The ENVIRONMENT in which We Deal

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One of the differences between a single family residential sale and a commercial sale is the requirement for an environmental report. Also known as a Phase I Assessment or an ESA, these beauties crept into our commercial real estate cribs in the mid 1980's.

According to our friends at Wikipedia, "...demand increased dramatically for this type of study in the 1980's following judicial decisions related to liability of property owners to effect site cleanup. Interpreting the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), the U.S. courts have held that a buyer, lessor, or lender may be held responsible for remediation of hazardous substance residues, even if a prior owner caused the contamination; performance of a Phase I Environmental Site Assessment, according to the courts’ reasoning, creates a safe harbor, known as the 'Innocent Landowner Defense'."

So now, an enviro assessment is a normal part of any due diligence and folds into most loan approvals. Rarely, will we encounter a Phase I in a lease transaction - although depending upon the size of the tenant, we've seen this as a requirement as well. 

Generally, the progression of reporting is as follows:

Limited Phase I - also known as a Transaction Screen Assessment - TSA. Eliminated in this report is a site visit, a review of certain county or city records or something else. We generally see TSAs for a refinance or in the case of an office building or retail center - where the chances of contamination are unlikely. The TSA is much more limited in scope than the following assessments. 

Phase I. Most typical is the Phase I Assessment. The Phase I reviews old aerials and county and city records for any history of contamination locally or regionally - super fund sites, leaking gasoline tanks, underground storage tanks, or other recognized environmental concerns. Interviewed are the neighbors and cataloged are the current and previous uses of the site with an eye toward anything that would pose an environmental risk. Nine times out of ten, the Phase I recommends no further action and the deal can progress. However, in that other 10%, additional testing may be required. 

Phase II. When additional testing is recommended, an invasive test - Phase II is employed. Several soil samples are taken in the area of concern on the interior or exterior of a building. Analyzed are the soil samples for evidence of hazardous chemicals which may pose a health risk to occupants of the building. Also taken into consideration are the gases emanating from the soil, which if breathed could be carcinogenic. The State of California places certain "screening levels" to serve as a guideline for the amount of chemicals allowed. 

Phase III - also known as pre-remediation. Now we are into the area where significant contamination is detected from the Phase II sampling and a decision is made to dredge up the bad stuff and remove or aerate it. A Phase III outlines a plan to rid the site of the harmful soil and building materials including an estimated cost and time table as well as a plan for future testing. 

Remediation. You may have seen a shuttered gasoline station with a big pile of dirt where the pumps once resided - you guessed it, that site is being remediated. In some occasions, remediation may take years and require monitoring wells for future readings. Gas stations, chromium plating companies and dry cleaners are the biggest culprits when it comes to the trifecta of enviro testing - Phase I, II, III. 

The Building Blocks of Commercial Real Estate

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My biggest fan and harshest critic is an avid reader of this column. He also is my neighbor and a veteran of the construction industry. 

So as not to embarrass him, we will call him Sam. Sam approached me over the weekend and lamented the fact I don't write about construction topics - specifically the way commercial real estate is built. 

So in an effort to retain good circulation for the OC Register and pleasant neighborhood conversations, here goes.

Many moons ago, commercial real estate - industrial buildings - was built of steel or concrete block. 

Steel, although structurally sound with condensed engineering, permitting and construction time had a shelf life shorter than most 25-30 year loan maturities. In our coastal climate of Southern California, steel is susceptible to corrosion. Nowadays, newly constructed metal buildings are not allowed in most Orange County cities. Many, however, are still found in the Inland Empire and numerous older industrial areas in Anaheim, La Habra and Santa Ana. 

Concrete block buildings have their unique advantages and challenges. The warehouse height of most concrete block buildings is shorter than modern logistics companies require. You are limited to the height at which you can stack blocks before a giant game of Jenga ensues. Openings - windows, truck loading doors, and man doors - create obstacles for concrete block construction as well. The more openings - the strength of the construction wanes. When the Earth starts to shake, a concrete block building - if not seismically retrofit - can end up a pile of rubble. The good news - concrete block buildings don't require much staging area during the construction phase - so they can be built in a smaller configuration. We still see concrete block construction in many schools, retail buildings and government facilities. In industrial applications - not so much. 

Enter the concrete tilt up building. 100% of new industrial construction and a large percentage of existing industrial inventory is comprised of concrete tilt up construction. Why, you may ask? It's design flexibility, structural integrity, and height capability. Watching a concrete tilt up building rise is akin to an enormous card house. The foundation is poured, the footings are dug, the slab serves as the casting area for panels which are poured in a stack. Once the panels (walls) are cured, a large crane plucks them and tilts them until the roof can be set atop. It is truly a cool process to observe. 

So there you have it, Sam. The building blocks of commercial real estate. Oh by the way, I like the new paint job on your house!

Are YOU an Arbitrary Commercial Real Estate Owner?

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Arbitrary. Defined as: "based on random choice or personal whim, rather than any reason or system. Or, unrestrained and autocratic in the use of authority." Also synonymous with capricious, whimsical, random, chance, or unpredictable. 

We encounter many owners of commercial real estate these days who have arbitrary expectations. Thus, I thought it would be fun - in Jeff Foxworthian fashion - to describe some of these characteristics as "you may be an arbitrary commercial real estate owner if..."

So, here goes!

You may be an arbitrary commercial real estate owner if you price your building at twice what the recent comps would suggest it's worth. 

You may be an arbitrary commercial real estate owner if you refuse to address necessary repairs that are highlighted in a building inspection.

You may be an arbitrary commercial real estate owner if your trusted advisor is a Ouija board - do they make those anymore?

You may be an arbitrary commercial real estate owner if you are offered a lease rate 30 percent higher than the latest lease deal - and you counter at an even higher rate. 

You may be an arbitrary commercial real estate owner if you believe you can always lower your price but you can't raise it. 

You may be an arbitrary commercial real estate owner if your market view is based upon cocktail party chatter. 

You may be an arbitrary commercial real estate owner if you are certain that second story, un-permitted office space is worth the same a ground floor office space. 

You may be an arbitrary commercial real estate owner if you are convinced a digital presence is a gift from Amazon.com.

You may be an arbitrary commercial real estate owner if  you shun an offer below your asking price by saying - "he's just not seeing the value!"

OK. You get the idea. Thanks for playing along and having some fun with this. The arbitrary nature of owners these days stems from the seller's market in which we find ourselves deeply entrenched. When will the "worm turn"? Next year! Why, you may ask. I'm not certain - just being arbitrary. See there. It's works both ways.

3 Tasks to Accomplish - NOW! With Your Commercial Real Estate

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Ahhh, January 2018. New beginnings, an infant year and clear sailing ahead. Rather than focus on resolutions which many of us break before we habit writing the new date - 2018, let's spend some time discussing the three things you should accomplish NOW - in January - with your commercial real estate.

Examine the new tax law! Run, don't walk to your tax advisers office. That line you see protruding out the front door includes his clients with similar questions. Specific to your questioning should be "pass-through" entities and how your specific entity(s) is treated under the new tax plan which took effect on January 1, 2018. For certain LLCs, S-Corporations, sole proprietorships, personal service corporations, etc., there is a 20% tax deduction from the income the entity generates. Many, many commercial real estate ownership entities may be effected. Limits on the amount of qualifying income exist as well as the types of entities that apply, so plan on spending a couple of hours or so understanding the ins and outs.

Roof and Heating, Ventilating, and Air Conditioning. If you are a tenant, you may be responsible for the repair and maintenance of your roof and systems that heat and cool your building. As an owner-occupant, yes - you are responsible. The winter months are a great time to fire up that AC and see if there are any glitches. Waiting until the temps are sweltering is a bad time to realize your cooling is blowing hot air. SoCal will experience a relatively dry winter as La Nina conditions persist. Awesome, you say - no need to maintain or repair the roof with no rain in sight. Wrong! Santa Ana winds which accompany dry weather, blow all sorts of debris onto your roof. If the leaves, dirt, and other detritus are allowed to clog the down spouts  - your roof will suffer when the rains return. Hot dry winter weather also causes the mastic around skylights to crack and peal - causing - you guessed it - leaks!

Leases, extension rights, loan maturities. The month of January is an appropriate time to grab a copy of that lease or mortgage papers and take a look. At the forefront of your perusal should be any expiration of your lease or extensions that must be triggered this year. Does your loan reach maturity in 2018? If so, now is a great time to re-finance that note.

A very Happy New Year to you all!

5 Commercial Real Estate Lessons Learned in 2017

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Good bye 2017 and hello 2018! This year was particularly good to us as commercial real estate professionals. Our market continues to rock on, break value records, and enjoy the longest up-trend in decades.

Since the doldrums of 2009-10, sales prices have tripled in some cases and lease rates are not far behind.

As I reflect on the year of 2017, what lessons were learned? Indulge me while I regurgitate a few.

When you believe you've seen it all - guess again. This year we revived a suspended entity - a seller's LLC where no renewal fees had been paid or tax returns filed - for 28 years!, auctioned a property through Ten-X, convinced a buyer - on behalf of our seller -  to cancel a non-contingent deal, achieved record selling prices for several buildings. Never, in a span of four decades have I experienced any of these events. Whew!

EVERYTHING will sell - if properly priced. I will forever remember this year for the mis-fit toys that traded. You know the mis-fit toys - a Jack-in-the-Box who wants to be a dentist? Commercial real estate has its version of mis-fit toys as well. Price it properly and it will go!

Pay close attention to where we are in the cycle. Several clients renewed leases this year. Unfortunately, lease rates are close to their all-time high. Sign a ten year lease today and chances are - come renewal time - rates will be comparable to today. A three year lease may present you with a surprise - a rate lower than you currently pay.

Most don't understand what we do. I frequently speak to groups of residential agents and other trade organizations. Questions revolve around our profession - what we do, how we are compensated, are we that different from our residential counterparts. We do three things; either on the owner or occupant side - sell buildings, lease buildings, or renew leases. Most commercial brokers "eat what they kill" - we are paid commissions for closed transactions and receive no guaranteed salary. Commercial deals are business transactions vs a consumer sale in the case of a residential deal. Both are contractual agreements. Generally, residential brokers sell house whereas a commercial broker will do as many lease as sale transactions.

This up trend is unlike any we've witnessed. Historically, commercial real estate values ebb and flow in 7-10 year cycles. Typically, when housing hits the skids, we follow within a year. Our present up-tick started in the third quarter of 2009 - eight and one half years ago. Many of us believe an adjustment is overdue. But, despite our dark predictions, the market keeps rising to heights never witnessed. 2018 should be interesting indeed!