You've Really FOUR Choices with your Commercial Real Estate

This week, I had the pleasure of advising a family. Held as income properties were two parcels of commercial real estate which had been in the family for years.

As the ownership morphed over time due to succession, the heirs were looking for counsel - thus they contacted me. The conversation which ensued I believed was column-worthy - so here goes.

As a qualifier, these folks are arms-length investors - they reap the rent the buildings generate and do not occupy either building with a business.

So, if you own commercial real estate as an investment, I believe the ownership directions are fourfold:

Continue to own and manage the buildings. Vacancy throughout the term of ownership has been minimal - the family has managed to keep the spaces filled by offering below market rents. This is a great strategy for a long-term hold. Avoided is the origination of a new tenancy which costs time - abated rent and vacancy - and money - tenant improvements and broker fees. In some instances, originating a new lease can consume 25% of the expected rental revenue! Wow. That's a big bite just to nudge a tenant up to a market rate and risk them moving.

The next three scenarios could potentially generate a taxable gain - which is the subject of another column.

Sell the buildings leased. Remember those rents at below market rates we discussed? Yeah. That is the downside of selling the buildings leased. You see, the value is determined by the cash flow produced - less cash flow equals less value. So, if your desire is to maximize your sales price by selling with tenants in your commercial real estate, you should consider moving the rents to market - potentially suffering the vacancy and re-letting. Easy math would analyze the expected increase in the selling price minus the cost to re-rent the buildings if necessary.

Sell the buildings vacant. Your ideal buyer for the real estate may be the tenants the buildings house. Afterall, they are in residence and may dream of owning the space they occupy. Approach them. If you receive "no interest", explain your strategy of allowing their leases to expire and locating an owner occupant to buy the buildings. Their tenor may change. In most cases, an occupant will pay more than an arms-length investor - because occupants look at utility - investors at their returns.

Scrape the buildings and sell the land. Sadly, at some point, the improvements eclipse their useful life and the underlying land is worth more than the land with a building. You'll need to take a look at the necessary upgrades - roof, air conditioning, seismic, parking lot, plumbing, electrical, etc. A review of the costs to bring the building up to "market standards" will help you determine the value of your building improvements - and whether they are worth salvaging.

Four Ways a BUILDING adds to Business Profit

Your decision to relocate your business was well reasoned. Considered were the operation and growth trajectory. Analyzed was the best deal structure for the company - lease or own. You endured countless tours of the available commercial real estate that met your criteria. Negotiations and paperwork followed - and culminated in the lease or purchase of your new business home.

If you decided to buy - alright! echoed your rejoice when the title officer called with word your "recording was confirmed" - which meant you finally owned a building.

So now that you've moved - can the building make your business more profitable? Humor me as I build a case for profitability - you know - revenues minus expenses.

If you chose to buy a building:

Your "rent" is fixed. Expenses are generally lumped into three broad categories - the cost of sales, operating expenses, and miscellaneous. The amount of rent paid is an operating expense of the business. Whether the "rent" is paid to an alter ego of the company's ownership or paid to an arm's length landlord, matters. If the owner of the building has no relationship to the business ownership - his sole motivation is to collect as much rent as possible. At the expiration of your lease - expect an increase in rent. Conversely, if the occupant and owner are mirrors of one another - a favorable rent can be achieved. If the debt financing the acquisition is at a long-term fixed rate - even better.

Regardless of leasing or buying:

Employees are happier. Pride of ownership in your location causes employees to produce more - because they are happier. A private office, a collaborative work environment, clean lunchroom, ample parking are all intangibles that create a positive work environment.

The operation is more efficient. Lack of space or poor space utilization means you are spending time unproductively. Classically, we see this when products have evacuated the plant and are temporarily stored outside during operating hours. Paid are the people moving the stuff in and out - when they could be producing more goods. Also, by properly maximizing the height of a building, you may be able to occupy fewer square feet - fewer square feet - fewer dollars spent - more money in your hip pocket.

Customers can find you. If you can't be found - you are invisible. The right location with close freeway access can boost your business - just because more customers will flood your doorway.