4 Random Commercial Real Estate Leasing Thoughts

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Today, I decided it would be fun to regurgitate a few random thoughts as they pertain to LEASING commercial real estate.

As we have discussed before, leasing is a big part of our daily activity - unlike our residential counterparts. We, as commercial real estate professionals help occupants find space to lease or buy.

Typically, leases account for 70-75% of our deal volume - sales the balance.

We differ from our residential counterparts. Our fees are based on a percentage of the deal's total consideration - purchase price or the amount of rent paid over the term of the lease. Generally, commercial leases run 3-10 years - so the amount of rent payments negotiated is a significant sum. Whereas, residential leases are month-to-month or a year maximum. Consequently, the potential fees on a residential lease - because the term is much shorter - make it unprofitable for residential agents to pursue.

Subleases are a pain. A sublease is necessary when an occupant no longer needs the building - for myriad reasons - yet has a term of lease remaining. The owner of the building still wants his rent. So, the occupant resorts to finding a substitute - a subtenant - to move in and assume the rent payments. Differences in uses, credit, number of players, and changing market conditions all create the pain in a sublease transaction.

Credit requirements of a property owner. At a minimum, the owner will look at the total amount of the lease - let's assume $10,000 per month for sixty months or $600,000. The owner is leasing an occupant the building in return for $600,000 in rent payments. Therefore, the owner is extending the occupant $600,000 of credit - so to speak. Carefully scrutinized is the occupant's ability to repay the $600,000 - through an analysis of the business's sales and credit history.

Process. Searching for a space to lease is similar to searching for a building to buy. The similarities: Facility requirements are discussed - loading, power, amount of office space, warehouse ceiling height, etc., geographical areas are considered, a list of alternatives is toured and a candidate is chosen. Now, the differences occur. A sale deal will proceed to a negotiation, an agreement, an escrow, due diligence and closing - approximately 60-90 days. But, a lease will involve a negotiation and a lease - much quicker - fewer than 30 days, in most cases.

If ever we can assist you in leasing or buying a building, please call us at 714.564.7104 or email us at abuchanan@lee-associates.com.

Commercial Real Estate Sale Leasebacks - the DOWNSIDE

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I've advised a number of my clients recently to consider selling their commercial real estate and striking a three to ten year lease with the investor that buys it. A few have listened.

This structure, in our parlance, is known as a sale leaseback. Different than a straight lease and not a short term lease that accommodates a purchase, a sale leaseback allows an owner occupant the chance to sell at today's high prices and remain in the building - albeit as a tenant - and avoid a move.

It's a slick arrangement when the correct motivations are involved. I wrote about those reasons in a past post. You can read about it here. 

Today, I want to spend a moment and discuss the downside of a sale leaseback.

The message it sends to the market. When a sale leaseback is listed and marketed for sale, the questions from buyers range from - "why is he selling?" to "is his company leaking at the gills and needs cash to survive? Generally, there is a story. Its critical to understand the story, why a seller is selling, and how the current financials present.

I will just pay more rent. Value is determined by taking the rent your company is willing to pay and packaging the rent as a return on investment. Simply, if your company can afford to pay $10,000 per month or $120,000 per year and the return is 5% - your building is worth $2,400,000. Easy, yes? Now the fun begins. Where is $10,000 per month in relation to what other comparable buildings achieve in rent? It's either above, below, or at par. Par or below - you're golden. Above and you're scrambling. You see, an investor looks at the worse case scenario - you spit the hook after a year, can't pay the rent - or worse file bankruptcy - and he's stuck with a building he can't rent for the same amount you were paying.

You strap your operating company. If you own your building and times get tough, you can adjust the rent your company pays you - after all, you are the owner AND the tenant. Once you inject an arm's length investor into the mix - that flexibility evaporates. You are now bound to a lease. If you don't pay, you may get evicted.

There are tax consequences. As we've discussed, selling appreciated commercial real estate comes with a heavy tax consequence - unless you employ a tax deferred exchange. Yes, you free your equity, but at a significant cost - in some cases up to 35%.

REASONS Your Commercial Real Estate ISN'T Selling

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I've opined for months that Southern California is immersed in a seller's market - there are many more buyers in the market than sellers - advantage sellers!

Today, however, I want to discuss WHY your commercial real estate isn't selling.

After all, with more buyers around than sellers, you should be flush with offers  - folks clamoring to buy your building - but nothing - crickets! So what's up?

Below, are my reasons why your building isn't in the sold category.

Your building is over priced. As we've discussed, asking prices are tricky. Hopefully you've looked at recently closed sales, compared those to what is currently available, checked the trends - up or down trending, and finally placed your building under careful scrutiny to determine its value. Great. You've established an asking price. However, if the asking price has no basis in fact - comps or avails to support it - your building will sit. Oh, you'll get tons of inquiries - there are not a lot of available buildings - but no one will want to tour. Or worse, offer on your commercial real estate.

Your building lacks a key amenity. If you own a space with challenged loading, a logistics building with low ceilings, a manufacturing location with insufficient power, a service depot without an outside storage area for trucks - congratulations! Your building lacks a key amenity. Some of these issues can be solved with dollars - others cannot.

You are un-realistic in your expectations. If you have received a number of showings - with no offers - chances are there is a problem. You are likely overpriced or your building lacks a key amenity. With this market intel, if you continue to believe your kitty is the cutest in the contest and refuse to consider others may be cuter - your expectations are out of whack with the market.

There are use restrictions. We toured a building recently with a prospective buyer. Our guy liked the possibilities because there was a large outside staging and storage area - a key requirement of his occupancy. As we were completing our pre-proposal research, we discovered the area in question was unusable for the purposes our client intended. Furthermore, there was a giant easement running through the middle of the yard. Ooops. No deal here.

Your representative is un-cooperative. I'm honored to work in an industry with so many highly skilled professionals. However, on occasion we encounter a rogue element who sees the real estate brokerage business as a way to pad his bank account vs working in the best interest of his seller. If your activity is waning - it could be your representative is not doing what's necessary to ply nicely with others.

The Downside of a FAST Growing company - Where would Amazon go?

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The genesis of this post came from two sources. First, a very well written article in the New York Times entitled: Amazon Plans Second Headquarters, Opening a Bidding War Among Cities. Secondly, from my Orange County Register editor who posed the question, "where would Amazon locate if they chose Orange County?"

Clearly, Amazon's footprint in the Seattle area is massive - around 80,000 folks draw a paycheck and consumed is about 20% of the available prime office space in the city - roughly equivalent to 8,000,000 square feet of space! Imagine the chaos created if Amazon were to vacate even half of that occupied space - incredible.

For the HQ2, Amazon's plan would include 50,000 new hires and a facility to house them. Close to an international airport, skilled labor, affordable housing, access to mass transit, fiber optic capabilities, and a business friendly environment are all on Amazon's checklist - with all the appurtenant goodies states like Texas seem willing to dole out - tax breaks, free land, employee relocation expenses, no state income taxes, cameo with the governor, etc. 

Although many of the checklist items can be found in the OC - labor, airport, fiber - California has shunned economic incentives with the abolition of redevelopment districts and enterprise zones. Gone are the halcyon days of California cities writing a check for the promise of future sales tax and incremental property tax revenue increases - the proverbial "I scratch your back" scenario. 

So, where would Amazon go in the highly unlikely event the OC was in the running? Well, it depends. On what, you ask? On the type of facility they are seeking. It appears the new headquarters would house a number of engineers and skilled labor - therefore a facility much like Broadcom abandoned when they were recently acquired. 50,000 employees at 100 square feet each would require around 5,000,000 square feet of office or flex industrial space - like those that litter the Irvine Spectrum. A quick search yielded approximately zero existing - occupied or vacant - buildings that could garner that amount of footage in the county. Therefore, someone would have to build the building for Amazon to occupy. If we stacked the building with two stories, this new construction would require close to 100 buildable acres - roughly the size of the old Boeing campus in Anaheim, an eighth of the Great Park or around half the size of Angel Stadium - parking and field. Probably ain't happening. 

Lets go a different route. Amazon has constructed 77 warehouse buildings around the nation since 2005. A number of others were either planned or under construction and Amazon became the occupant. Generally, the buildings are 750,000-1,000,000 square feet apiece. To put that figure in context, we are describing 25 football fields - under one roof - plus, the appurtenant parking and circulation around the building - or another 10-25 football fields. The only vacant building in Orange County that could house an operation such as that would be the former JC Penneys building in Buena Park. But, there is an issue - the ceilings are too low for Amazon's proprietary procurement system. Ooops!

Have fun in Dallas, Amazon. Go Cowboys!