Little Things Add Up!

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We are scheduled to close a deal today. Yes! Deals are happening - albeit a bit more challenging - during the year of the pandemic. Time on market, due diligence periods, and loan processing require additional days vs the halcyon era of 2019. Shortened are buyer’s and seller’s patience with the delays. This particular transaction found its genesis in February. Met with enthusiasm was the offering. We quickly selected a buyer and opened escrow - just in time for the ballooning cases of Covid-19 and state lockdowns of non-essential businesses. Our buyer bolted. We re-launched in late April. Curiously, we received more interest than in February. Granted - at a lower price -but only about 10% from the previous contract. Not bad.

 In reviewing our estimated closing statement - it occurred to me there are numerous “small” charges that can really add up in a commercial real estate purchase. Seller’s net proceeds are diminished and the amount of buyer cash needed for close are greater. A bit of a review of these “small” charges is in order. So, here goes.

 Purchase Price. This is the starting point from which a number of the amounts below are based.

 Documentary transfer tax. Depending upon the county in which your sale is located - this charge is generally $1.10 of every $1000. Simply, if your sale amount is $5,000,000, the documentary transfer tax is $5500. In Southern California, this expense is born by the seller. However, this varies in other parts of the state. By the way, here is a great website if you need further clarification - California Documentary Transfer Tax Explained | Viva Escrow

 Escrow holder amount. Your escrow company will want to be paid. Fees vary wildly, especially as the deal size increases. Generally the bigger the deal, the smaller the amount. Think of an escrow as a sort of Switzerland. They are neutral. Serving as a clearinghouse for money and documents - an escrow company only performs the tasks mutually agreed upon and instructed by buyer and seller.

 Prorations. Many sellers are surprised by prorations and if not properly anticipated - tcan be shocking! Normally, prorations are computed based upon a 30 day month regardless of the true number of days. “30 days has September, April, June, and November - indeed!” But, with prorations, the months with 31 days only get the benefit of 30 - like July. Let’s use a closing date of July 17th. Escrow will figure out rents (if any). As the seller - you are entitled to 17/30ths of the rent. The buyer the other 13/30ths. If our rent is $10,000 per month - as the seller you’ll receive a debit of $4333. Presumably, the rent was paid by the tenant in early July. So, as the seller, you’ve received a full rent payment and now must credit the buyer for the amount the buyer deserves for owning the property the final 13 days of the month. Property taxes can be very tricky and seldom understood. Simply. Our state runs its budget from July 1st of the current year to June 30th of next year. 1st half taxes - July through December - are due in November. 2nd half taxes - January through June - are due in April. Yeah, confusing. Therefore, depending upon your close date - property taxes will be debited and credited. A July closing is particularly interesting. You see, although the 1st half of the year started on July 1st - property tax bills are not sent until October. Therefore, an estimate must be made of the anticipated total. An easy way to accomplish this is simply to add a 2% increase to last year’s payment. Inexact, but simple.

 Policy of title insurance. Generally a seller charge. Here’s a great interactive website to compute title policy amounts. http://www.firstam.com/title/resources/calculators/title-fee-calculator.html. Based upon a purchase price of $1,000,000 an ALTA owner’s policy will run you about $2100.

 Lender fees. Appearing on the buyer’s ledger. Included are loan origination percentages, processing fees, document preparation, etc. if you’re funding a loan, your bank will outline all of these charges for you in great detail.

 Brokerage commission. Typically from 2-6% of the purchase price and commonly paid by the seller. Therefore a debit will appear on the seller’s statement.

 Miscellaneous charges. Copies, notaries, recording fees, attorney fees, natural disclosure reports, pad for closing date fluctuations, and others - can find their way to a closing estimate.

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.blogspot.com.

What Can Loss Teach us about Commercial Real Estate?

Loss. Simply, “the state or feeling of grief when deprived of someone or something of value.” 2020 so far has been a year of loss. Businesses bankrupted, careers cratered, freedoms foregone, routines re-routed, celebrations cancelled - all losses - in some cases forever. Required are we to change - like it or not.

 Last week, our family experienced loss in its most poignant form. Our father, Samuel A. Buchanan Jr. left us to be with the Lord. I’m certain this is true. Dad was a faithful follower of Jesus and loved his church. Suffering from a terrible bout with cancer - fortunately, Dad’s final days were peaceful. He left a legacy of five children, ten grandchildren, nine great grands, and countless friends. I’m sad that Dad is gone but relieved he is no longer in pain. Thank you for allowing me to share that!

 So, what - you may be wondering - does loss have to do with commercial real estate? Only this. From loss comes gain. Here are a few examples.

 2008 ended with many commercial real estate professionals scrambling. Our world abruptly halted. Buyers weren’t buying, sellers refused to sell at such depressed values, and lenders were more frozen than Queen Elsa. Tenants suddenly were seeking great deals. Landlords were stubborn. A mist of uncertainty shrouded our industry akin to that over the Enchanted Forest in Frozen II. Yeah. Recently, I got my Papa cred by watching The Disney Channel with our grandkids. But I digress.

 In 2009, we were forced to adapt. With vacancy in commercial properties rapidly rising, I focused on tenants and buyers. “Blends and extends” became a thing - a reduction in a rental rate today in exchange for a longer lease term. ‘Working out loud” - a phrase coined by my wife, Carla - was the start of a blog in 2010. Authored is digital content for owners and occupants of industrial buildings in Southern California. The Location Advice blog is now published by the Southern California News Group on Sundays. Yep. You’re reading a post now. A return to fundamentals caused the decade of the 2010’s to be my best yet.

 Gains from the losses we’ve experienced in 2020 are starting to sprout. E-commerce has exploded. More folks are shopping from their iPad vs visiting a brick and mortar store. Logistics companies that feed the supply chain are hustling to fulfill demand.

 Material handling outfits - forklifts, racking, dock and door equipment - are recording a record year. Owners of warehouses have enjoyed steady rent checks.

Rumored is a re-shoring of manufacturing. Our economy’s dependence on cheap stuff may shift. Less reliance on low cost production will cause prices to rise but quality and reliability will as well.

 Regional malls could spell the end of our housing crises. How, you might ask? Brookfield Properties made an enormous bet on mall ownership in 2018. Currently, Brookfield is the nation’s second largest owner of regional malls. As we see major mall tenants such as Sears, JC Penney, Neiman Marcus, Macy’s, Pier One, J-Crew, Forever 21, Brooks Brothers and others struggle and fail - watch a gradual re-tooling of these massive spaces into multi-family mixed use re-developments. Closer to home, Integral Communities just bought the land beneath the JC Penney store at the Village in Orange. A similar proposed development is slated for a portion of Main Place Mall. So, it’s happening!

 I’ll always be grateful to my Dad for not hiring me to run the family business. The rejection motivated me to seek an alternate career path - commercial real estate brokerage. What I viewed as an horrendous loss at the time resulted in a huge gain.

 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.blogspot.com.

How to AVOID the Re-Trade in Deals

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Last week week we covered four things that can occur once a commercial real estate deal reaches the end of its contingency period - that time frame whereby a buyer can determine - in its sole discretion - whether the proceed to close. As you recall - the four outcomes are - move forward, cancel, seek additional contingency time or ask for a price reduction - AKA re-trade.

 Promised last week was a discussion of how to avoid a re-trade. But first, let’s spend a moment and dissect this request a bit more. Once a buyer spends time and money understanding a commercial real estate purchase - in many cases they know the building better than the owner. After all, they’ve poked, prodded, reviewed, surveyed, and analyzed every aspect of the structure, title, roof, HVAC, mechanical systems, zoning, tenancy if any, and operating history. Therefore, it should come as no surprise if something untoward is discovered. Hopefully, what’s uncovered is a minor fix and the deal can proceed smoothly. However, if the issue requires a price reduction, your options as a seller are:

 Agreement. If the request is well reasoned and thoughtful you might simply agree.

 Cancellation. I’ve seen sellers get very defensive and cancel. Certainly, this is your right. You entered a contract to sell for a certain price. Your buyer agreed to buy the property in its “as-is” condition. Now they’ll proceed - but at a lesser amount. Sure. Something is cheesy about a buyer that operates this way. A deal’s a deal. But, if you walk away, the next buyer may ask for more. You’ll certainly have to disclose what you encountered. Plus, you’ll now start over with another buyer and reset the shot clock with another contingency period.

 Compromise. We just completed a lengthy due diligence. The buyer discovered three things that gave them heartburn. We successfully whittled the three down to one and the seller agreed to a slight price reduction to remedy the remaining problem. Had the buyer sought recompense for all three - the conversation would have been short. Fortunately, the seller was prepared and the buyer’s ask was reasonable. Game on!

 But, in my experience the best way to avoid a re-trade is to anticipate them and prepare. You know your buyer will require a water-tight roof. How about conducting a preemptive inspection? You’ll then know if there is a problem. Take it a step further and get bids from contractors to repair the leaks. I’ve found some buyers will inflate the cost to remedy what they find. Imagine that! It’s your option whether you bear the expense pre-marketing or wait. You’ll then be armed to address any request for a price reduction - because you know the extent of the issue and what it costs to fix it. I also enjoy putting a seller into a great offensive position - with back-up buyers who’ll step in and perform in case buyer number one hiccups.

 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.blogspot.com.

The DREADED Re-Trade in Commercial Real Estate Deals!

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Ahhh, the dreaded re-trade! Simply. A buyer asking for a price reduction well into the purchase process, prior to close, but before they are contingency free. 

Buying a parcel of commercial real estate is really three negotiations. I even wrote about it here. http://allencbuchanan.blogspot.com/search?q=Three+negotiations. A quick review of the three is in order. First - price and terms. This conversation could take place through a binding Purchase and Sale Agreement but typically is negotiated via a non-binding Letter of Intent. Next - Purchase and Sale Agreement talks - if not handled in the first dialogue. And the final discussion - which occurs once a buyer has completed their due diligence - and where the re-trade can happen. 

Generally, commercial real estate transactions allow the buyer a certain amount of time to inspect what he’s purchasing. Reviewing a title report, conducting environmental surveys, insuring the AC blows cold air, and confirming the roof doesn’t leak usually are done. Also in this no obligation contingency period - the buyer arranges financing, interviews the tenants if any, and pours over leases, utility bills, aged receivables, operating statements, and anything else they can dredge up. A quick trip to the city may be important to work out any zoning concerns. We see 30-45 days as a typical contingency time frame. Once ALL this is completed - the buyer decides to move forward, cancel, request additional time, or ask for a price reduction to offset anything untoward discovered. Since a monetary remedy is sought - in effect the purchase price is re-traded or re-negotiated. Bummer!

Let’s discuss in detail the four ways a deal can proceed once due diligence is completed - shall we?

Move forward. The BEST result for buyer and seller! Everything came out great. Lender approved the loan, city welcomed the new business with flowers, all systems are AOK and pilot you are cleared for landing! I can tell you from experience, this happens about 10% of the time. As a seller - if you get this outcome - awesome! Count yourself among the very fortunate. 

Cancel. Extreme! But it happens. Generally cancellation is trumpeted far before the end of a buyer’s contingency. Sure. We’ve all had deals stall in the “red zone”. However, in my dealings, you know when a transaction is doomed. Entrenched within all real estate professionals is a sixth sense of sorts that shouts “danger Will Rogers!” Cancellation occurs in around 5% of all deals. What causes a buyer to walk away will be discussed another day. 

Request additional time. Executing deals during our shelter-in-home period found many buyers asking for additional days to complete their study. Inspectors - hampered by rules and regs, lenders swamped by PPP loan processing, sellers squeamish about tours - all contributed to slow the process. Typical 30-45 day contingency periods became 45-60 days. Frankly, the delays were out of the buyer’s control. 50% of deals reach this crossroad. 

Re-trade. Maybe my least favorite outcome! Why? Because you are so close - yet so far away. Sellers have agreed to the purchase price. Buyers now want some blood. If not properly managed - this can quickly spiral out of control. Plus, as the intermediary, you’re often sought to “bridge the gap”. Candidly, sometimes a cancellation is easier. At least contention is avoided and energy can be expended to locate another buyer. However, close to 75% of agreements include some sort of “ask”. Roof and heating, ventilation, and cooling head the buyer’s list. These are major capital expenditures that must be addressed. Buyers gladly ask for a seller to pay. 

Next week I’ll discuss the ways you can minimize or avoid a re-trade. So, stay tuned!

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.blogspot.com.

The BIGGEST Deal Ever! AKA Deja Vu all over again

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We are confirmed! Three words that live in every commercial real estate advisor’s lexicon. Confirmation means a deed - transferring ownership - has recorded. Whether spoken, written, texted, emailed, or smoke signaled - trumpeted is the completion of a transaction and a payday which follows. You see, as commercial real estate professionals - our livelihood depends upon earned commissions. No salary, stipend, advance, grant, draw, or lifeline exists. We eat what we kill - similar to that sergeant of the Serengeti. Therefore - we must close deals in order to survive.

The words “we are confirmed” - in April 2010 - were particularly sweet - as they culminated the largest commercial real estate deal of my career to that point - which eclipsed four decades. Seven years of work preceded the close. During this itch - in California - we recalled a governor, elected a Terminator, relaxed mortgage qualifications, burst a housing bubble, and witnessed the largest collapse of our financial system since the 1930s - and the demise of our commercial real estate market. Sound familiar?

So why the reflection? I see many similar characteristics in today’s 2020 environment.

Budget woes. As 2003 dawned in Southern California, our state government of California was not forward thinking with their budget. As I surveyed the business landscape in Southern California - several troubling things were observed. Our legislature seemed hell bent on driving manufacturing businesses out of California. For a commercial real estate advisor - who relied upon industrial companies to acquire real estate for their operations - this was an uncertain time. Short sighted policies which increased public pension costs - placed a greater burden on cities to generate revenue. Targeted were employers - especially those who made things. Vehicle licensing fees tripled. Diesel fuel costs doubled. Suddenly delivering goods became costlier. Driver’s licenses for undocumented workers became a thing. Air Quality Management Districts tightened the noose - through regulatory fines - around operations that generated any pollution. Worker’s compensation insurance rates quadrupled. Bottom lines for companies narrowed. Neighboring southwest states of Nevada and Arizona served as catcher’s mitts of organizations fleeing California. Because of our recent business shutdown - California faces a 54 Billion dollar budget hole. Will this shortfall increase the costs of doing business? Hmmm.

Some sectors are thriving others are not. In 2003 an emerging dichotomy across commercial real estate assets in Southern California was occurring. Large manufacturing concerns we’re getting crushed but smaller, lighter uses were finding favor. Investors and developers – flush with capital - were seeking industrial buildings in which to invest. If an investor could purchase a large manufacturing campus, scrape the improvements, and build smaller light industrial facilities - substantial profit could be made. Cities loved the new building permit fees that were generated. Consequently, we witnessed substantial appreciation in land values. New construction flourished. Today, large retailers face the same pressure that large manufacturers encountered in 2003. Investors are skimming the landscape looking for distress. I suspect we will se many regional malls converted into an more favorable asset class - such as apartments.

Exodus from the state. So in 2003 - when California was in a world of hurt with worker's comp rates, employers leaving the state, driver's licenses for illegals (which all lead to Governor Gray Davis being terminated by the Terminator), we saw a huge amount of sale/leaseback activity from national corporate occupants. Numerous large Orange County employers including Aquatics-Lasco Bathware, Akzo Nobel, Johnson Controls, Smurfit Stone, Parker Hannifin, Illinois Tool Works, Limbach, Boeing, Beckman and many others sold manufacturing locations in Southern California and leased them back from the new owners. Occupied by these companies were mammoth facilities - many built in the fifties and sixties - on large swaths of land. The two main reasons in 2003-2005 that many national (multi location) companies sold their locations and leased back, were real estate values and the business climate in Southern California. By selling the locations when the market was at its value peak and leasing back for a three to five year time frame, the companies maximized their real estate equity and could decide at the lease expiration whether to stay in California or consolidate into another location. Some stayed, but many left. Today, companies are employing the same means to generate cash.

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.blogspot.com.