building is more valuable and will sell or lease for a higher price. As an example, a freestanding building on its own lot is more desirable than a building that shares a wall with the building next door. An outdoor storage area is a feature widely desired by occupants because they can use the exterior for more space. More amenities - higher asking price.

Owner Motivation. This is probably the BIGGEST determinant of an asking price. An owner must have realistic expectations of the price his building will command in the market OR have enough staying power for the market pricing to "catch up" to his asking price.

Recent Comparables. Too often, folks in my profession, tend to generalize the recent market sales or leases without truly understanding the motivation behind the transaction. Such as, did the occupant renew his lease or consider market alternatives and choose this particular building? Was the occupant motivated by any special circumstances - such as being next door? The "true story" of the transaction should be considered in any asking price decision.

Current Availabilities. As closely as possible, the number similarly equipped buildings that are currently available in the market should be analyzed and understood.

Up or Down Trends. If the market is up trending, you can push pricing a bit. The opposite would be true of a down trending market. An owner might benefit from preempting a down trending pricing market by leapfrogging. Leapfrogging is a method of taking the lowest recent sale or lease deal and asking even less. Sometimes occupants react because they believe the building is a bargain.

Current Borrowing Rates. If capital is plentiful, easy, and cheap, an increase in pricing generally will result - and an owner can ask more - for his building. The reason is the buyer pool will be more plentiful, competition will be more apparent, and available inventory will leave the market more rapidly - thus upward pressure on pricing.

Once an asking sale price or lease rate is determined, the market takes over- that illusive force that pits buyers, sellers, tenants, and landlords into the wrestling match of a commercial real estate transaction. Ask too much for a building with few amenities - the building will sit. Bring a properly priced, well appointed building to the market - the floodgates of potential occupants will rain on your door.

Thursday, July 2, 2015

TIME Kills ALL Commercial Real Estate Deals!

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One of the first hard lessons I learned when I entered the CRE fray in 1984 was that TIME is not a friend to a commercial real estate transaction.

As time lapses - motivations of buyers and sellers morph, market conditions vary, pricing fluctuates, business ebbs and flows, and all manner of havoc occurs that can queer a business deal.

A reminder of this lesson surfaced last week.

I received a call from a client.

In summary, my client's business model had changed and he required fifty percent more space - immediately! Normally a great situation - but - he leases his existing location and thirty three months remain on his lease obligation - so a relocation to a larger building was out of the question. We needed to lease something VERY close by to accommodate the shift in my client's business.

Good news! A building was available next door and had been for nine months - which is rare in Southern California these days - as seven of every ten industrial buildings are occupied. The two reasons the building had lain fallow for 3/4 of a year were the lack of a truck loading dock and the owner's reluctance to paint and carpet the office space.

So, the building next door to my client's mother-ship was a bit of a misfit toy. Most occupants, considering a building over 20,000 square feet (which this was), require some form of dock access - again this building had no dock access - which meant product delivered in large tractor trailer rigs had difficulty un-loading their wares - thus making the building un-desirable for most industrial occupants. My guy didn't care about the loading - he only wanted the space - and the fact that his mother-ship was next door made the vacant building ideal. I was confident we were in a great position - until...

We excitedly inquired as to the vacant building's availability. Even though a building may appear as available in a multiple listing service - you still have to verify. In this case, we were told the building owners had agreed to terms with a tenant and were negotiating a lease - BUMMER! What are the odds? A building sits for the better part of a year and right when my guy needs it, it's leased? Come on!

I am happy to say the cloud has a silver lining and my client is now the vacant building's tenant.

What happened? Time. Time killed the competing tenant's deal.

Here is how. The competing tenant believed that the owner had no other interested parties. After all, no one had stepped forward to lease the building since last Halloween - why would anyone appear now? Therefore, the competing tenant and the competing tenant's advisors became a bit over zealous in their requests for concessions - prolonged the process - and provided a window of opportunity for my client. You see, a deal is not DONE until BOTH parties sign the lease agreement. We had to move VERY quickly, ask for no concessions, and lease the space at the asking rate - but, losing the space was potentially more costly to my client than the agreed upon terms.

So the moral to the story? Approach every negotiation as though ten people are nipping at your heels. The truth is, they may be!