Subleases - What Causes Them?

Image Attribution: www.housekey.jp 

Penning this in the final month of 2020 - my thoughts consider 2021 and what might be coming. I suspect, a tremendous amount of “shadow space” better known as subleases will fill the landscape of office and retail availabilities next year as occupants adjust to the realities of the pandemic economy. Sure. We could also see industrial overruns - but for very different reasons. 

A bit of context to begin. Commercial real estate is occupied by the building’s owner, also known as an owner occupant or by an entity unrelated to the title holder - a tenant. In the case of the latter, a contract exists. Leases, rental agreements, or the like state the terms of the relationship - monthly amount paid, number of years, responsibility for maintenance, and who pays the property taxes and building insurance. When a change occurs during the term of the lease - causing a shift in the real estate requirement - one result is sublease space. 

So, with that general background, allow me to explain excess square footage and specifically what causes it with office spaces, retail storefronts, and industrial boxes. 

In our first example, let’s take your local attorney’s office. Generally, these counselors lease their spaces. Ok. Some take advantage of the benefits of owning their locations...but play along with me. Assume at the beginning of 2021; three years remained on a five year lease the firm signed in 2019. Once “stay at home” orders took effect in mid-March - the group found itself with most of its practitioners working from home - and loving it! Now, that marble floored and mahogany paneled boardroom is rarely used. The plethora of private offices - which are typical - now lay fallow. However, rent payments are still owed. Decision time. Is the under utilization permanent - meaning a need for a smaller footprint? Or, will full staffing exist soon? In the former - you have the classic need to find an occupant willing to morph into the vacant seats and fulfill the law firm’s remaining obligation - a sublease. 

Another situation - which floods the sublease market - is observed at virtually - sorry - every regional mall, power center, strip, and freestanding big box retailer in SoCal. Pier One, Steinmart, Bed Bath and Beyond, JC Penney, Brooks Brothers, Forever 21 and other name brand outlets all took their lumps this year. Many shut their doors for good. Others are surviving - but just barely. In every business failure, leases must be considered. Some are abandoned through bankruptcy courts. Select ones leave vast, vacant, dark holes where vitality previously existed. Low cost providers such as Tuesday Morning take over. Although, for how long? Creative solutions emerge such as the Union Marketplace in Tustin’s District - a former Border’s Book Store. There, the larger space was chopped into smaller experiential retailers. But suffice to say - leases must be consumed. 

Finally, industrial buildings. You know, those concrete behemoths which house a variety of manufacturing, warehousing, and service concerns. A very different dynamic will create vacancy in 2021 - companies outgrowing their spaces. With the spate of on-line shopping - ECom providers cannot keep enough stock on hand. Food producers are slammed. Any company manufacturing repair and replacement parts is thriving. Try getting a plumber out to fix a leaky toilet at your home or business - good luck! One of our clients distributes mufflers. With the number of folks staying home and extra $$ piling up because they can’t go to Disneyland or the movies - yep. They’re fixing their cars. A building conversation faces them next year. They’ve eclipsed their capacity. Another is also an automotive distributor. Recently, their demand was so great they opted to double their square footage and find someone to sublease the building they vacated. 

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 to Expect in 2021

Image Attribution:www.gallery.yopriceville.com 

Wow! December. With Christmas lights festooning the neighborhood - we are reminded 2020 is almost history! 2021 is a mere 30 days hence. What can we expect of the commercial real estate landscape next year? Someone famous once opined - “well, they’re only predictions, but they’re all mine.” So please bear with me as I get my Nostradamus on.

Bullish industrial owners. We represent an importer. Warehoused are goods they distribute. He’s slammed for space - thus our engagement to find more. Recently our full priced offer was met with a reluctance - by the owner - to grant a financing contingency. I’ve seen this with investment properties - but never with owner occupied real estate. You see, time is needed for a lender to nod yay or nay. Very few occupants have idle cash sitting in an account awaiting a purchase.

Shorter leases. Until the aroma of economic uncertainly ceases to waft, expect occupants to seek commitments of fewer years than before. Ten year leases will become five and so on.

Clarity in the office market. I suspect by this time next year - the runway will be clear and office occupants will have a direction - up or down. As previously mentioned, uncertainty is a killer for any business trying to gauge a need for space. But, as we are seeing in retail storefronts with their downward trajectory - at least we can plan.

Low interest rates. The Biden administration will most likely be gridlocked by a Republican senate. With the house near balanced, a Democrat in the White House and a red senate - expect the Federal Reserve to keep interest rates low. Our ten year treasuries - a bellwether for commercial real estate loans - are expected to wallow at historic bottoms as well.

Burgeoning ECommerce. If the Buchanan household is any indication - internet ordering and “just in time shipments” to your door will continue with a vengeance. Recently, we purchased a new mattress on-line. The next day, two beefy gentlemen ushered it into our upstairs master suite. Will someone kindly develop a box compactor for home use? Something between the kitchen trash masher and the ones in Albertson’s storeroom would be awesome. There’s your million dollar business idea for 2021! You’re welcome.

Continued safety protocols. As the pandemic blossomed in March, predicted were temperature checkpoints, masks, hand washing stations, and distancing. Actually, it was not terribly futuristic. Observed was what other countries were employing. I am startled how quickly we adapted, however. Akin to airline changes post 9.11 - we can’t simply attend a concert, eat in a restaurant, or shop without a face covering. Shocking. Although, expect more in 2021.

An innovative technological offering? Commercial real estate is rarely disrupted by something shiny and new. CoStar - in the mid 1990’s was probably the last big thing. With CoStar’s acquisition of Ten-X this year - we could see a more robust platform from which to transact. At the site’s disposal now is available inventory, what’s recently sold, and an auction template. Hmmm. Where do brokers fit in? But, look no further than our residential counterparts to get a glimpse. Matterport tours, consumer facing available inventory, and accurate internet loan processing lessen the need for “buy-side” representatives.

Scant industrial vacancy. I see nothing on our immediate horizon that would cause industrial availability to rise. The drivers of increased square footage could be new construction. Nope. Not enough vacant land in the OC to stem demand. Plus, it takes an eternity to get a new development entitled. Business failures - probably not. We’ve just endured the greatest health crises in 100 years and many industries thrived. Exodus out of state. Maybe. We’ve definitely seen some movement. However, our local businesses are largely private. They’re your neighbors with a rich history and deep rooted residency in SoCal. A financial meltdown. Yeah. That could do it. 2009 again. I certainly hope not.

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.

Building Still Vacant? Ask MR BOB!

Image Attribution:www.dreamstime.com

You may have consumed my recent column on the acronym N.U.C.L.E.A.R. wherein a discussion took place. You see, I channeled Pat Sajak to create my own Wheel of Fortune. Provided was a fool proof way to analyze the viability of a commercial real estate requirement. I’ll buy a vowel, indeed! The Need, Urgency, Catalyst, Loyalty, Expectation, Authority, and Resources - if reasonable considered - allow buyers, sellers, tenants, and commercial real estate professionals to “qualify” their need and proceed to a successful conclusion. Many contacted me with their own acronyms. One actually from our neighbor, Rudy! I thought them column worthy. So here goes!

Our friends own several properties from which the rent fuels their livelihood. When considering a buy, he and his wife use the acronym C.L.I.P. Condition, Location, Income, and Potential. This simple four quarter system touches all the bases.

Condition. The current repair of the improvements is a very important consideration. Many look at the roof and air conditioning as key components that can require significant investment in the future. However, things such as the parking lot, exterior appearance, plumbing, electrical, and the nature of a property’s office improvements are also key.

Location. Often opined - there are three things that matter in real estate - Location, Location, and Location. Yes! Even if a parcel is the “ugly duckling” of a premier neighborhood - can it one day be the “black swan”?

Income. Unfortunately, this element falls third in line - it belongs first - so that the letters spell something. Otherwise the acronym would be I.C.L.P. - not as compelling or easy to remember. But suffice it to say, the Income is critical! Where is the rent compared to similar buildings? How sustainable is the stream? Sure. You may be looking at a multi-year lease - but if the tenant is gasping for air - you may have to replace the rent sooner than planned. Few properly bake-in the true cost to replace a tenancy. Downtime, concessions, commissions, and improvements all can diminish your future take and should be considered. Remember the condition? Yeah. You’re now competing with other options in the market. Best be spic and span!

Potential. Finally. In addition the the present income - where can you take the property in the future? I refer to this as the exit strategy. Will your family hold on and pass the holding along to your grandkids? Or is the idea to fix it and flip it? Can rents be raised? Will a freshening cause the occupant to renew? Is there excess land from which additional square footage can be added? Maybe the resident is your exit and is a prime candidate to buy. Be quite candid with yourself on this point.

Another really good nemonic came my way last week. This five letter assemblage can explain why your building remains vacant. Want to silence the crickets with the sound of commerce? Run through this list.

Market. If you own a vacant suite of offices - you’re faced with the uncertainty of a Pandemic economy. Virtual work and stay at home orders have created a real dilemma for office occupants. Few know exactly how many square feet they need. Case in point. Our operation in Orange which is tooled for 50 in-house practitioners and staff. We own. We don’t want to relocate into a smaller suite. But, the reality is we don’t presently use all of our space. So, what to do? This conversation is happening in board rooms throughout the country. So with an office vacancy - the market is not your friend.

Rate. Does the rental rate or purchase price you’re asking have any resemblance to the current COMPS? In an up-trending market, you can be bullish - yet realistic. If things are going the other way you easily can “chase the market down” by holding firm.

Building. Is your contruction a warehouse with insufficient ceiling height? How about the corresponding loading? An abundance of office space within a building sans the appurtenant employee parking spots or windows to the outside world is not desirable. Finally, an address meant for manufacturing but without proper electricity will be quickly discounted.

Owner. Take a look in the mirror. Are you a good owner - fair dealer, concerned about the repair and maintenance of your properties, a “big picture” proponent who eschews the little stuff, and avoids extracting the last penny in favor of keeping your parcels rented. If you answered no to any - YOU may be the reason your structure is fallow.

Broker. Finally. How is your vacancy being marketed? Does your representative play nicely with others or is she egocentric and uncooperative. The commercial real estate community is a small one - read. We all know each other! Snakes are avoided. Fortunately, they are few, fortunately! But, the reputation of the person whose sign advertises your offering is paramount.

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.

We’ve MUCH for Which to be THANKFUL!

Image Attribution: www.clipart-library.com

As a craft this column from my garage office exile - my thoughts immediately drift toward today’s date - Friday the 13th? Yes I know, you’re reading this on the Sunday before Thanksgiving - but nonetheless. Historically, a day portending bad luck; but as I gaze to the east at the glorious blue sky - I realize I am a very lucky guy! And speaking of the Season of Thanks - much for which to be thankful. After all, with the Masters tourney resuming play yesterday - what could be better? Sure, our nation has taken its licks this year. But, as proud Americans - we are resilient.

Commercial real estate - depending upon the segment - has been crushed during the year of the Pandemic. But, I believe we are a hearty bunch capable of similar resiliency. Commissioned sales is not for the squeamish. Those of us who’ve survived a few peaks and troughs understand this excruciatingly well.

Please indulge me as I recount a few of the blessings for which I’m grateful this year.

I’m an industrial specialist. As I’ve written ad nauseam, our sector of commercial real estate is en fuego! Manufacturing and logistics spaces have continued to be the darlings. Office space, retail storefronts, and multi-family - not so much. Plus, we generally see a bit of a reset during an election year. Typically, owners and occupants of commercial real estate postpone major decisions on long term commitments until after direction is clear with a new administration. When activity slowed to a trickle this spring and with a contentious election season looming - I braced for impact. We also figured a recession was due because we’d not experienced a downturn since 2009-2010. As economic expansions generally run 7-10 years - and we were approaching 11 - I feared the “perfect storm” was massing. Our office was also at rapt attention. Operating cash was preserved, long term commitments postponed, and staff furloughed. A happy ending was forged for which we are thankful. After a temporary pause in March-May, our demand returned with a vengeance mid-summer. We are on pace for our best year yet!

None of our immediate family has contracted the “Rona”. As a matter of fact, I don’t know anyone locally whose had a bout. Maybe those masks do work. We shuttered our office in mid-March. Only, reopening in August. Many of us still enjoy the freedom of a virtual practice.

Working from home has enhanced relationships. I’m closer to our two year old grandson than any of our other kids and grandkids. Don’t confuse. I love them all equally. But, I’ve been present for over a third of his life. Early on, there was no place to go, I was working from home - wherever I could steal some quiet - so he’s grown up with me there. We’ve both have benefited. Not to mention. Nap time is great! For me - not for him. We shall see how workplaces evolve. I suspect companies will maintain space but with greater flexibility for a virtual workforce and enhanced safety measures.

Despite its warts, America is the greatest country on the planet! This year has been riddled with election mishaps, divisive rhetoric, a departure from civility, and declination of our freedoms during this time of crises. But, we are free to choose how we spend our days. We live in a beautiful place with amazing weather.

It’s DARKEST. Many, many have suffered the loss of loved ones, industry disruption, demolition of the status quo, interruption of gainful employment, the insanity of staying at home while attempting to work and keep little ones engaged in something productive, and face an uncertain future. Yes! All of those and more. But a new dawn is coming. We will emerge better than before. I guarantee it! What can we expect from owners and occupants of commercial real estate in 2021. That, dear readers, you’ll be thankful to read next month.

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.