Who Will Pay the MOST for Your Commercial Real Estate

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Generally, as a seller of commercial real estate - you have three motivations - to transact as quickly as possible at the highest price with the fewest conditions. Simple. In practice, it’s a bit more complicated. Your offering - if properly marketed - will appeal to a number of different types of buyers. Below is a recap of each buyer type you may encounter and their pricing expectations.

Developer. Motivated by the highest and best use the property can generate - a developer views a parcel of commercial real estate in terms of a re-use, demolish and re-build, or new construction. Critical in a developer’s pricing is their calculation of the new construction’s ultimate value - rent or sales price. Considered are things such as construction costs, construction time, city approvals, market trends, and exit strategy. Generally developers are well heeled and can close once a city gives them the green light. Price they will pay - Low.

Investor. If the building you are selling has income - great! Where is that income relative to the market? How stable is the tenant? How much lease term remains? In simple terms - an investor will value the income stream based upon their risk tolerance. The higher the risk - the lower the number he is willing to pay. Occasionally, an investor will purchase a vacant building - one without a tenant. In this case - the cost to originate a lease is formulated. Taken into account are market rents, downtime, concessions, improvements, and broker fees. The dollar amount of lease origination is generally deducted from the purchase price - akin to a car dealer who will give you a wholesale price - retail less the cost of refurbishment. Price they will pay - Low to Low Medium.

Out of area occupant. Certain areas of SoCal are “catcher’s mitts”. Meaning - the natural migration of local buyers gravitates in their direction. Typically, this exodus occurs west to east - as our basin developed this direction. Orange County attracted buyers from Los Angeles and the Inland Empire attracted occupants from Orange County and the San Gabriel Valley. Geography like the port of Los Angeles or the greater Ontario area also can have national appeal. Folks looking east are pleased with the affordability and quality of construction. Companies forging a new Southern California location suffer from sticker shock. Price they will pay - Medium.

In area occupant. These businesses are established within the community where your building resides. Chances are their labor force is close by, they may own a home in close proximity, and they attend Rotary and the Chamber of Commerce meetings monthly. Plus, they don’t want to leave. Price they will pay - Medium High.

Neighboring occupant. Take all the components of an in area occupant and couple those with a facility next door - Voila. Add in some stickiness to their existing operation - extra power, excess parking, a use permit - Boom. Price they will pay - High.

Existing tenant. I’ve said many times - in this space - your best buyer is generally your existing tenant. Why? They understand your building better than you do. They’ve found great utility in the location and improvements. Their cost to move is huge. Trifecta! In some instances your transaction costs - no broker - are less by selling to your tenant - your bottom line is enhanced. They also pay rent to you while you are closing the deal. Price they will pay - High to Very High.

Black swan. Warning. These are rarer than a Ram’s Super Bowl victory - they happen - but not often. Defined as a buyer with a unique vision, need, or requirement that ONLY your property will fill - these “swans” swim in elevated waters. Some recent examples - a brewery operator who bought an industrial building across from a sport’s venue, an investor motivated by a tax deferred exchange, a church who’d sold their existing sanctuary and had a wad of cash to spend on a new location. Price they will pay - Off the Charts High.

Allen C. Buchanan, SIOR, is a principal 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.

With the Slowdown - How should you Change - 4 Ways

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I read with great interest this week a column by Jeff Collins entitled Home Seller’s Market Cooling wherein he reports the year over year home sales in December of 2018 declined 20.3%! This is a staggering figure and confirms “the bloom is off the rose” officially in the housing market. Economic uncertainty, a spike in interest rates, and a glut of homes for sale are the culprits - a decline in the median home price in SoCal is the hangover that will follow. Will the carnage be similar to 2008-2009? I doubt it - but we will have to stay tuned.

You may be wondering - I thought this was a column on COMMERCIAL real estate? Indeed. But our world closely mirrors that of our residential counterparts - albeit nine to eighteen months later.

So with that hurricane of change on the horizon - how should you - an occupant of commercial real estate prepare for the downturn that is blowing our direction?

If you’re in a lease. The owner of your building relies upon the rent you pay each month to fund his livelihood. He’s had a great run! You may find yourself paying a rate which is over market. Remember that renewal you signed in 2016 when no alternatives existed for your consideration and you decided to stay put? Yep. You’d have more leverage this year. So now you’re faced with a few more years of rent premium. Do you have an argument? Of course. Depending upon the nature of your building owner - you may be able to appeal to his need for stability. He may be willing to reduce your rent in return for your commitment to stay another few years past your expiration. Give it a try. The worst he can say is no.

If you’re lease expires this year or next. You’re golden! The market is moving in your favor. Find a commercial real estate professional who can report to you - monthly - on the market. You’re interested in new availabilities and new completed transactions. Pay close attention to how long these avails stick around, how many leave the market each month, any variance in “ask” vs “take”, and the concessions owners are including - such as abated rent and money for upgrades. If my prediction is correct - you’ll start to see more owner motivation creeping in.

If you want to buy. Wait! Similar to the posture you adopt with an expiring lease - the market is moving your direction. It may not appear that way because our vacancy is still historically low. But, we are seeing two things which confirm the shift. First, we are witnessing price reductions for offerings that have not sold. In a robust market - the only price reductions you see are for buildings with problems. Now, that is evolving into solid offerings - maybe overpriced at the outset - settling into reality. Secondly, fewer buyers are orbiting waiting for an open place to land. Those in the market are not afraid to “make an offer” at well below asking price.

Position yourself for success. Some believe - as the market changes - the need for preparation vanishes. Not so! If you’re scouting the area for that perfect lease with a motivated landlord - you still must make sure your financials are updated and solid. Give some thought to your story and verify it’s compelling. Create a laser focused understanding of your value as a tenant and be conversant with his cost to originate a lease with you. Specifically - how much revenue will your lease generate over the term minus the abated rent, improvements, and broker fees. Will he lay fallow a few more months until someone else wanders by? Buying? You still need a pre-qualification from a lender. Certainty of close is what most seller’s seek today. Finally, remember - negotiations work best when both parties win.

Allen C. Buchanan, SIOR, is a principal 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.

New Industrial Buildings - Why not More of Them?

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Industrial buildings - where folks make, store, stage, service, and ship things - have been the darling of investors and developers for almost ten years. Given the simplicity of design and the flexibility of uses - these large concrete boxes rise out of the ground akin to those card houses you erected as a kid. Demand from occupants has been robust as every new development in Orange County has been consumed - many before the completion of construction.

 

So with these realities as a backdrop - investor interest, simplicity, demand - why don’t we see more new development in the OC? The short answer? It’s risky!

For a longer review - I posed the question to Gary Edwards and Jeremy Mape of Western Realco. What follows is their take on why. By way of background, Western Realco has developed over 3,000,000 square feet of industrial buildings since 2010. Most notably - the former Beckman site in Fullerton, Neville Chemical site in Anaheim, vacant land formerly owned by Harte Hanks and Suzuki in Brea, and a couple of shuttered data centers - they’ve been active!

Site scarcity. In order for new development to occur, a vacant site is needed. Vacant land sites in our county are rarer than a blood moon - so, developers are forced to re-purpose obsolete manufacturing plants - such as the ITT site in Santa Ana or the former Boeing campus in Anaheim. Because the operations housed on the parcels commenced in an earlier regulatory era - simply demolishing the old structures can be complex. Environmental concerns such as asbestos, methane gas, underground fuel storage - or worse - can be encountered. Someone must pay to clean up the mess before new buildings appear. Fewer and fewer of these opportunities exist. Plus the remaining ones are costlier - partially because many developers have opted to scrape aging plants in favor of multi-family projects.

Processing time. The old adage “time is money” certainly applies here! Frequently, cities have a different vision for a project than the builder. Time is required to sync the expectations. “Short staffed” typically describes the city workforce tasked with reviewing conceptual drawings, offering commentary, making changes, preparing staff reports, and approving the development. Occasionally, residents will weigh in with their concerns about increased truck traffic, noise, and disruption. All of these issues must be carefully anticipated, massaged and resolved - without breaking the bank. Generally, a land owner will want his money before a final plan is approved and permits can be issued. Therefore, a huge uncertainty is born by the builder - if something unexpected arises - he’s stuck.

Rising construction costs. Site scarcity described above means you pay more. Materials including concrete, steel, drywall, roofing paper, and paint have all seen a bump in price - especially if the products are petroleum based. Contractors are busy. They can charge more for their contribution. The modern industrial occupant demands more goodies be contained in the new construction. That extra 4-8 feet of building height requires more concrete and engineering calcs. A beefed up warehouse fire system needs bigger pipes and stronger water pressure. Concrete vs asphalt parking lots? Yep. Costlier.

Rents haven’t kept pace. Site, processing, and construction - the three pillars of a project’s expenses - create a cost model from which a return is derived. The return is formed by the rents a resident pays for the facility. In the 1980s - for instance - a 10% return on costs - after a preferred return was paid - was the norm. Nowadays the expected return is around 5-5.5%! You may be thinking - where do I get a 5.5% return? That sounds great! Just remember a lot of risk is associated with the return. One surprise - boom! Bye bye return. Net effect? Rents have now eclipsed $1.00 per square foot - vs $.55 per square foot nine years ago. However - they’ve not kept up with the increased costs - despite a lower return expectation.

Allen C. Buchanan, SIOR, is a principal 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 Random Commercial Real Estate Thoughts

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Every now and then, it’s fun to empty the inbox of my consciousness and share with you some disparate thoughts circling my brain. So, in no particular order - here goes!

Two types of listing presentations. If ever you’ve sold or leased commercial real estate - chances are you’ve sat through one or a dozen pitches from someone in my profession. Common with all was a request to exclusively list the property with them. You may have noticed - these “pitches” fall into one of two categories - an owner centric or broker centric approach. 

A broker centric package starts with a recap of their qualifications, years in business, all the deals they’ve done, their amazing marketing support - blah, blah, blah. As your eyes glaze and your thoughts wander toward your weekend plans - two questions arise. So what? How does any of that apply to my specific situation? Enter the owner centric review. Demand this of your providers. Contained should be a review of your reality, a recap of your property, market stats and a plan to elevate your offering above others on the market.

Has the government shutdown affected us. Yes. In two ways - uncertainty and loan approvals. The wild stock market gyrations, news of a global slowdown, tariffs, and the longest government shutdown in history have given small business owners reason to hit the pause button on long term commitments such as hiring, machinery purchases, leasing and buying buildings, or borrowing money. Plus - a high percentage of building purchases are financed through the Small Business Administration - SBA. No SBA loan applications are being processed. Once the government reopens its doors - plan on a severe backlog of applications and approval delays.

What if face to face is impractical. Presentations, building tours, and discovery meetings are best accomplished in person. But what if logistics don’t allow - the owner is in Germany, there are multiple decision makers, or one of the parties is ill? Tools such as FaceTime, Zoom video, and FreeConferenceCall.com can all replicate an in-person experience.

Supply chain improvements. As customers demand purchases to be at their doorstep instantly - the supply chain allowing that to occur must get better. Supply chain - from manufacturer to consumer - has evolved since the catalog ordering days of the sixties - when your item arrived seven weeks later. Now - click an image in an app - complete the buy with PayPal or your Visa - and a knock on your door occurs with your purchase. What’s not seen is the enormous infrastructure of shipping containers, truck terminals, warehouses, and delivery vans that are required. Look for cool new stuff in 2019 - vendor apps and warehouse ordering systems based on LED lighting - just to name a couple.

Are we in a recession. Technically no. Defined as negative growth in gross domestic product - our economy is still expanding. However, uncertainty breeds inaction. Inaction leads to a slowdown. Voila. Stay tuned.

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.