Operating Expenses - A Primer

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Generally, January is the time of year when your landlord will present you with an invoice for expenses - in addition to your base rent. This assumes - of course - that you lease your business home. However, if you own your business home - take heed - as you may be able to take a few more dollars from your left pocket and move them into your right pocket - by asking your occupant to pay for some stuff. This column is designed as a primer for these expenses.

Let’s define a couple of key terms - shall we?

Operating Expenses. Typically defined as the costs of maintaining the commercial real estate in which you reside.

Lease form. Forms of leases vary as widely as days of the week but commonly are either net or gross. Meaning - your base rent is net of the operating expenses - or in the case of a gross lease - your base rent includes operating expenses.

Now let’s dive in!

What expenses are included as operating expenses. Biggest in this category are property taxes. Currently, property taxes are based upon roughly 1% of the building’s assessed value. I say roughly because certain cities may add fractions to this percentage. You can easily check on the amount through your county assessor’s website. Next, insurance on the property - which is different from the liability policy you carry for your business and contents.

Finally, common area maintenance which is a broad category of expenses which can encompass mowing the grass, trimming the trees, sweeping the parking lot, disposing of the trash, exterior lights, property management, changing the air conditioner filters, and reserves for capital expenditures such as roof replacement. Treatment of these CAMs - as they are called - varies widely among owners. Simply, some may not bill for these until due whereas others may budget for them monthly. Still others may not ask for any reimbursement.

What expenses are not included in operating expenses. A major system replacement - such as a new roof or air conditioner - or, changes made to the exterior of the building - like new pavement or parking lot lighting - falls into a class known as capital expenditures. As noted above - some landlords budget for these through reserves while others bill their tenants when the changes occur. Please check your lease. Treatment of these costs should be outlined. Commonly - language allows your owner to bill you for portion of these expenses spread over time - but not a lump sum. Expenses related to accounting, mortgage interest, entity fees, and business licenses should not appear on your invoice.

Gotchas. If an ownership change occurred recently - property taxes will increase based upon the sales price. As a tenant - you generally shoulder this bump. Watch out for generalized expenses. Most leases allow for you to reasonably audit any expenses you’re asked to reimburse. If you don’t understand a line item or if your owner simply sends you a flat amount to pay - ask for back-up. Check to see if your lessor can require you to paint the exterior. This clause killed a deal for me recently. 

Finally, anticipate these costs when you negotiate your next lease or renewal. Simple things like asking for operating expense increases to be limited or moving a base year forward can save you loads.

Allen C. Buchanan, SIOR, is a pricipal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.

5 Things I Learned in 2018

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With the year of 2018 almost in the books and 2019 dawning in a couple of days - what follows are the commercial real estate lessons I learned this year.

If you want to know what’s to come - watch the housing market. Actually, this was a 2008 lesson which unfolded again this year. A downturn in housing metrics can portend a bit of doom in the commercial real estate market. So much of our local economy is tied to housing - loans, brokerage, sub-contracting, construction, legal, accounting, home improvement retail. All of these sectors hire people, lease or own commercial space, and rely upon a robust exchange of homes to fuel activity. When the housing music stops - our engine slows as well. Early in 2018, when I noticed a decline in year over year home sales, rising availabilities, increased time to escrow and unsold builder inventory - I knew the end was near.

Our commercial real estate market can change overnight. We accepted a number of listings mid year. Several are still available. This did not occur in 2017. You dealt with multiple offers before the ink was dry on your Agency Agreement. Although our percentage of available buildings is still at record low rates - greater emphasis is now placed upon quality well priced offerings. The market simply shuns unrealistic owners these days. This phenomenon occurred rapidly from July through now. Prior to this time - the only period historically with as rapid a change was the summer and fall of 2008.

Uncertainty. I wrote a bit about this two weeks ago. When markets are moving - up or down - transactions occur. On the upside - companies require a larger footprint from which to conduct business. Additionally, more folks are needed to sell, fulfill, execute, and manage the burgeoning increase in volume. Operations are acquired. Cultures are melded together. Things are hopping. Commercial real estate advice is needed. Factor in a downturn and a large divesture occurs with people, physical plants, and overhead. Advice of a different sort is required - but still needed. If an air of uncertainty wafts - nothing happens. Lenders don’t lend, businesses don’t expand, employees aren’t hired, and our commercial real estate market freezes quicker than Elsa’s stairway.

Fundamentals matter. After thirty something years plying my trade - I decided it was time to take my practice to a new level. Why now? Why not? So, I hired a coach. Although specific to my business, this lesson can apply to any sales endeavor. If you don’t know where you’re going - how will you know when you arrive? A keen understanding of “where my bread is buttered”, enhanced prospecting, and weekly accountability are now pivotal.

You gotta have fun. One of my tasks in 2018 has been training our new crop of agents. Attrition in the commercial real estate business is horrendous - in some cases 80%. So, we are trying an enhanced program of weekly sessions - from an active broker - to bring the new pups along. Watching these newbies progress has been a blast. Maybe one will become a columnist for his local periodical? Not as long as I’m having fun - however!

Thank you dear readers for a wonderful 2018! May your 2019 be filled with love, joy, and much commercial real estate success!

Allen C. Buchanan, SIOR, is a pricipal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.

7 Ways to Insure Your Building Doesn’t Sell or Lease

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My VERY best to you for a Happy Holiday Season! Merry Christmas and Happy 2019! As we forge our way into the final year of this decade, I wanted to share with you the ways you can derail any effort to sell or lease your commercial real estate. So, in no particular order, here goes.

Hire an un-cooperative professional. Remember, that name on the sign advertising your listing for sale or lease is your front man. All inquiries are funneled through his phone or email. If he is tardy with follow ups - refuses to answer texts, emails, or calls or is generally non-responsive - you are sunk.

Ignore the offers below your asking price. Our market is changing. The days of multiple offers and frantic bidding are over. Carefully consider every serious proposal from qualified buyers or tenants. I believe you’ll be glad you did.

Market the building while occupied. Generally, vacant buildings are the fastest to lease or sell. Specifically, spaces that have been vacated, properly staged or have received new flooring and a fresh coat of paint are most desired. If your building has an occupant - sure - you get some marketing time while collecting rent. The downside of this? Showings are challenging, buyers have difficulty envisioning their operation in the building, and tenants have to imagine post occupant refurbishment. Plus, folks who need to occupy immediately are forced to consider readily available choices.

Set a ridiculous price. That is so 2017 of you! Now days, emphasis is placed upon a realistic value and motivation.

Don’t do any investigation. If selling - invest a few thousand dollars for an inspection and possibly an environmental report. You shouldn’t wait for your buyer to discover what issues exist. If leasing - assemble all the maintenance records and expenses. Plans or drawings are essential for either buying or selling. These items should really be accomplished prior to marketing.

Do it yourself. Sure. You may save the fee - but are you prepared to generate interest, field inquiries, arrange showings, negotiate proposals and execute the transaction? How do you insure you’re getting top dollar? Are you keenly in tune with the last few deals that transacted? How will you justify your value with a lender’s appraiser? Suddenly, that 6% looks like a post holiday bargain.

Value the property on projections not actuals. In up markets - sellers look to the future, project the next up-tick in rents - even though there is lease term remaining - and create pricing based upon this dream. Buyers happily play along because of the lack of available buildings. Once the market changes - buyers scrutinize the numbers and are unwilling to buy on “maybes”.

Allen C. Buchanan, SIOR is a principal with Lee & Associates Commercial Real Estate Services. He can be reached at 714.564.7104 or abuchanan@lee-associates.com  his website is allencbuchanan.com

What Creates Vacancy? Five Factors

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Southern California has experienced a nine year run of great economic times which has created a shortage of commercial real estate. 99 of every 100 industrial buildings is occupied. As a result - rents and sales prices have sky-rocketed - through a simple case of supply and demand.

 

The tail end of 2018 has shown some signs of a cooling economy - which have been well documented in this space - a slowing housing market, rising costs of doing business, stock market gyrations, uncertainty.

So, to the question - what creates vacancy? Seemingly an easy answer - someone moves, right? In practice, however, complicated elements underlying the move exist. Indulge me while I describe in detail a few of these circumstances.

The business is sold. Merger and acquisition activity in our market has never been greater. If you talk to ten company operators - three have recently sold and two more are in serious talks to sell. For those keeping score - yep! Half of the small businesses are in play. Frequently, buyers are in the same industry as the companies they court. Therefore, once the sale is complete - excess building capacity exists - thus one or more of the buildings is scrapped.

Right sizing the operation. Automation, advanced material handling solutions - higher racks, electric lift trucks - just in time deliveries, the use of third party logistics providers - all allow an operation to function in fewer square feet. When coupled with a cheaper overall rent - smaller footprint - a move can occur to save costs.

Ownership of the business is different than ownership of the building. Many times a small business will have multiple owners. If the business ownership is synonymous with the ownership of the commercial real estate - great! A nice symbiotic relationship exits. Over time, however, this balance can shift - leaving two disparate parts. The most extreme example I’ve witnessed? A building ownership had morphed into a collection of exes, former girlfriends, a church foundation, the owner’s children, and the occupying business. Unfortunately, no lease existed with the operation in residence and the new improved ownership decided the real estate was worth more vacant. Adios tenant. Time to find new digs.

Another state lures the company. Our business community is the target of several business friendly states touting abundant labor, cheaper taxes, and incentives to re-locate. It’s working.

Closure. Unfortunately, we experience businesses who must shutter their operations. Foreign competition, escalating costs, an obsolete product, the “Amazon” effect, can all spell the demise of once viable companies.

Allen C. Buchanan, SIOR is a principal with Lee & Associates Commercial Real Estate Services. He can be reached at 714.564.7104 or abuchanan@lee-associates.com  his website is allencbuchanan.com