Investors Buying Empty Buildings - Why?

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As an owner of commercial real estate, you fall into one of two categories. You either are entirely divorced from the occupant - read - you have no ownership in the resident company or you do. We refer to the latter as an owner occupant and the former as an arm’s length investor.
 
If we then dissect the genres of arm’s length investors - those who rely upon a tenant to pay rent - myriad classes unfold.
 
The folks next door might own a small strip center housing a nail salon, fast food joint, and an animal hospital. We’d call them a “mom and pop”.
 
As their holdings grow over time and more properties are acquired - so does their class. Now, they fall into the heading of private investor.
 
With private investors, generally, used as seed capital, is money made from other sources - a business, inherited wealth, or savings. Thus, a private investor uses its own money to buy buildings. Sure, a bank loan might assist - but the down payment is from their personal account.
 
Now, contrast the use of “your own money” to “other people’s money” and a capital market investor is identified. Capital market investors rely upon Wall Street dollars (Real Estate Investment Trusts - REITs), pension funds (California Teachers, CalPERS, State of Washington), or in some cases insurance company premiums (Principal, John Hancock, Aetna) to complete buys.
 
Ok, with that preamble - down to a trend we’ve seen since the beginning of 2020. Investors - all types - are buying empty buildings! Remember. Relied upon is rent. They’re not occupying a location with their business. So, with no rent - because there is no tenant - why is this happening? Indulge me as I proffer a few opinions.
 
Origination costs. Every leased parcel acquired the resident - at a price. Included were time on market, rent concessions, improvements, and professional fees. Resulting from the expenditures was an income stream. Currently - because available buildings are in short supply for those who need them to operate - all four categories of costs have been compressed. It’s quite common to commence construction on a new project and have the entire square footage leased prior to completion. Time on market evaporates! With more groups looking for space and fewer places to consider - concessions and offered improvements are slimmed. Consequently, it’s fairly easy, these days, to compute the cost of new occupancy. Plus, captured is the current market rent vs waiting on a below market rent to catch up.
 
Lack of quality. A brand new - even though it’s vacant - building comes equipped with all the goodies - tall warehouse ceilings, ample truck loading, and a pristine condition. Those operations targeted benefit operationally with more efficiency. More appeal to potential tenants is realized.
 
Musical chairs. Akin to seven players and six chairs - competition for fully leased assets is fierce. It’s quite common for a new offering to generate multiple interested parties. Therefore prices get bid up and returns suffer. Faced with the need to deploy dollars into real estate - vacant buildings have now gained favor.
 
Cost and time to produce. We concluded several meetings this week with some of the largest developers of real estate in SoCal - Birtcher, Hillwood, REDA, IDIL, and Blackcreek. They build ‘em, then lease or sell the finished buildings to occupants or investors. You see, a buyer we represent was in town from the East Coast. We are trying quite diligently to find a building for our client to purchase. Good luck! We heard over and over - land prices, government overreach, environmental impact studies, increasing construction costs ALL are pinching the supply of new inventory. Therefore, if an investor can avoid the hassle of construction and simply buy existing - even vacant - it makes good sense to do so. 
 
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 I Hear From Business Owners

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My days are filled counseling business owners. You see, my commercial real estate practice focuses upon family owned and operated manufacturing and logistics companies experiencing a transition. Frequently, this transition causes a decision to be made about their locations. As an example - let’s say the operation is considering a merger. When two groups morph into one - a duplication of their facilities emerges - and in some cases excess capacity results. Our services are engaged to dispose of the overage through selling or subleasing the unwanted space. An expansion into another state also requires a partnership with us. We are able to locate vacant buildings in need of an occupant and negotiate lease or sale transactions. A dramatic increase in orders could lead to the need for a larger building. Yep. We see that transition a lot these days. 

But today, I’d like to focus on the conversations I’m having with entrepreneurs - outside of their commercial real estate concerns. After all, small business is the fabric of our economy and employs a substantial percentage of our workforce. Never in my four decades as a commercial real estate practitioner have I heard this much angst. 

Hiring is tough. The pandemic of 2020 placed many people on the unemployment roll. To combat this - state and federal government created unemployment benefits which in some cases could reach $1000 per week. Additionally, the time an unemployed or furloughed worker could receive these benefits was extended. Consequently, a worker could make a fairly nice living by not working. Now, that our economy is opening again - manufacturing and logistics companies are finding it difficult to persuade workers back into their plants. An acute shortage of available candidates for job openings exists. Even prior to the pandemic, skilled workers were difficult to find. Those who operate CNC machining or other specialized equipment were in short supply. Now it’s downright impossible to employ these experts. Plus, our community colleges have done a lousy job of preparing students for manufacturing careers.
 
Raw material pricing is skyrocketing. Copper, petroleum, plastic resin, building materials, lumber, and steel, are all in terribly short supply. Doubt but I say? Go to your local Home Depot and check out the price for a piece of 2 x 4 lumber. You might want to bring your mortgage broker along with you as a purchase could require a second mortgage on your home! Manufacturers are pinched at every stage - stocking enough components for the creation of their product, increased wages for the folks running their machinery, and higher gasoline prices which cause shipping costs to escalate. Expect to see your pocket book affected eventually.
 
Is the grass greener? Regardless of the size of an operation - many are considering locating outside the state of California. But are other states really more receptive?Yes! I just concluded a trip to Georgia on behalf of one of our clients. They have engaged us to locate three facilities for them nationally – one of the west, one in the central part of United States, and one in the east. We found the state of Georgia and the individual communities to be extremely receptive to the 200+ jobs our client will deliver to the local economy. Incentives, reduction in regulation, property tax rate rebates, streamlined building permits, sales tax reduction, industrial development bonds, employee training, tax credits for hiring, are all on the table. We were shocked at the red carpet that was rolled out for our requirement. And here I thought the red carpet was only seen at the Academy Awards. Boy was I wrong!
 
Government overreach. AB5, new AQMD requirements, increases in the minimum wage, noise abatement, and lengthy permitting processes all have an impact on the operation of a manufacturing or logistics company. Layer in some uncertainty about property taxes, long-term capital gain increases, the potential abolition of the tax deferred exchange, and the absolutely insane pricing for commercial real estate and you get a sense what’s keeping owners awake at night.
 
The California I remember embraced small business and provided a platform to succeed - by stepping aside. Hewlett Packard, Disney, Microsoft, Apple Computer, Amazon all started with a dream in someone’s garage. My how far we’ve drifted. 
 
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

More Space Than Needed - Now What?

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Recently, we represented a tenant in a successful lease transaction. Provided by the new location are ample space and amenities for years to come. This address is one of four occupied by the company. We’ve now been approached - by the client - to review their other three buildings. You see, an acquisition of a competitor is in the works. Thus, there could be a redundancy of capacity very shortly. Our counsel to them was column worthy. So, we mashed up an old column on the subject along with an update on the new information. So, if you find yourself in any of the following scenarios - consider your alternatives:
 
Your company was just purchased and the operation will be rolled into another location - check!
 
Or, you've out stripped the capacity of your facilities but you have time remaining on an existing lease - check!
 
Or, you have decided to shutter the operation, and outsource the manufacturing to Texas - but your lease expires a year from now - check!
 
Or, you decide to take advantage of  historically low interest rates and buy a building but there is that landlord who wants to receive her rent for the next two years - check!
 
ALL of these situations and more can cause the need for a lease termination. But, just how do you accomplish this?
 
First, ask yourself these questions:
 
How much time remains on your lease? If the term remaining on your lease is less than two years, be prepared for your owner to use your remaining term as a "free" marketing time. The owner has the luxury of rent payments while searching for a replacement tenant or buyer.
 
What type of entity owns your location? A private individual may be a bit more flexible than an institutional owner such as a pension fund advisor or a REIT.
 
Where is your rental rate in relation to the current market? If your rate is above market, plan on subsidizing payments on the remaining term - if a replacement tenant can be found. If your rate is below market, your remaining term could provide a good alternative for a fast growing company concerned about a long term lease.
 
How does your lease treat assignment or subleasing? Most commercial leases allow for subleasing or assignment. Rarely is there a removal of your obligation, however. This means that if you sublease or assign the remaining term, you may still be liable for the payment of rent if the sub tenant defaults.
 
If your are moving to a bigger space, what is the rent amount monthly? If you are doubling or tripling in size, one month of rent in the old building could be a fraction of the monthly rent in the new location. IE: Old rent is $5000 per month. New rent is $15,000 per month. There are nine months of term remaining in the old digs or $45,000. If you negotiate three months of rent abatement in the new unit, you avoid a double payment.
 
How long would your building take to lease? Any competent commercial real estate broker can answer this for you. The answer to this question will have bearing upon a lease buyout.
 
Can some portion of the operation stay through the term? I just sold a building to a company with 15 months remaining on a lease term. Rather than try to sublease the space or negotiate a buyout, my client elected to open another related operation in the space.
 
Are any of your neighbors crowded and in need of square footage? A fast growing neighbor can consume your space with a moment's notice - AND thank you!
 
Once these answers are clearly understood, you have some options:
 
Negotiate a buyout: I generally will suggest that an occupant call his owner and discuss the reason that the space is no longer needed. I suggest that the occupant ask the owner if she would consider a buyout of the remaining term and if so, for how much? Depending upon an up trending or down trending market, the owner response will vary. Assuming 12 to 18 months of term remain, an owner will generally compute the marketing time to find a new tenant, lease concessions (free rent and improvements), brokerage fees, and the variance of the current rental rate to market. All of these factors form the basis of a buyout offer.
 
Sublease or assign the space: If more than two years remain on your lease, unless you are dramatically below market, most owners will not consider a buyout of the remaining obligation. You then must find a replacement tenant to live out the remainder of your lease term. You can either do this yourself, hire a commercial real estate professional, or ask the owner to do it.
 
Cease payment: I have NEVER recommended this but it is an alternative.
 
Live out the term: In the example above, my client loved the old location so he created a business operation to house the space and live out the remaining term.
 
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.

Class A Industrial Availability - Big Changes Coming!

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I’ve written ad nauseam about the imbalance existing between demand and supply of available industrial buildings in Southern California. Since the economy was awakened - akin to Rip Van Winkle - in 2011 and after the mortgage meltdown, we’ve been on an upward trajectory. Recently - in the last six months of 2020 and the first four months of 2021 - we’ve been on turbocharge! If your desire is to lease or buy a 100,000 + square foot class A building in Orange County - you have exactly one choice! That’s it. And, by the way, the building isn’t complete and won’t be until October. What about older stock? Unfortunately, the inventory isn’t more plentiful. Therefore lease rates and sales prices have eclipsed sanity.
 
You may be wondering what differentiates older buildings - Class B and C - from newer Class A alternatives. These things - age, location, and amenities. During the last construction boom in the mid 2000s, very few industrial buildings in Orange County came equipped with warehouse ceiling heights in excess of 24’. Additionally, the fire suppression system rarely allowed high pile storage without special permitting. Consequently, logistics providers - read. ECommerce folks who stack and ship things to your front door - were forced to consider areas where abundant new construction was occurring - the Inland Empire. Well. That’s about to change! Development pipeline plans 10 new offerings with all the modern goodies of 30’ ceilings and early suppression fast release sprinkler systems. Large truck access will be eased with 180’ turn radiaii. Beautiful new offices will be housed at the entrance.
 
By the fourth quarter of 2022, approximately 3,200,000 square feet of pristine new warehouses will be delivered to the Orange County market. To put that in perspective - that sum is approximately 2.8% of the base of 116,000,000 square feet. A whopping number!
 
Where, you may be wondering? Fullerton has three projects totaling over 1,900,000 square feet. Brea three projects with 450,000 square feet. A new development in Orange contains 300,000 square feet. Two projects in Anaheim with 350,000 square feet and finally Tustin with a new 225,000 square foot location.
 
Underpinning the new construction was a ravenous rush by developers to consume land at the end of 2020 and continuing this year. But, not vacant acreage. 100% of the new product is replacing obsolete manufacturing and flex campuses. A few of the notables - Kimberly Clark, Kraft Heinz, National Oilwell Varco, Schneider Foods, and Universal Alloys. Yep. Very sad to see the manufacturing jobs stripped away.
 
Many of the major players are in the fray - IDI, Duke Realty, Goodman, Rexford, and Western Realco. Capital is flowing in from internal sources and institutional means. Quite a boom in construction will keep contractors very busy. KPRS, Millie Severson, Oltmans, and Fullmer lead the pack. Finally, our local architects have been drawing like crazy - Hill Pinkert, Ware Malcom, and Architects Orange.
 
Rents for the new product are projected to be well north of $1.00 per square foot! When I started in 1984 - we were lucky to achieve $.30. My how the landscape has changed!
 
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.