Random Commercial Real Estate Thoughts

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Occasionally, it’s a great idea to clear the inbox of your mind. Today, I unpack several issues clogging my consciousness.

When is an owner “unreasonable”? Often an occupant will find itself with too much or too little space. If they lease their premises - this can be problematic - especially if lease term remains. You see, a tenant cannot simply “walk away” from a lease - it’s a contractual obligation. Therefore, the options are threefold - sublease, a buy-out, or make do. Generally, a sublease is the route taken. Language in most leases allows an occupant to find a replacement - sub-tenant - to fulfill its term. The owner has the right to approve any assignment and cannot unreasonably withhold permission. But what is “unreasonable”? Credit of the proxy, use to which the surrogate will operate, portion of the space taken, and term desired all form the basis of an owner’s approval. If all of the boxes are checked - creditworthy, clean legal use, and all of the space and term absorbed - a refusal may be construed as unreasonable.

Small business owner attitudes. As 2019 dawned - I sensed a shift in outlooks. After all, the government was shuttered, the stock market was wildly gyrating and interest rates were rising. The stench of uncertainty wafted. With almost half the year in the books - unemployment is at record lows, interest rates have fallen, and attitudes have improved. Candidly - the housing market performance and tariff hikes still have me wary. But we will see.

The unexpected does occur. I received a call last Thursday from a residential colleague of mine. She and I concluded a deal in 2009. A friend of hers was panicked. An F-16 had just crashed through his space. He needed to move - FAST! But what about his remaining lease term, the damage to his inventory, the gaping hole in the owner’s roof? That’s why we have insurance - on the owner’s and tenant’s side of the aisle. Note to owners - make sure your occupants have updated their policies and their premiums are paid!

Lawyers. I love the legal profession! So much so - I nearly went to law school. But, I chose commercial real estate instead. Too many in my profession find themselves at odds with counsel. In order to succeed as a commercial real estate professional - you must learn to peacefully co-exist with attorneys. Just understand - we get paid to solve a deal’s issues. If an attorney irons out a problem too quickly - the fees stop and liability begins. Our job is to negotiate economic points - price, term, deposits, concessions. Inherent risk is involved when transacting, however. Enter lawyers. Most want the same result - a closed deal. Just allow them to have their say.

Networking is not selling. Networking is about giving - not receiving. Doubt what I say? How many times have you attended a Chamber meeting, Rotary lunch or Provisors gathering to buy anything? Bingo! So - if none of the attendees are there to buy - why would you show up to sell? You’ll be sorely disappointed. You might as well spend that time knocking on doors or making prospecting dials - if you’re looking to sell. Discover how you can help another achieve their goals - and networking will become a gold mine of strategic contacts.

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.

How On Line - On Purpose has Changed Commercial Real Estate

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Admittedly - the way we buy goods has evolved. No one will dispute that. Some that I know refuse to enter a brick and mortar store. Why should they? With a better selection, lower prices, and fewer attitudes on line - there is really no reason. Darkened display windows and news of retailer bankruptcies are further evidence of this perspective.

Fewer folks watch network television or read publications. Doubt what I say? Have you cut the cable in favor of Netflix, Disney, Amazon, or Hulu? Are your fingers stained with newsprint or are you reading this column on your phone? When is the last time you bought a magazine? Traditional media sources with which advertisers push their products have morphed. Now, if you perform a Google search for a product - you see a creepy ad for a similar product in all of your internet pages. How did they know?

You may wonder what any of this has to do with commercial real estate. A few things - actually.

People shop for commercial real estate differently. Currently 90% of commercial real estate searches start on-line. Historically - if you were in the market to buy a building - you jumped in your car and drove the area where you wanted to locate. Carefully observed were broker For Sale signs. You called and inquired. Created was a connection to a commercial real estate professional who became your tour guide through the available inventory. However, folks who shop for commercial real estate on-line get frustrated as our consumer facing sites pale in comparison to our residential colleagues. But people still try. Absent are Zillow, Realtor.com, and Redfin - which provide reams of data for your perusal. Sure - Loopnet will give you a taste - but if you want a full meal - you’ll need to connect with a commercial broker. Once you find a building to purchase - the process is largely unchanged - although streamlined. Offer, counter, acceptance, escrow, due diligence, contingency waiver, fund and close are still the norm. iBuyers and auction platforms? Sure. But - a very small percentage of sales occur these ways.

Our job as marketers. We must - as commercial real estate professionals - appeal to the on-line searcher. A common mis-conception is we simply use the modern media sources - FaceBook, Twitter, YouTube, Instagram - as a way to advertise available properties. Unfortunately - these ads get deleted like that cable subscription. What pulls a building shopper to us these days is content. Content that portrays us as experts in our field - not simply a name on a sign. Content that inspires to action, entertains, or educates as a means of demonstrating our knowledge. Good content - videos, “how-to” articles, thought pieces - serve as a large net for existing and future buyers. Advertising buildings for sale only appeals to folks in the market today - a very small slice of the population.

Retail apocalypse. Yes. Retail buildings are commercial real estate. Yes. The way in which consumers consume has torpedoed traditional retail. Think about sporting goods, pet items, books, office products, clothing, furniture, electronics - all have seen dramatic reductions in the number of locations. Sports Chalet, Sports Authority, Borders, Circuit City, Wickes and countless others are gone forever. Left in their wake? Large blocks of vacant space - which owners struggle to fill. A partial re-purposing to residential perhaps - such as MainPlace Mall considers and the Spectrum or the District has accomplished. An experiential conversion like the LA Times building in Costa Mesa or the Packing House in Anaheim. Or an entire re-branding akin to the furniture retailers south of South Coast Plaza. Innovation such as these examples will generate foot traffic and sales. But as the lights flicker in your favorite mall - shining bright is the beacon of e-Commerce. What’s on sale through your computer screen gives life to another genre of commercial real estate - warehouses, trucking companies, logistics operators and delivery services - who must work hard to ensure your purchases arrive at your front door.

Is a Commercial Building Worth More Vacant or Leased?

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As we’ve discussed - commercial real estate is owned by those who occupy it with a business or investors who rely upon the rent the property produces. Therefore - a slice of commercial real estate is valued according to its utility - in the instance of an occupant or to an investor - in its ability to produce income. Occasionally the lines cross - which I will cover in the last section.

Utility varies. Think about it this way. If you’re a company that tools aerospace parts - the electricity feeding a property is critical because you use it in your operation. Without the amperage - the parcel is worthless to you. A logistics company that stacks products in a warehouse relies upon the number of truck doors and inside ceiling height. Therefore - utility is found in a property with such upgrades. An easy way to consider utility? Generally, an occupant considering a selection of buildings will place a greater emphasis on utility or use in its decision. Said occupant is willing to pay more if the commercial real estate has the features he seeks.

Income production. Rent. How much? How certain? How long? Easy. Let’s assume a building has market rents and is leased to a Fortune 500 tenant for ten years. So, there is very little risk. The valuation is simple - an investor will buy the income stream for a price. His price? Easy math. Annual rent divided by his desired return - also knows as a capitalization or “cap” rate. Thus, an annual lease payment of $12.00 at a 6% return yields a value of $200 per square foot. Consequently - your 20,000 square foot building is worth $4,000,000.

If a building is vacant - is it of no value to an investor? If he is smart - certainly not! However, the analysis is more complex and the stars must align for the resulting price he can pay to compare to an occupant purchase. Here’s the way it works. Since an investor relies upon the income - rents - a property produces, he must calculate what those rents will be, how long it will take to achieve them, and at what cost. We refer to this as lease origination expense. If he’s looking at a vacant building and the seller wants $200 per square foot - the investor must factor in the origination expense. If an investor can pay the $200, absorb the origination expense, and still get his return - golden!

If a property is leased - is it worthless to an occupant? It depends. Keep in mind - an occupant looks at utility. And he must be able to occupy the building. So, if the PERFECT site - with all the bells and whistles - is available but leased for awhile - it might still work. Here is how. We recently represented a buyer. Obligated for two years in a lease - they wanted to pursue a purchase for their next move. So, if we located a building for sale with a short term lease in place - that was beneficial. We did! Plus. Because the lease on the building we bought was short term - the buyer got a better price. Because - most investors were turned off by the impending lease expiration and most occupants couldn’t wait two years to move. Boom!

When do the lines cross. We are seeing a fair number of investors buying vacant buildings these days. Recently - a high percentage of the structures in a new development in north Orange County were sold to investors - vacant! Their motivation? Money needed to be spent. Capital had to be deployed. It was costlier to wait than to buy vacant and incur the origination expense. A similar trend is occurring inland where new logistics boxes are trading without tenants in place. The reason? More occupants are seeking leases vs purchases. As an investor - if you can buy the right utility - your origination costs are reduced, you create the income, and the world is a happy place.

Commercial Real Estate is Still Local - Three Reasons

When I started plying my trade in the early eighties - our means of sourcing new business were the phone, a Rolodex, shiny shoes, and a big smile! My, my, how things have changed! If you were engaged to find someone a building or secured an agency to list a vacant property - your methods of getting the word out we’re limited to the U.S. mail, newspaper ads, calls, signs, and telling your fellow brokers. Area specialization was key. Because there were no multiple listing services - local knowledge was your value.

Flash forward. From our kitchen table - we now can access an ownership of any commercial property in the United States - and there are over 48,000,000 of them! Want to find a vacant building in Austin, Texas? No problem. Your client operates four hundred locations nationally? We are now equipped to manage his account through the technology at our fingertips. Competition for business is no longer local as everyone has access to the same information.

So with the advent of technology and the open doors we all share - has the local nature of commercial real estate been lost? Hardly!

Value is still local. One of my current assignments has taken me a bit out of my patch. I’ve been hired to locate a distribution center for an East Coast operator. Generating a list of available properties is a snap. Understanding the nuances - not so much. An example. We discovered the zoning of one of the buildings we liked would not allow our use. Hmmm. Had I been entrenched in that area daily - I would have saved some time. In SoCal, the farther east you look - the cheaper commercial real estate pricing becomes. However, distance from the port is greater - which adds a layer of cost. In some cases utilities are higher. Hmmm. Didn’t think about that.

Relationships rule. We recently competed against four different buyers for a building for sale. All four buyers had made asking price offers. Demonstrated by all was proof of funds and an ability to close quickly. We won the deal! Why? Because I had successfully closed several previous transactions with the owner’s broker. He had confidence in our ability. We see each other at the gym. We talk at open houses. We play golf together. I sat at his table at our recent SIOR event. This sort of familiarity is impossible if your practice spans many states.

It’s the market. I can look at a building on paper - let’s say in Tempe, Arizona. Certain boxes can be checked - size, amount of office, loading, warehouse clearance, price. I can jump on Southwest Airlines and see it in an hour. Great! What I can’t determine is recent sale and lease activity. How many properties - with similar features are currently available? What are the local value drivers - employment, population growth, attitudes of municipalities, housing? Sure. I can utilize the same database used for the avails but a true understanding of why the comps sold or leased can only be catalogued by someone there every day. That’s value!

Akin to a beat cop who walks the streets or patrols a neighborhood - commercial real estate is still a local business - and always will be.

Negotiations are Stuck! Now What? _ Suggestions

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Commercial real estate transactions require negotiation. Duh! But, candidly, the back and forth is my least favorite part of a deal. Many consider the volleying a sport - one that must be won or lost. Skillful negotiators realize - in order for there to be a successful outcome - both parties must win. I’ve witnessed sellers - down to their dying breath - decide they’d rather give the building back to the bank vs conclude a transaction with an over zealous buyer. 

Conversely - I’ve seen buyers - whose business growth depends upon buying a building walk away due to a minute tweak in the terms. The worst - however - is a stand-off. Akin to heads-of-state squared up in an intense disagreement - the mantra of “he who first blinks loses” is repeated. As commercial real estate professionals - we find ourselves between the warring factions - struggling to find common ground.

If your negotiations are mired - what can be done? Below are _ suggestions.

Why are you at an impasse. Price? Terms - such as the length of escrow or deposit structure? Maybe your issue is more esoteric - your seller has the impression the buyer can’t perform and therefore is holding firm. If the conversations have been many rounds - sometimes a party gets weary - enough already! Regardless - the solution is often contained in the reason for the roadblock.

What’s at stake. The owner I referenced above had to sell or the bank was going to foreclose. However, he had to salvage something - even if it was his dignity. Buyers came along sensing a fire sale! What the buyers failed to recognize? At a point - the seller would simply fold and allow the lender to take the premises - consequences be damned. Just when you believe a seller has no room to maneuver - in fact he does. Never underestimate a desperate seller.

What are your alternatives. Too often a buyer will confuse his operational goals with his purchase criteria. Early in the process - gain an understanding of the buyer’s motivation for the purchase. If the buy will allow him to hire more folks, generate more sales, carry more inventory, accommodate new machinery, or manufacture a new line of products - there is an economic motivation. If negotiations reach a standstill - we review the benefit and downside. Sometimes that difference in price becomes moot in light of the increase in business revenue - or loss if he doesn’t move forward.

Are there non-monetary solutions. Occasionally, parties will agree on price but stall for other reasons. Most common would be a closing date. You see, some sellers benefit from a quick conclusion while others would prefer to postpone the final bell. Sometimes a buyer requires a bit more time to process a loan or bridge a lease obligation. So hypothetically - a seller wants finality in 60 days but the buyer is adamant about 90. Maybe the buyer can beef up his deposit in return for the extra 30 days.

Time to say good bye. Once in a while - the best deal is the one you DON’T make. I’ve found if transactions are meant to be - motivations are aligned and transparent negotiations take place - a rhythm evolves between the parties. It’s a beautiful thing! However, if you find yourself working diligently to resolve minutiae - maybe the stars won’t align. Time to crank up that search for another building.

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.