Transfer Taxes

      

      

       We sold two buildings last month in Los Angeles county - Chatsworth to be exact. The deal was lengthy - spanning the horrors of the changing finance market  and Jerome Powell’s ratcheting up of bank borrowing rates. But alas, we got it done, satisfied the buyer’s 1031 exchange, and provided the seller a long term lease from which to operate his business. 
 
Chatsworth, as well as most of the San Fernando Valley cities is considered the city of Los Angeles. For context, imagine if all North Orange County cities of Anaheim, Buena Park, Orange, Placentia, Brea, La Habra and Fullerton weren’t sovereign and were under the purview of say Santa Ana? Yeah. That’s the situation. Consequently, Los Angeles wields tremendous clout when determining taxation - especially in the transfer of real property. 
 
One line item in our estimated closing statement caused the county recorder to pull our file. It seemed the transfer tax was improperly computed - or so they thought. When our able title officer pointed out the correct calculation - which appeared on the deed - the county capitulated and allowed the recording. Never, had I spent so much time understanding how such taxes are determined. My education, I believed was column worthy. But recently, another development in Los Angeles known as Measure ULA or the “mansion tax” - which was passed by voters - encouraged a deeper dive. So here we go. 
 
From the website  https://www.deedclaim.com/california/documentary-transfer-taxes/ - a wonderful resource, BTW - “California’s Documentary Transfer Tax Act allows counties and cities to collect tax on documents that transfer real estate. The Documentary Transfer Tax Act is broadly worded, imposing a tax on: 
 
each deed, instrument, or writing by which any lands, tenements, or other realty sold within the county shall be granted, assigned, transferred, or otherwise conveyed to, or vested in, the purchaser or purchasers, or any other person or persons, by his or their direction, when the consideration or value of the interest or property conveyed (exclusive of the value of any lien or encumbrance remaining thereon at the time of sale) exceeds one hundred dollars …” In reading further, “this language covers almost every interest in property that can be created or transferred under California law. It includes:
·        Outright property transfers;
·        Tenancy in common interest;
·        Joint tenancy interests;
·        Community property interests;
·        Life estates and remainder interests;
·        Long-term leases;
·        Non-temporary easements;
·        Mobile homes installed on permanent foundations.
A transfer of any of these interests is subject to documentary transfer taxes. The documentary transfer tax is due even if the instrument is not recorded in the county real estate records. The creation and delivery of the deed causes the documentary transfer tax to become due.” 
 
Most counties in California impose a transfer tax equal to $1.10 per thousand dollars of value. In addition to the county rate, cities may impose additional documentary transfer taxes. From www.deedclaim.com  “The amount that the city may impose depends on whether the city is a charter city or a general law city. A charter city is a city in which the governing system is defined by the city’s own charter instead of by California law. Charter cities have supreme authority over their municipal affairs and have broad leeway to impose their own tax rates. Many of California’s 121 charter cities have enacted their own tax rates. Cities that are not charter cities are known as general law cities. General law cities may impose a transfer tax equal to one-half of the rate imposed by the county. When the city imposes a tax, the county transfer tax is reduced by the amount of the city’s transfer tax so that the amount that the taxpayer pays remains at 55 cents per $500 of property value or consideration.
 
The website below gives you a breakdown of all the counties and cities in California, which are charter and general law, and the respective transfer taxes. But to save you some reading - Anaheim, Buena Park, Cypress, Huntington Beach, Irvine, Los Alamitos, Newport Beach, Placentia, Santa Ana and Seal Beach are charter cities. The balance of OC is general law. http://www.californiacityfinance.com/PropTransfTaxRates.pdf
 
Now to Measure ULA which recently passed in Los Angeles city. From www.gibsondunn.com “Measure ULA, commonly known as the “mansion tax,” would impose a new “Homelessness and Housing Solutions Tax” on transfers of residential and commercial real property in the city of Los Angeles valued in excess of $5 million.[1]  The revenue raised by the new tax, expected to be between $600 million and $1.1 billion annually, is intended to be used to fund affordable housing and tenant assistance programs.  As of the date of this Client Alert, the measure is ahead in the latest vote count. Under the measure, sales of residential and commercial real property valued at over $5 million but less than $10 million would be subject to an additional tax at the rate of 4%, while sales of properties valued at $10 million or more would be subject to an additional tax at the rate of 5.5%.  The new tax would apply to the entirety of the sale value, not solely the amount in excess of the $5 million and $10 million thresholds, and regardless of whether the property is sold at a gain or a loss.  The thresholds would be adjusted each year based on inflation.  The tax would apply to property sales occurring on or after April 1, 2023. The new tax would be in addition to the existing documentary transfer tax imposed on property sales in the city of Los Angeles, which is imposed at a combined city and county rate of 0.56%.”
 
So what does all of this mean? Selling a property greater than $5,000,000. in Los Angeles just got a lot more expensive. A $10,000,000 property used to cost $56,000 to transfer. Starting April 1, 2023 that same $10,000,000 transfer will be taxed at $606,000 - more than a ten fold increases. And by the way, a $5,000,000 residence is a big deal. A commercial deal in LA will trigger the tax on a very small square footage - affecting many occupants who own their building and choose to sell. But so what? We’re in the OC. Just this. Will unfunded pension liabilities straining city budgets cause city governments to search for revenues to bridge the gap? 10 of the 34 cities within Orange County have charters that allow such an increase in transfer taxes - with voter approval. We will see. 
 
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.

Random Commercial Real Estate Thoughts

Occasionally it’s good to purge my inbox and my mind. After a week in the place of my birth - Texarkana, Arkansas - there’s much to unpack - literally and figuratively. So, allow me to unload a few items swirling in my consciousness.
 
Thanks to all who commented. The outpouring of love and kindness resulting from my column last week - 6 Lessons my Mom Taught me About Commercial Real Estate - was amazing! Thank you to each of you who took your time to read the column and send me a note.
 
28th Annual AIR CRE Fall Market Trends. The Association of Industrial Real Estate met in November for a discussion of what’s happened in 2022 and what we can expect in 2023. On the dais were Jaclyn Ward of JLL, Kelly Johnson of Colliers, Michael DiBernardo of the Ports of Los Angeles, and Gerald Singh of Oltman’s Construction. Moderating the discussion was James Breeze of CBRE. As panels go, this was very well done, rehearsed and filled with information.
 
I found particular value from Jaclyn’s description of the state of office leasing - given the uncertainty that mires long term space decisions. But three applications were unveiled in her talk which I found interesting. Office tenants are separating into distinct genres - office first, home first and hybrid. Firms such as Goldman Sachs have adopted the attitude - you’ll come in to an office to ply your trade or you won’t. But if you don’t, look for employment elsewhere. Many of the content creators - Apple, Amazon, Facebook, Zoom, DropBox eschew the work anywhere mantra. And then you have those - our firm being one - that allow a mix of in an out. The out is fine so long as productivity is maintained. Our production is easy to track - you’re either selling buildings or you aren’t. Ok. Maybe these are old themes. Certainly since 2020. But, home first and hybrids realize that culture, employee attraction and retention, mentorship, and training all ebb as time away flows. There’s a concept know as clubhouse which is gaining traction. Addressed are these issues in a space suited for same. Akin to a ballroom at the Marriott reserved for an annual meeting - club housing retools space to suit the needs of an organization.
 
Michael DiBernardo answered a burning question I posed in this space a couple of months hence. Why are there Christmas decorations in Lowe’s in September? The answer is simply many big box retailers front loaded inventory early in 2022 to avoid supply chain snags. Faced with warehouses filled with seasonal items - retailers shipped things like fake Christmas trees to their stores to free up space. Things at the port of Los Angeles have largely returned to normal with four to six cargo ships waiting in the unloading queue. At its zenith some 104 waited at anchor. Container costs have also returned to par with a cost of $2000 vs the $20,000 this time last year. You’ll see some changes in the months and years to come as the basin edges toward zero emission vehicles by 2030 and 2035.
 
Gerald Singh recapped construction topics - cost escalation, and lead times since March of 2020. Since May of 2020, construction costs have increased 67.7%! A typical 100,000 industrial box now weighs in at $86.75 per square foot. Before you race out to build your own - remember land, architectural, engineering, off-site costs such as storm drains and curbs, on-site costs such drainage plus carrying expenses must be added. Oh yeah. Don’t forget if you said go today - you’d be lucky to have a building completed by Q4 of 2024 - largely due to the city’s entitlement processes and long lead times for construction elements. As an example, a roof structure requires one year to deliver.

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.
 

Six Lessons My Mom Taught Me About Commercial Real Estate

Mary Collom Buchanan Fore departed this life on Tuesday November 22, 2022. She died peacefully surrounded by family. She was 89. Ironically, the day was the 59th anniversary of a tragic event in our nation’s history - the assassination of President John Fitzgerald Kennedy. Mom was in Dallas the day that happened. The motorcade had passed, she’d waived to Jackie from a downtown department store and returned to shopping with my grandmother when they heard the sirens. Mom always liked the number 11. So it’s no wonder her last day on Earth was 11.22.2022. 
 
You may be wondering what this has to do with commercial real estate? Please indulge me as I share some lessons I learned from Mom that prepared me for a career providing location advice to owners and occupants of manufacturing and logistics companies. 
 
Use your imagination. My Mom grew up an only child. With no siblings to harangue - she resorted to her mind to keep entertained. Sugar cubes became building blocks for igloos and empty spools of thread were transformed into end tables for her doll houses. I’ve relied countless times on my imagination to solve complex real estate problems and see everything for what it could be. 
 
Kill them with kindness. Mom was quite regal but treated everyone with a joyful smile. A crabby clerk got the same bright greeting as a high school classmate she’d not seen since graduation. Her theory was you attract a lot more flies with honey than vinegar. So now, I attempt to be nice to folks. I’m not as good as she - but I had a great role model. 
 
Give back whenever possible. Mom devoted her life to her three kids, our wives and husbands as well as her nine grands and thirteen great grands. But she was truly mom to all who graced her doorway. Whether it was a young friend with relationship issues or a wayward teen with parental woes - Mom gave back. Her true legacy lay in the civic involvement through countless clubs, ladies groups, and cotillions. Likely, my belief the universe is abundant, therefore share your time and knowledge freely had it’s genesis with Mom. 
 
Family first. Mom’s marriage to my Dad ended in divorce - largely due to the absentee nature of his involvement with us. Mom was a huge part of all of our lives here in SoCal even though she lived across the nation. Calls, cards, visits, and always present at key events was her cadence. My wife reminds me the kids don’t care whether you’re at a bar or closing a multi-million dollar deal - you’re away. My life has balance thanks to these two strong ladies. 
 
Don’t wish your life away. Mom would not allow us to say “I wish…”. Her response always followed - “if you can wish it - you can do it.” Today, I calendar a time to consider even my craziest ideas. I’m a man of action largely because I wasn’t allowed to wish my life away. 
 
Adversity can be your friend. Mom lost her Dad to suicide at age 22. Her mom was crippled at age 38 and relied upon my Mom for care in her later years. Mom was diagnosed with cancer in 1970 -when it was a death sentence. Dad left the next year and she raised us as a single parent. Never complaining, always with a positive attitude - she took each setback with grace and poise and with an outlook things would improve - and they always did. I embrace challenges in transactions the same way. What is God trying to teach me? - and a solution is close if you simply allow your positivity to reign. 
 
Rest well, Mom. We’re sad you’re gone but thrilled you’re in a better place. I love you! 
 
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.
 
 

Advice We’re Giving These Days

It’s been said March comes roaring in like a lion and leaves like a lamb. Metaphorical for the weather patterns experienced - this can be said for our commercial real estate market this year.
 
Shaking off the cobwebs of a post pandemic hangover, 2022 started with great momentum - only to be cooled mid year. We received some decent economic news of late with the consumer price index not increasing as fast and some major retailers posting better earnings than expected - but our path forward still remains murky.
 
So what advice are we giving to tenants, investors and occupants who own? Allow me to categorize each.
 
Tenants. We recently recommended a client of ours renew for a short period of time - six months - to gauge the market trajectory. Our tenant is faced with a lease expiration at the end of this year and we’ve been watching what’s become available for several months. His options to relocate were limited and we’d even created a plan B to stay put if we didn’t see some loosening. Low and behold - we noticed a trickle of new buildings hitting the market in October. Now it’s running about three per week. If you’re looking for space - this is a vast improvement versus six months ago when we were lucky to see one every three weeks. Another interesting metric is the asking rates have declined. Gone are the days when a new avail was swept up before it was widely marketed. Every new deal was a new high. Not anymore. Our advice centers around our belief of future softening. Tenants are becoming valuable again - especially if they pay on time and are easy on the building - which our clients is. What’s causing the increase in supply? Some businesses, faced with the new rent structure are headed out of state or out of business. What’s left in their wake are vacancies.
 
Investors. We see two sets of motivation these days - tax deferral and non. Unless motivated by tax reasons - it may be wise to put your money in short term treasuries - two years - and wait for the right opportunity to come along. Institutional capital is largely sidelined and occupants are priced out. Private investors rule. If belief suggests a softening of rents in the face of rising interest rates - values can only decline. Will there be better deals mid 2023 than today? Our opinion is yes. Certainly, if your investment is dictated by tax deferred timeframes - you either transact or pay the gains taxes. But remember, the impetus of those buys was a sale. Our sense is they’ll be fewer equity sales as values have declined or the market’s evaporated - leading to fewer tax fueled purchases.
 
Occupants who own. We saw a voracious appetite from institutional capital targeting these arrangements. Their pitch was a sky high purchase price in return for a leaseback of two-ten years. This activity peaked in June. With the uncertainty of recession, inflation, and rising rates - these deals weren’t as attractive. With more lease deal hitting the multiples - our prediction is some of these owners will need to sell - especially if faced with a refinance bullet or a shortage of dollars necessary to refurbish the building into rent ready condition. Once again. Patience is key.

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.
 

A Conversation with Jeff Ball, CEO of the Orange County Business Council

Recently, I had the privilege of participating in a panel of Commercial Real Estate professionals at the Cal State Fullerton economic forecast luncheon held at the Disneyland hotel.

Moderating the panel was Jeffrey K. Ball, CEO of the Orange County Business Council and former CEO of Friendly Hills Bank.

Our conversation was followed by my invitation for Jeff to attend a group meeting of business professionals with whom I network. We meet monthly and discuss trends in our respective fields of commercial real estate, banking, law, human resources, information technology, accounting, peer to peer coaching, investment banking and fractional C-suite interaction.

You might wonder why the meetings? In my experience, my clients (owners of closely held manufacturing and logistics businesses) are touched by all these professions and yet we don’t compete, we complement. I’ve found great value in understanding their worlds.

But in this meeting, Jeff was our guest to describe his mission at the Orange County Business Council. If you’re unfamiliar with OCBC, here’s a brief overview I curated from its website:

“Orange County Business Council works to enhance Orange County’s economic development and prosperity to preserve a high quality of life. For more than 125 years, it has promoted economic development and served as the voice of business in America’s sixth-largest county. OCBC serves pro-business interests so that the region’s vibrant economy continues to expand, bringing the benefits of prosperity to every corner of the county.”

Jeff is quite engaging and passionate about his role. He described the tenets of the group: advocacy, research and networking events — of which the economic forecast was one.

With economic development serving as an overarching umbrella from which our county grows and prospers, we spent time discussing the retention of business within the county, attracting new companies and expanding existing firms here in Orange County.

Some of what Jeff chatted about includes showcasing Orange County during the upcoming Olympics by offering a tour package including beachfront hotel stays, amusement park and museum passes.

We also talked about how the 34 cities within our county can use the council and its available data as a repository for available manufacturing and warehousing space.

Finally, Jeff said he plans to place much emphasis on the council’s role in economic development through leadership, strategy and execution. 

All of this doesn't come without its share of challenges, he noted.

He shared how the county faces a housing shortage which causes affordability issues. In order to keep the best and brightest of our young people, he said, the council and the county will have to figure out how to add new housing while dealing with NIMBYism, CEQA, and the regulatory maze of getting new housing entitled and built.

OCBC and Jeff will help with these efforts by focusing on pro-business candidates. Advocacy in the areas of clean water, cutting edge technology, safe streets and highways are just a few ways Jeff said OCBC is taking charge.

Our business roundtable found Jeff to be knowledgeable, resourceful and well qualified to set the vision and execute the strategy of the OCBC.

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.

An Investor Briefing

I consume a ton of economic news each day, week, and month. Maybe it’s my degree. After all, I do have a Bachelor of Arts in economics. It could be I’m smitten with numbers. Or possibly, I believe having knowledge of the broader economy - not just what’s happening locally makes me a better resource to my clients and prospects.
 
Recently, I delivered a briefing to my investors which I believed was column worthy.
 
Macro economy. If you watch CNBC, attend conferences, read this publication or the Wall Street Journal - you know the Federal Reserve is on a tear to tame inflation. Their only hammer to tamp down the nail is to systematically raise the rates banks pay to borrow. For years this rate was next to nothing but now hovers around 3.5%. Plans are for this rate to eclipse 5% by year’s end. The hope is that by doing this the supply of money will be choked - causing it to be more expensive. How does this trickle down to the pump and the grocery checkout line? With less money circulating, the theory is competition for purchasing will also lessen thereby causing downward pressure on pricing. In short, this takes time. Consumer interest rates have also risen. A mere year ago, you could originate a thirty year mortgage of around 3%. Now it’s over 7%. Still historically cheap money but not compared to last year. And finally, we have an economy poised for recession - some believe we’re already there.
 
Commercial real estate asset classes. Folks continue to buy and consumer confidence is bustling. Certainly the way in which dollars are expended was forever changed by the pandemic. Savvy retailers who provide an experience are thriving. Those who simply sell things are struggling. Thus the state of retail.
 
If our economy should truly recess in 2023 - a return to the office might be the unintended consequence. Getting more from fewer and having them close could stem from a downturn. Expect headcount to reduce in 2023. Look at big tech such as Twitter, Meta, Alphabet, and Apple - preemptively planning for a reduction by mass layoffs.
 
The drivers of the huge uptick in industrial demand are cooling. Because we’re back to work and not strumming our keyboards means less on hand inventory is needed. The big retailers have commenced the purge. Third party logistics providers - especially that cater to folks who sell things - need less space.
 
All asset classes are experiencing a rise in capitalization rates - the percentage that defines your return on an all cash basis. The question is - what’s causing the bump? Some opine as the cost of borrowing increases - cap rates must climb lest there be negative leverage. You’ll find a school of thought believing it’s all about fear and greed. As interest rates rise, uncertainty is created which causes some investors to tap out - fear. With the buyer universe smaller - less competition - pricing must be reduced to generate activity - greed. I believe it’s a combination of both. We’ll see less equity selling in 2023.
 
Commercial real estate micro trends. Manufacturing and logistics buildings are still in extremely short supply. 99 of every hundred buildings is occupied. Rents for class-A industrial are now over $2.00 per square foot. For context - those rents were only $1.00 in 2021. In Orange County, many exhausted manufacturing campuses have been retired. Once bustling operations such as Kimberly Clark, Beckman, Schneider Foods, Kraft Heinz, Boeing, and National Oilwell Varco have been replaced with monster boxes to fill the pressing need for the new purchasing paradigm. Repurposing aging research and development campuses has found favor with many developers. Examples include Ricoh, Bank of America, OC Register, and locations along Imperial Highway in Brea.
 
What are tenants thinking. Companies that occupy buildings and pay rent are bracing for impact. As mentioned before, class-A industrial rents hovered around $1.00 per square foot only a year ago. They’ve since doubled. Operations whose lease payments comprise a small percentage of their overall cost structure are taking the increases in stride. But, closely held businesses are realizing increased rent will reduce their margins and may not allow for hiring, equipment purchasing, or acquiring a competitor.
 
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.
 

Another Week in October

This last week of October was highlighted by two key events - an inaugural episode of a new webinar series and participation as a commercial real estate panelist at the Cal State Fullerton Economic Forecast conference.
 
The webinar series is entitled Trendsday Wendnesday and features interviews with service providers that advise small businesses. My idea in hosting these was to give a spotlight to my network while providing actionable ideas for business owners. The first episode featured my friend and colleague, Allan Siposs of Keystone Capital Markets. Formatted to highlight three trends currently experienced in the merger and acquisition world along with a bit of Nostradamus mixed in with a prediction of what’s to come in the next six months - my goal is to produce a number of these throughout the year. Our maiden voyage was epic as Allan didn’t disappoint. You may be wondering what mergers and acquisitions have to do with commercial real estate? Just this. Anytime a company is sold or a competitor acquired a real estate requirement occurs. You see, if an enterprise is bought - two families of facilities, culture, employees and customers must be merged into one. Frequently, a duplication of buildings causes one or more to be jettisoned. Consider the bank consolidation during the financial meltdown of 2008. World Savings was acquired by Wachovia which in turn was swallowed by Wells Fargo. Imagine a neighborhood center where all three former groups had a branch location. Yeah. You get the idea. Allan’s three trends were - recessionary fears, interest rates, and because of the first two - folks with urgency. Allan does believe we’ll head into recession sometime in mid 2023.
 
Cal-State Fullerton’s annual Economic forecast, hosted by the Orange County Business Council, was held at the Disneyland Hotel. It was nice to return to the “happiest place on Earth” albeit for some not so happy predictions. Dr. Anil Puri along with Dr. Mira Farka narrated the journey through the European energy crisis, recessionary definition, consumer confidence, banking, corporate growth, inflation, fiscal spending, outlook for a soft landing, hard landing, or something else. There were some bright spots - our economy grew in the third quarter of 2022 and the pinched supply chain seems to have eased. I must admit, my eyes were bleeding after the fantasia - sorry - of charts and graphs. Rest assured, dear readers, I’ve kept you quite informed about the economy of things.
 
Jeff Ball, the new CEO of the Orange County Business Council, spun a new twist to this year’s forecast by moderating a panel of commercial real estate experts - Jeff Manley of Savills, Michael Nguyen of Banc of California and me. Discussed were our perceptions of the CRE environment, lending world, and our predictions for the future. We all agreed. Industrial has been the darling, rising rates will nudge cap rates higher and limit buying power and offices are tough assets to own these days.

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.

Conference Season

It’s October! I love this time of year - the weather cools, leaves crunch underfoot, pumpkins abound and for many of us in the commercial real estate trade - it’s conference season! I’ve often wondered why all of us flock to this month in particular. After all there are only four meeting weeks. But maybe it’s because the year is far enough gone to think about 2023 and we’ve not entered the crash of holiday festivities. Challenging, however is scheduling lest you are traveling the entire month. This year, I chose two - SIOR Create 360 and MassimoCon. I’m penning this from SIOR in the Big D - AKA Dallas - Fort Worth. Yesterday was a glorious fall day with early morning gems in the thirties but quickly warming to the mid sixties. Akin to a desert winter day - you just feel alive.
 
As I’ve attended sessions, my Remarkable is close by for copious note taking. Educational is the goal of this column as I review what the best in our industry have to proffer.
 
Technology and Innovation committee. When my career started in 1984, the only technology we enjoyed was a switchboard with multiple lines. Hand written notes were taken when a caller failed to connect. That’s right. No voicemail. Bliss! PCs on every desk was a distant dream of Silicon Valley visionaries named Jobs and Gates. And the business was much more local. It had to be because tracking markets was left to each of us individually. Nowadays, with a stroke of a keyboard I can search properties globally and communicate virtually. George Jetson indeed. All we need is a flying car and a dog named Astro! Will we see a time when tenant searches are fulfilled via the meta verse? By that I mean you receive a link and through your virtual headset you’re able to walk the spaces, ask questions, see the neighborhood and transact with your avatar. Think I’m crazy? Well, you can try on clothes virtually. So, it’s not that far fetched.
 
General sentiment around is we’re headed for a rough patch with finicky capital, rising cap rates, and the rising cost of borrowing. As I preached here in this space - tenant demand is still strong and vacancy scant.
 
America’s Team. I can now say I caught a pass from Roger Staubach - legendary quarterback of the Dallas Cowboys and even legendarier commercial real estate visionary. Roger’s key to success was hard work. I’m surprised he didn’t mention the fact he created the tenant rep concept! Humble as always. At almost 80 years young he still sports - sorry - an upbeat attitude and uncanny ability to fire a spiral. Fortunately, the one I cradled was more of a lateral so I didn’t fumble it. Mark Whicker would’ve approved.
 
That’s all from Big D! Buchanan out.
 
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 do We Believe is Important

I heard an interesting comment on a webinar this week. My goal is to tune in to at least twelve a month and supplement those views with listening to three podcasts a week. If successful, I consume between 288 - 300 hours of content each year. During every episode, I want to glean a minimum of one new idea or concept. Annually, I then learn 288-300 new things - a simple way to expand my knowledge to become a better resource to my clients and more interesting to our family and friends. 

My take away earlier was - we spend 99% of our working time each day in endeavors our clients spend 1% of their working day accomplishing. As I considered our clientele, family owned and operated manufacturing and logistics businesses - this rang true. Many only lease or buy one piece of commercial real estate ever. Certainly those “in the business”, such as investors, are more active. But perspective was gained with that in mind. Therefore, our advice must be straightforward and on point. After all, they don’t do it every day. We must learn to communicate complex concepts simply as if they were educating us in a manufacturing process. 

Although a scant amount of time is spent - 1% - my focus today is on that small percentage, as I’ve seen many great things transpire. 

Generational wealth. Those business that adopt a strategy of owning the building from which they operate use their 1% most effectively, in my opinion. The majority of the time is in the acquisition, fit out, and move. I’ve witnessed many groups who purchase a location and then never relocate. All the while, the real estate appreciates, tax benefits are enjoyed, and depreciation accrues. Equity in the buy can be tapped for business expansion - buying a competitor, purchasing new equipment, or hiring employees. When it’s time to sell the workhorse - the enterprise paying the mortgage - direction can vary. Some choose to sell the company, retain the building and originate a long term lease with the new owner of the business. Still others prefer to sell the real estate and deploy the equity into one or several income producing real property assets. Regardless, enormous wealth is created which can be passed to heirs. My most extreme example came through such a story. A family founded a manufacturing business during the go-go years of the mid sixties. Lifestyles were supported. Real estate was bought to house the expanding operation. When the patriarch and matriarch died - their children decided to sell the company and retain the real estate. When the family realized the new operators were cutting corners - a decision was made to liquidate the companies home and diversify into other locations. Six years later the holdings have doubled in value and cash flow has as well. Meanwhile the purchaser of the business is bankrupt. Apparently, their strategy was sound. 

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.

Strategies to Avoid a Massive Rent Increase!

I hosted a webinar yesterday. Our team’s first ever. I’ve watched others - no commercial real estate practitioners, btw - employ these as a way to add value, stay top of mind with clients, and generate new business. Excited was I to try my hand. We were thrilled with the outcome as our room was crowded with a combination of prospects, strategic partners and clients. All who attended found pearls.
 
So what was discussed? Ways to renew a lease on YOUR terms. A synopsis follows.
 
The genesis of the Zoom centered around many of our clients receiving a note from their landlords with a whopping rent increase. We believed a counterbalance of sorts was necessary.
 
Why the BIG increases. Pandemic fueled demand coupled with skimpy supply - little to no new construction in certain size ranges - has caused a classic imbalance which results in price increases.
 
Know your owner. Owner investors fall into distinct categories - Institutional, Private national, Private regional, and Private local.
An institutional landlord such as ProLogis or Rexford will view rents differently than your neighbor who may own one or two industrial buildings. How you may ask? A building’s worth is capitalized rent. Therefore to an instructional owner, coupon rate is paramount. Many times concessions will be given to keep the rate in tact. Generally, a private owner will be more interested in cash flow and will potentially discount the rent to avoid a costly vacancy.
 
Your value as a tenant. The most a landlord can achieve is the market rent - which is a look back and a look forward at the transactions that have occurred and the new availabilities. Let’s say that amount is $20,000 per month. With 4% annual increases built in - the maximum she’ll get over a five year term is $1,323,878. But. What will she expend to achieve the market rent? Downtime while the building is shopped, abated rent once a new occupant is located, refurbishing the space, potentially tenant improvements, and brokerage fees. ALL must be subtracted from the total expected. Known as an effective rate - seldom is this equal to the coupon rent. In down markets an owner will spend 20-25% of the future take originating a new lease.
 
Extensions rights. You may have pre-negotiated your right to stay. Take a look at these clauses - options to renew, terminate, expand and rights of first refusal or first offer. Just remember. Time is of the essence - you must adhere to the periods specified.
 
Timing. In today’s robust market and scant availability - you may be able to relocate, sublease your remaining term and make money. In some cases, your owner will want a taste, however.
 
Cost to relocate. The Yang to the Yin of the cost to replace you is the dollars you’ll deliver to move. If you have large machinery, a special purpose use, ISO certifications or a spray booth you will be shocked how expensive it is to alternate quarters. Know these costs. Your landlord with use this as leverage.
 
Next steps.
Locate a copy of your lease.
Abstract the key dates and terms.
Create a system for assessing the trends.
Schedule an annual virtual or in person meeting with your landlord.
Don’t forget. You have the right to representation. Your owner certainly will have someone.

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.

An Interesting Investor Conversation

Last week, I wished you all a Merry Christmas. This was my way of adding some levity to decorations appearing in stores the last week of September. But I then got serious and discussed the chats I’ve had recently with investors, tenants, and owner-occupants. If you allow yourself to listen, interesting challenges are disclosed. If you missed the column - below is a recap of what I’m hearing from investors.
 
From last Sunday. Investors. Our industrial market crossed a pivotal point in the middle of 2020. For the first time I can remember, the occupant premium disappeared and investors started paying more for offerings than those who bought them to house businesses. Deep pools of capital, a rabid appetite for return in a stable asset class, and skimpy supply caused pricing to hit a crescendo in May of 2022. With all the world happenings - inflation, recession, global strife, and rising interest rates - investors, especially institutional investors, have hit pause. Private folks are proceeding quite cautiously. Many require debt to acquire income properties. As rates have now eclipsed 5.5% - the resulting capitalization must be north, lest negative leverage will occur (return on invested dollars less that cap rate). So with fewer buyers and higher rates - yep. Prices have started declining.
 
Another week and several more conversations. One in particular I believed was column worthy. We are marketing an investment opportunity in Chatsworth. Included is the owner’s desire to sell the building and remain - after the close - as a tenant. Known as a sale-leaseback, this deal structure has curried favor recently as our values have eclipsed sanity. This particular offering has a bit of hair, however - configuration, company ownership, and re-use once the occupant vacates in ten years. Yes! Investors are concerned with the next round. Akin to a game of billiards where the current shot pales compared to the “leave” - investors look past the return today vs their risk once the tenant bales in the future.
 
As the market changes - an investor’s propensity for risk is padded by a need for more return. Generally, institutional investors - those which are publicly traded or invest pension funds as correspondents - seek one of two types of deals - a core or value add. The former falls right in the mayor’s office the latter involves some work to get the engine revving. Our listing is neither. Plus, with the market and global gyrations, many institutional types are playing wait and see and not transacting.
 
What buyers are left? Private capital. Your neighbor that owns a strip shopping mall or office building. Many private investors have considered our listing. Most have passed. Too risky if the tenant leaves, we don’t like the layout, how do we retrofit the building in the future, and what insurance do we have the occupant will remain in residence - are common refrains. But another interesting dynamic is occurring. Unless motivated by the need to place money via a tax deferred exchange, private capital can earn 3-4% investing in government treasuries. These afford a return of 10x versus a year ago and come with the full faith and credit of the United States government - very little risk. So, if faced with investing in a risky real estate deal with a return of 6% compared to the alternative of the bonds…yeah. Me either. Also, if I’m buying at a 6% return and I choose to finance the purchase - I must be keenly aware of my borrowing costs as loan constants are now north of 7%.
 
Allow me a simple example. Let’s assume you buy an income property for $2,000,000. If $1,000,000 is borrowed at 5.5% interest - the simple interest payment is $55,000. Easy. But, how is the $1,000,000 principal repaid? That’s where amortization comes in. A fancy way of repaying the principal over the loan term. So. If the $1,000,000 principal is repaid over 25 years at 5.5% interest - now the annual payment is $73,690. Your return on the $1,000,000 (rent from your tenant) is $120,000 but your loan payback is $73,690 - for a net of $120,000-$73,690 = $46,310. See the problem? Your $1,000,000 invested brings in $46,310 per year. Take the same $1,000,000 and throw it into treasuries and you make $40,000. Hmmm.
 
So what does all that mean? Continued downward pressure on pricing. If you want to sell to a private investor, be realistic. Times they are a changin! 
 
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.

Three Things I’m Hearing

As I’ve written before - we as commercial real estate brokers generally serve three types of clients - investors, tenants, and owner-occupants. Unlike our residential colleagues who represent buyers and investors - and the occasional tenant - many in our industry do quite well only servicing folks with leases.
 
We can be on either side - the owner side or occupant side. So our days are filled in one of six pursuits - three types of clients but working on either side. Clear as mud? Allow me to provide details. Number one and two. Investor hires us to find them something to buy or to fill a vacant building. Number three and four. Tenant engages us find them a location to lease or to sublease excess space. Number five and six. We work to locate a parcel for an occupant to buy or they ask us to sell their company’s address.
 
With that as a backdrop - you can appreciate we have our “ear to the ground” and are a great source for what’s happening. I’ve distilled this down to one thing for each genre - investor, tenant, and owner-occupant.
 
Investors. Our industrial market crossed a pivotal point in the middle of 2020. For the first time I can remember, the occupant premium disappeared and investors started paying more for offerings than those who bought them to house businesses. Deep pools of capital, a rabid appetite for return in a stable asset class, and skimpy supply caused pricing to hit a crescendo in May of 2022. With all the world happenings - inflation, recession, global strife, and rising interest rates - investors, especially institutional investors, have hit pause. Private folks are proceeding quite cautiously. Many require debt to acquire income properties. As rates have now eclipsed 5.5% - the resulting capitalization must be north, lest negative leverage will occur (return on invested dollars less that cap rate). So with fewer buyers and higher rates - yep. Prices have started declining.
 
Tenants. The period between 2016 and 2019 found record numbers of leases originated or renewed. These are typically 3-10 years in length. Baked into the agreements are annual increases. Up until 2021 - these hovered between 2.5% and 3% per year. Around July of 2021 - we saw a big push for increases to proximate 4%. We even saw a couple of deals with 5% yearly kickers. But even with the hefty adjustments, lease coupons didn’t keep pace with inflation. Consequently, come renewal time - many tenants are greeted with rate increases of 50% -100%. Folks who lease industrial buildings are concerned with how their bottom lines will be affected and how to counteract a whopping bump in rent.
 
Owner-Occupants. Distinction is drawn between two commercial real estate owners - occupants and investors. The difference? Occupants also own the operation residing in the facility. Before June of this year, many owner-occupants received unsolicited offers from investors seeking to deploy capital. In general - these offers were at eye popping numbers and included a provision to avoid a costly move. Many carpeyed the diem and sold. But others got tangled in the two issues that arose - Uncle Sam and sky high rent.
 
The balance of 2022 should prove interesting as we navigate this changing market. As an aside, I did see a Santa display in a Lowes yesterday. Earliest I can recall. Merry Christmas!
 
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.

Random Commercial Real Estate Thoughts

Currently, my inbox is cluttered. Seeking catharsis - this column will cause a clearing - which creates calm. Only one week left in the third quarter of 2022. 2023 is an Auld Lang Syne away. Blink and it’ll be here. 

Harvested from two calls today, here are a couple of situations that caused angst. 

What is a gross-up provision and why should you care? For context, this came up today in a marathon round with counsel, landlord and tenant. We are negotiating a lease with a public ally traded company and a local owner. These conversations are steeped in minutia but typically educational. According to Donald R. Oder, an attorney in San Diego, “Depending on the type of lease, the tenant may bear all or only a portion of the landlord’s expenses.  In a “triple net lease,” all of the landlord’s operating expenses are passed on to the tenant.  A lease may, however, contain an “expense stop” which establishes a point at which expenses begin to be passed on to the tenant.  In this type of lease, expenses for a “base year” are determined – the expense stop.  Thereafter, the landlord pays expenses equal to the base year and the tenant pays its pro rata share of the rest.  For example, if a lease contained an expense stop at $10,000 (“base year” expenses), and the landlord’s operating expenses were actually $11,000, the tenant would pay the $1,000 over the expense stop. It has become more common in recent years for office leases to contain what’s referred to as a “gross up” provision. Gross up provisions permit landlords to “gross-up”, or overstate, operating expenses to simulate the building being at full capacity.
 
Here’s how a gross up provision would work in the real world:

Assume the gross up provision states that common area maintenance expenses will be calculated for each tenant as if the building was fully occupied, or at 100% capacity.  Further assume the building is currently only at 50% occupancy.

Under this set of facts, a $1,000 expense to the landlord would be multiplied by a gross up factor of 2 (100% (the markup rate) / 50% (the level of occupancy)).  $1,000 x 2 = $2,000 (the grossed up operating expense).  The tenant is required to pay a pro rata share based on the percentage of space it occupies – let’s assume 20%.  In this scenario, the tenant’s total grossed up obligation would be $400.” 

Vacancy in office buildings has crept up in the past two years. In a healthy environment, the amount of dark space in a building would be a thing. But now it is. So, pay careful attention when leasing office space.

 Contingency periods. By definition, a contingency or due diligence period allows a buyer to study a purchase - upon their terms - with no obligation to complete the sale if something untoward is discovered and not remedied. Sometimes a seller passes along a vault of information which makes review and approval a snap. Other times, this becomes the buyer’s responsibility - third party reports such as environmental, building inspection, seismic, ALTA survey, zoning report, etc. must be ordered, completed, reviewed and approved. Presumably, enough time is built into the purchase agreement allowing the buyer to either approve existing reports or procure and approve. But what happens if the seller is tardy in delivering the reports to the buyer. Does the approval period automatically extend? This devil in the details caused havoc recently in a deal. We found common ground by saying the contingency period is the later of thirty days from opening of escrow or ten days from receipt of the reports. Bingo. 

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

Should you make a Long Term Commitment in These Times?

I once authored a column entitled “Worst mistakes occupants make”. Among these are - buying when you should lease, leasing when you should buy, signing a short term lease in a downward trending market, or signing a long term lease in a peak market.
 
To review.
 
Buying. A new, rapidly growing business generally finds a better fit leasing for a term than investing precious operating capital into a static purchase of real estate. Conversely, if the company has been around awhile, is privately owned, has generated a profit for the last two years, has an ownership structure that can benefit from depreciation, and can afford the down payment and debt service - enormous generational wealth can be created by owning the facility from which your enterprise operates.
 
Leasing. When an economic outlook is fuzzy - most operations hedge by making short term lease deals. In fact, much can be gained doing the opposite - think contrarian. While the world zigs - you should zag. But, I have seen companies goof by signing term leases when things are frothy only to see the monthly amount they pay be dramatically greater than current rates - and they’re locked.
 
Most would agree we are in a changing market with respect to industrial real estate. Those occupying retail and office spaces are way ahead of us as their markets morphed years and months ago. With retail it was pre-pandemic and office as a result of the pandemic. But, now here we are with an uncertain future for manufacturing and logistics spaces.
 
So, if you lease an industrial building and you are approaching a renewal - what strategy should you employ? Assuming the space still works for you - location, size, and amenities - feel out your owner. How does she view the current conditions. Is she bullish, bearish, or running for the exits? If she falls into category two or three - she’s probably willing to forego a risky vacancy in favor of constant cash flow. Read - make you a deal! Another idea is the “blend and extend”. We saw a ton of these used in the early 2010’s and they exchange a lesser rate today in exchange for additional years added to the lease term. Both are effective. Just know your owner, know your alternatives, understand your cost to relocate, and finally - be familiar with the cost to replace your tenancy.
 
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.

Three Pillars of Success in Commercial Real Estate

I was honored recently to be a podcast guest. Because of my tenure in the business and presence initiatives - I’m sought frequently. I guess they figure - after thirty eight years - I might have something to say to their audiences. My latest interview was at the behest of my professional coaching organization - the Massimo Group. If you’d like to listen - you may do so by clicking here. https://open.spotify.com/episode/2OHyYnWAG7imnyaMHGT5df?si=iy8zBft6QaCOFVnb4j_6ww. The founder and CEO, Rod Santomassimo, and I spent some time together discussing commercial real estate and my pillars of success. I believed them to be column worthy.
 
But before I delve in to the triplets - allow me to expand upon a question Rod asked at the outset: describe yourself in high school. In a word - a nerd. Too skinny and small for football, too slow for track, and afraid of a baseball - suffice it to say, I wouldn’t have been a Steve Fryer feature. But, I discovered golf. Sure. Golf is cool now - thanks to Tiger, Phil, DJ, and Rory. But in the seventies, only visored bespectacled misfits hit the links - with Arnie being the exception. But golf created a self reliance that no team sports can do. This prepared me well for a career brokering industrial buildings. My parents divorced during my high school years. Being the oldest of three siblings - I often found myself in the role of intermediary. Once again, good prep for advising owners and occupants of commercial real estate. So a self reliant intermediary I became.
 
Allowed during the interview was my list of three pillars of success.
 
Become client centric. By this, I mean your client’s best interest is more important than your fee - period. So many new agents suffer from commission breath. The fee takes priority over all else. After all, we’re commissioned sales people whose livelihood depends upon transacting. But, if at the expense of your client - your longevity will be short. Early in my career, I counseled many against purchasing when I believed they’d be better off leasing. I should mention, the fee for selling is greater than leasing. You see, buying requires a certain set of criteria - years in business, abundant operating capital, stable growth trajectory, and an ownership structure that can benefit from owning the building in which your business operates.
 
Cooperating agents are a great source of new business. Many view an agent within their firm or another as competitors. They certainly can be. But, I’ve found they can also be a great source of referrals. I’ve found if agents in your market know your skill set and expertise cooperation can exist. I attempt to be uber transparent - without compromising my clients position - with my fellow agents. This transparency has served me well over the years.
 
Do what you say, when you say. With clients, with agents, with friends and family - just do it! One of my keys is to only commit when I know I can and then don’t let anything - short of a frontal lobotomy - cause you to break your promise. This is such a simple concept - but not an easy one.
 
So, there you have it!
 
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 Market Disconnect

As I’ve written, in this space, numerous times - uncertainty is a killer of markets. Please allow me to elaborate. When investors or business owners have a murky view of the future - reluctance to make commitments abounds. Conversely, an optimistic opinion of what’s coming leads to hiring, equipment purchases and operational expansion. Therefore, we see long term leases and commercial real estate purchases transacted. Uncertainty is rampant in office space. Covid lockdowns, which forced many of us to work from home - was followed by tepid reopenings, high gasoline prices and a reluctance to commute resulting in a hybrid workforce. When will all of this stabilize? It’s anyone’s guess. Great deals abound for those office space occupants willing to sign a lease term of five years or greater. In my opinion, office landlords are resigned to meeting the demands of tenants by offering free rent, abundant tenant improvements, moving allowances, and bonus fees for agents.
 
We see a different dynamic unfolding in the industrial sector. When interest rates spiked in mid June, we experienced a tectonic shift in buyer attitudes - especially institutional investors. Many are on the bench awaiting an indication of which way we’re headed. We saw a similar pause in March of 2020. But, six weeks later a boom of epic proportions transpired. This rabid appetite continued through the first half of this year. Record lease and sales prices resulted. But now, we’re witnessing deal retrades - a fancy way of describing requests for price reductions - and cancellations. Even acquisitions which appear to be accretive to investor portfolios are cratering.
 
However, on the flip side - occupants of industrial real estate are thriving. One of our aerospace clients has a nine figure backlog. Another one - who slaps adhesives on tape will record his best year yet. A moving and storage operation we counsel has experienced back to back to back revenue spikes. Three peat indeed! And finally, a group we advise who provides engineering for large commercial air conditioning projects cannot keep pace with the demand. When these business boons require additional space - occupants are met with one in every hundred buildings available. Yes. Correct. A 1% vacancy! Because there’s no place to move, renewal rates have increased. Companies are being forced to get creative in solving their need for space. Some have narrowed their stacking aisles and gone vertical. Oh, but wait. That he swing reach forklift that allows you to pick orders way up high cannot be delivered for 26 months. That’s right! Over two years from now. How’s a business to plan?
 
So what’s up? Why the massive disconnect between investors and occupants? Here’s what I believe is happening. Commercial real estate prices shot up so high with expectations of rent growth and lack of supply. Then we felt some global pressure with Russia’s invasion of Ukraine, followed by four decade high inflation which caused a rise in rates to tamp down price hikes and two quarters of declining GDP. Institutional investors, en masse, chose to be bearish lest they find themselves chairless when the music stopped. Meanwhile, business marches on. Folks are working, wages have risen, demand remains strong, and the stock market is appreciating. It’s as though enterprises didn’t get the memo. Aren’t we in a recession? Isn’t the cost of borrowing more? Yes and yes. But somehow this recession is different compared to others I’ve survived. Generally, we spend our way out of downturns. But this time, the lower echelon of earners is getting crushed by higher prices at the pump and grocery store. No disposable income remains. So it’s a recession of the consumer vs a structural issue with our economy.
 
Only time will tell if I’m right.
 
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.

Deal Cancellations Abound!

The commercial real estate market has an entirely new feel these days. Gone are the buyer fueled bidding wars brought about by too few buildings chased by too many occupants - the classic supply demand imbalance. We were clipping along at warp speed for the first five months of 2022 when bam! We hit a massive speed bump named the Federal Reserve. You see, to tamp down rampant inflation - the Fed raised interest rates - some would opine too aggressively. Buyers felt emboldened to behave - well, like buyers. Personally, our team has felt the impact as we’ve had three deals cancelled at the alter. Jilted indeed.
 
Our latest divorce - terminated transaction - was the representation of a private investor in his search for a suitable upleg purchase. He sold a property in June and now must redeploy the proceeds to defer capital gains taxes. As we scoured the universe of available leased buildings - we settled on single tenant net leased industrial buildings - ideally in Southern California. Flooded in our search area were sale/leasebacks. After all, net leased real estate is created by: one, an investor believing now is the time to sell or two, an occupant who needs the equity contained in her owner occupied facility. The latter was the genesis of our deal implosion.
 
Therefore, I thought it column worthy to review sale/leasebacks and some things to consider when pursuing them. So here goes.
 
I've advised a number of my clients recently to consider selling their commercial real estate and striking a three to ten year lease with the investor that buys it. A few have listened.
 
This structure, in our parlance, is known as a sale leaseback. Different than a straight lease and not a short term lease that accommodates a purchase, a sale leaseback allows an owner occupant the chance to sell at today's high prices and remain in the building - albeit as a tenant - and avoid a move.
 
It's a slick arrangement when the correct motivations are involved.
 
Today, I want to spend a moment and discuss the downside of a sale leaseback.
 
The message it sends to the market. When a sale leaseback is listed and marketed for sale, the buyer’s questions range from - "why is she selling?" to "is her company leaking at the gills and needs cash to survive? Generally, there is a story. Its critical to understand the story, why a seller is selling, and how the current financials present. Our challenge recently was the creditworthiness of the occupant and the seas of red ink we were asked to navigate. In the end, we said - next.
 
Rent. Value is determined by taking the rent a company is willing to pay and packaging the rent as a return on investment. Simply, if the business can afford to pay $10,000 per month or $120,000 per year and the return is 5% - resulting value is $2,400,000. Easy, yes? Now the fun begins. Where is $10,000 per month in relation to what other comparable buildings achieve in rent? It's either above, below, or at par. Par or below - you're golden. Above and you're scrambling. You see, an investor looks at the worse case scenario - if the occupant spits the hook after a year, can't pay the rent - or worse files bankruptcy - then you’re stuck with a building you can't rent for the same amount she was paying. Thus was our conclusion in the failed deal.
 
Operating company is strapped. One of the befits of owner occupied real estate is the flexibility when times get tough. As an example, we own the office building we occupy. We’re the owner and the tenant. When our revenues dipped in 2009 and 2010, we simply reduced our monthly payment - to ourselves. Once an arms length investor enters the fray - you’re simply a tenant and the flexibility evaporates. In our cancelled scenario, rent was inflated in order to get the most dollars out of the sale. The problem was the rent was unsustainable.
 
There are tax consequences. As we've discussed, selling appreciated commercial real estate comes with a heavy tax consequence - unless a tax deferred exchange is employed. Yes, equity is feed, but at a significant cost - in some cases up to 35%. You may be wondering why this matters. Unless the seller has carefully thought through these consequences - the deal can screech to a halt.
 
Fortunately, we still have the engagement and are proceeding to the second possibility. This time the seller is arms-length from the company. So we’ll see.
 
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.

Is Your Real Estate Worth More than Your Company - Part Deaux

Last week we spent some time examining those fortuitous business owners who’ve enjoyed the good fortune of occupying - with their business - a facility with which they hold title. Their companies have enjoyed steady rent over the years with no need to sweat dramatic increases. Appreciation in commercial real estate values has eclipsed the businesses worth - in many cases.  As we talked last week - subsidized rent can play a role in enterprise valuation. After all, the cheaper the rent, the more profit an operation generates - which is used to project a company’s multiple. 
 
My question is - does it matter? You own both - the real estate and the enterprise. Both have more decimals than before. Business is worth more due to a rent of less than market. Real estate because of forces around us such as scarcity, demand, lack of new building starts, etc. So what? 
 
Here’s what. You now believe it’s a great time to liquidate your equity by selling the operation. Generally, two genres of business buyers will come knocking - a private equity group or a strategic operator. 
 
In the former, a goal could be to acquire a number of companies like yours, create value, and sell the bigger unit. Typically, they’ll utilize the existing footprint and attempt to operate without moving. A boon for your building ownership - IF they’ll pay a market rental rate. Don’t forget, the profit of your group is partially bolstered by the rent discount. A huge bump in rent could crater the profit of the company. In one instance, I’ve seen the difference in subsidy and market cause the profit margin to be zero! 
 
An option could be to sell - rather than lease - the real estate. Akin to selling a used car and buying a new one - this arm wrestling match rarely results in a maximum number for both your enterprise and your real estate. Many times the company  buyer will inflate the price of the business at the expense of the real estate - only to then create a long lease and sell the facilities to an investor. The proceeds are then used to “buy- down” the business acquisition. 
 
If favor is garnered by a strategic operator, a new set of circumstances occurs. Operating within the same industry, this buyer type views the acquisition as a way to expand market share, geographical reach, or specialization. Typically, they have adequate facilities and don’t want the real estate. Now you have a costly vacancy that must be filled. 
 
Finally, you should consider your return on investment. Assume your investment is the real estate from which your enterprise operates. Therefore the return is the amount of rent you charge divided by the price you paid. Structured as a home to your operation vs a return driven investment - you’ll likely leave shekels on the sideboard. Plus, now the parcels are way more valuable. The same rent divided by a new larger value will cause the returns to diminish. 
 
So what’s the answer? So long as you own the operation and the buildings are needed - it rarely makes sense to sell them. Certainly a transition - death of a principal, a move out-of-state, divorce, loss of a key piece of business - can skew direction.  
 
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.

Is Your Real Estate Worth More than Your Company?

Owning the building from which your company operates can be a great deal. After all, the enterprise needs an address from which to transact business. Rent must be paid to someone. Why shouldn’t that someone be you?
 
It generally works like this. A suitable location is identified and negotiations for its purchase commence. Owner occupied financing is originated from the Small Business Administration - the SBA. Banks love this, BTW. Why you may wonder? Under an SBA 504 program, banks only loan 50% of the purchase price. The other half is made up of a government second trust deed of 40% and a ten percent down payment. A lender’s risk is minimized and insulated by the Fed’s involvement.
 
From a buyer standpoint, you’re own for a pittance - only 10% plus points and closing costs. If the resulting mortgage payment - called debt service in a commercial buy - is proximate to market rent, you’re golden!
 
Don’t forget the tax advantages. If structured properly - the ownership entity leases the building to the business. Rent is paid by the occupant to ownership. Bank debt gets paid by the owner. Bingo! Depreciation of the building improvements over 39 years allows a tax break. Expenses related to the operation of the real estate are deducted from the rent. And don’t forget, the real estate appreciates over time.
Meanwhile, the resident - your company - enjoys a stable payment and is protected from market rate swings. It’s a beautiful arrangement.
 
I have many family owned and operated manufacturing and logistics providers whose real estate value far eclipses the worth of the company that lives there. How can this be, you may be wondering? Allow me to walk you through an example.
 
First the real estate. Let’s say your enterprise needed a 50,000 building for its operation. If you purchased between 2000 and 2010, an investment of around $4,000,000 was common. Back then, interest rates were a smidge higher than today as you could borrow 30 fixed residential debt for around 6.25% and ten year treasuries weighed in at between 4 and 4.5%. In contrast the rates today look mighty good! But in the year 2005, if you financed 90% of your $4,000,000 acquisition at 6% - your payment was $27,031 per month. If we add $3300 per month for property taxes, $750 for insurance and $1000 monthly for miscellaneous expenses - your all-in figure was $32,081. If we equate this to a rent per square foot by dividing by the square footage - your cost was $.65. Today, that rental figure is $2.00! Even if you set up the occupant - your company - with a lease that increased by 3% per year - today your figure would be $53,025 or just over $1.00 per square foot. Therefore, because of your smart move in 2005, your company has benefitted from an under market rent for 17 years. Presumably, this delta allowed the operation to function profitably.
 
Now the company. Recall, a business’s worth is a multiple of the profit generated. Sometimes this profit is given a fancy formula called EBITDA or EBIDA and further defined by Investopedia - “EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a measure of a company’s overall financial performance and is used as an alternative to net income in some circumstances. EBITDA, however, can be misleading because it does not reflect the cost of capital investments like property, plants, and equipment. This metric also excludes expenses associated with debt by adding back interest expense and taxes to earnings. Nonetheless, it is a more precise measure of corporate performance since it is able to show earnings before the influence of accounting and financial deductions.”
 
Thus, a company paying rent in an owner-occupied scenario would understate its building expenses by almost half. Recall, it’s paying $1.00 per square foot vs a $2.00 market rent. When the profit of the company reflects a market amount, the profit is less and EBIDTA suffers making the company’s value less as well.
 
On the commercial real estate front, values have far eclipsed a 3% annual kicker in rents. Today, a 50,000 square foot building - if you could find one - would be in the $22,000,000 range. A whopping 450% increase over 17 years!
 
Next week, I’ll describe the conundrum created with this imbalance. 
 
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.