Is Your Building Ownership a Mirror Image?

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Commercial real estate ownership is a beautiful thing! What other investment can you own and experience the tax advantages of depreciation, passive income treatment, and capital gains - all while the asset is appreciating.

If you own a business that occupies your commercial real estate - even better! Now, you have the occupant (tenant) paying you (landlord) rent. I’ve witnessed this structure numerous times over the years - and it works the majority of the time.

Today’s column is centered around those few occasions when the structure hits a snag.

First a bit of background:

Common among commercial real estate ownership is an entity known as an LLC - Limited Liability Company. An LLC may have one or a number of “members” each with a percentage of the stake. The LLC owns and operates the real estate - collects rent, pays the bills, is registered with the state, and files a tax return. Generally the taxes owed are passed down to the members via a K-1. Great!

Common among operating business ownership is the corporation - generally a C or S Corp. Each have different rules of taxation - which is a topic for another day. Suffice to say this entity pays rent to the building ownership - LLC. Cool!

Here’s where things can get dicey.

The LLC and Corporation have different owners. More than once recently we’ve seen this. What starts as an LLC with members whose ownership percentages mirror the shares of the business corporation can morph over time. In one extreme example - we had a building ownership comprised of a church, an ex-wife, two of the original owner’s children, a non-profit, and a former health care taker. By the way - initially the LLC had one member - the proprietor of the company! Death of the original owner caused all manner of chaos - as you can imagine. The result? An eviction of the business and a forced sale of the real estate. Ugly!

The operating business changes hands. With the spate of merger and acquisition activity these days - this is quite common. Typically, the company is acquired, a lease is struck with the LLC and things proceed. Over time however, a disconnect can occur - a smaller footprint is needed, sales decline, expensive improvements are required, the business goes bust. All easy when the building and business are identical twins. Not so easy when the twins are fraternal.

The commercial real estate is sold. No problem if you’re happy to fork over close to half the gain the commercial real estate has enjoyed. Sell it and pay Uncle Sam and Cousin Gavin. Done! If, however, the LLC chooses to defer the gain through the use of a 1031 tax deferred exchange - the LLC - all of the members - must be in lock step. What if an LLC member wants to take his cash and move to Cabo? A complicated buyout must follow. We’ve witnessed what’s called a “swap and drop” in these instances. Simply, the LLC is disbanded and replaced with a Tenants in Common vesting. Now the “tenants” - upon the sale - can self direct their percentage of the sale proceeds. In practice, this is much more complex. Please seek tax and legal counsel before employing this strategy!

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.

Read the Tea Leaves to Move Your Commercial Real Estate

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Hours of prospecting, client meetings, and presentations have resulted in a new assignment. Awesome! You’ve carefully scrutinized each sale and lease deal. You’re up to speed on your competition - you’ve toured each building with which you compete. Prepared is your owner. She understands the tax impact of a sale or the origination costs of a lease and is on board. All that’s left is to produce that glossy brochure, plant that sign, call the neighbors, and publish in the multiple listing service. Now the fun begins! You must interpret the market signals - AKA “read the tea leaves” - to guide your owner to a successful close. Here are a few of my favorites.

Lots of inquiries - no tours. Something is awry - and typically it’s not the asking price. We experience this when a key feature is missing - IE: the electrical feed is substantially below average. Or, there is too much office space in the building. Compounding the office issue is a percentage of mezzanine. You see - mezzanine may be counted as overall square footage - thus it can’t be easily removed. Outside yard storage area is a very desirable component. If this is lacking - you’ll get folks inquiring to see if a yard can be added. If the answer is “no” - no reason to tour.

Tons of tours but no offers. Generally, this means the offering is solid with an amenity laden building - at least on paper. The asking price seems fair based upon the market comps and current availabilities. But when prospects actually view the building - warning sirens blare. This could be signs of deferred maintenance, an unworkable office layout, an unusually messy tenant in the space, or a farm of 55 gallon drums in the yard.

Offers well below asking. We are seeing this a lot currently. Buyers ignore the asking price and simply offer at their comfort level. I refer to this as “making the market the bad guy”. Please understand - I’m not suggesting you puff the price of an offering. However - what a ready, willing, and able buyer will pay is the best indicator of what your building is really worth.

Many offers at asking. Eureka! You’ve priced the listing correctly, building features are appealing, and interest has been generated from qualified buyers. Now it’s incumbent upon you to ensure the buyers can perform. Don’t simply assume that pre-qualification letter from the buyer’s lender is for real. Ask the tough questions. Cross qualify if necessary. Get a complete understanding of the buyer’s story - are they presently leasing? When does their lease expire? Are they expanding, contracting? What is their source of funds? You need to select the right buyer the first time. False starts are painful.

Crickets. Oops. You missed the mark! Pricing is too high. Location blows. The space lacks numerous features which cause it to be undesirable. Encumbering the building is a short term lease - thus occupants can’t move in immediately. You’re attempting to lease the building when the majority of activity is sales or the opposite - no one is buying and that’s your direction. Adjust course matey!

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.

What Can Make a Sublease Unmarketable - 5 Situations

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I recently wrote about the Yin and Yang of subleases wherein I discussed the elements which make a sublease risky and non-beneficial to the owner and occupant of a building - “because subleases are generally unfavorable to the original occupant (sub-landlord) and owner (master landlord), risky, and complicated.” Also discussed was a definition of a sublease - “What is a Sublease? When a tenant must relieve himself of a lease obligation prior to the expiration of the lease, the need to sublease occurs.”

Today, I embark on an explanation of the five situations which can cause a sublease to be unmarketable.

The term of lease. We toured a space yesterday being marketed for sublease. A decision to vacate prior to the expiration of the lease was made by an occupant whose corporate headquarters are out-of-state. Now fifteen months remain on the lease obligation. Akin to a well shopped clearance rack at Nordstrom - the short term will appeal to very few occupants. You see - generally - a three to seven year term is sought by prospective tenants. A move is expensive, disruptive, and quite inefficient. Most are unwilling to move only to do so again a year later - if extension terms can’t be reached with the owner of the building.

Uncooperative owner. Owners ride the length of their leases through market swings. In the example above - additional years could be tacked onto the fifteen months - if - the owner will play ball. Where we are in a market cycle - up or down trending - can predict how a landlord will react to a request for a longer lease. If our market is improving - he has no incentive to strike today. Storm clouds on the horizon? Yes! Let’s deal.

No concessions. A tenant with remaining years on their lease wants out - as quickly and cheaply as possible. Consequently - requests for changes to the space - at the tenant’s expense - are not typically on the table. Furthermore - most occupants - who have vacated - are not interested in investing to re-furbish the interior. Therefore - a sad, worn out building greets prospective occupants. Not terribly inviting.

Credit of the occupant. An owner with an Amazon lease will not be terribly interested in accepting anything less. Why should he? He has Amazon on the hook. If Amazon has decided the unit no longer meets their needs and vacates - the owner can be quite selective in backfilling.

An above market rent. Any lease in SoCal originated after 2015 will most likely be above the going rate today. So grouped with your amazing credit, a short term lease, an uncooperative owner, and an unwillingness on your part to paint and carpet - you could be stuck. So what’s the answer? Conduct a fire sale of sorts. Take a look at what you owe and figure 75% of that amount. Now market your sublease at that reduced rate. You might just find that unicorn willing to transact.

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.

Technology I USE Everyday - Top 10

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Often, I have opined how our residential counterparts have the edge on commercial real estate professionals when it comes to our use of technology. Simply, it revolves around three reasons - the demographics of our industry, techno providers selling individual vs enterprise solutions, and the biggie - our available inventory is not shared with a Realty board - which means the consumer cannot widely view what’s for sale on-line. Some of us, however, have seen the light and adopted technology to benefit our practices and our clients. Below is a review of the technology I USE everyday.

iPad and iPhone. I spend the majority of my days on the road or in the field. Therefore - it’s critical for my technology to be mobile. The two Apple products above allow me to transact anywhere, anytime.

DropBox. My team saves all of our files - brochures, contracts, reports, offers, and correspondence to DropBox. We can then access the docs from our dining room table on Sunday or at client’s office on Tuesday.

I-Annotate. This cool app allows me to make changes to a PDF and forward the changes to our team for editing. Collaboration is enhanced as all of our team members see the changes real time.

Buildout. All of our marketing collateral originates here - brochures, presentations, opinions of value. If we change a square footage or an asking price - the edit occurs throughout all of the syndicated channels. Our listings are published through ten on-line broker portals with the click of a button. My favorite feature, however, is the document vault - a cloud based repository of every piece of paper related to a deal. No more endless emails with PDF attachments or files too large to forward. We simply send a link and anyone can access the important paperwork.

MailChimp. Email marketing made easy. The first 2000 contacts are FREE! Plus, you can see who opened the piece and who opts out.

DocuSign. Our residential brethren have used this for years. Commercial agents are slowly adopting this pain-free way to execute contracts quickly.

CoStar Go. All of our available buildings, comps, tenant and owner information is available through this app. Not quite as powerful as the desk top - but close - we can drill down from an aerial view and see particulars on any parcel of commercial real estate.

ClientLook. The heartbeat of our business! This Best in Class contact relationship manager allows our team to track conversations, follow-ups, tasks, meetings, and events. I especially am drawn to the CRM’s integration with our other technology such as MailChimp, Buildout, and DropBox.

Keynote. All of my listing and tenant rep assignment pitches are generated through Keynote - the Apple equivalent of PowerPoint. Super intuitive and flexible - I can sit in my living room and design a presentation in a flash - including live video, images, and internet links.

Zoom. Can’t be there? No issue! Just create a Zoom call and you and your client can share screens and see each other face-to-face.

Social Media. My use of social media alone is column worthy. Suffice it to say, I create two pieces of original content per week - this column and a video. We then re-purpose the content via several channels - Facebook, LinkedIn, Twitter, and Blogger.

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.

Six Tough Commercial Real Estate Conversations - Cooperation Can Help!

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Cooperation is a reality in commercial real estate deals. Meaning - a buyer and seller or landlord and tenant - must reach an agreement. Simple. But there are other layers of cooperation which factor in - the professionals representing each side - brokers, lawyers, lenders, CPAs, and the like. All must genuflect at the alter of a deal for it to close. Generally, the level of cooperation is enhanced when the advisors do their jobs. That is - conduct the tough conversations which should precede any transaction. Indulge me while I describe a few of my favorites.

The disruption of a move. Sure. Moving to save a few dollars may seem like a good idea. But, a move is expensive! Once physical moving expenses, the potential loss of key employees, downtime, fixturization of the new facility, and customer confusion are weighed - are you really saving? Have you considered things such as internet speed, a new phone number, website changes to reflect the new address, revised marketing collateral? Add any sort of complexity to the use with which you utilize the building and a costly use permit may be needed. Someone must consider the true cost of a move before you wander into the market.

Taxes, taxes, taxes. Uncle Sam, the state of California, and the Affordable Care Act will all want a major taste of your sale proceeds. The time to understand the impact is before you plant that “for sale” sign. Easy math. You can plan on approximately 40% of your gain to be consumed by taxes. Whaaaat? That’s correct. A tax professional can run the numbers for your specific situation. Sure. You can employ certain tax deferral strategies - a 1031 tax deferred exchange, a charitable remainder trust, or an installment sale - but all come with complexities which should be fully vetted.

Market realities. Small business owners that buy or lease commercial real estate are smart. They read. They listen to their customers. They’re informed. In today’s market - unrealistic owners get crushed. The halcyon days of crazy asking prices, waves of buyer interest, and feeding frenzies have vanished like La Niña. Sure. Deals are transacting - but, at a more normal pace.

Condition of the building. During the go-go days of 2016 and 2017 - a buyer would overlook repair necessities such as the roof, air conditioning, paving or exterior condition. Not anymore. We recommend a pre-sale inspection to identity any issues and an assigning a cost estimate. Even if you opt to wait on the fixes - you know what they will run.

Limited availabilities. The weird thing is demand still exceeds supply - there are fewer buildings on the market than buyers. What’s changed since last year? Buyers are proceeding more cautiously, offers well below asking prices are the norm, and market times have increased.

Complete information. Access to scaled drawings, an office layout, a building inspection highlighting the condition and needed repairs, a current title report, copies of leases, expenses, maintenance contracts, and utility bills - all can hasten the timing of a transaction. Buyers will ask. Have them ready.

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.