Advice I’m giving these days

As I pen this, it’s Good Friday and Passover. Happy Easter and Zissen Pesach! Most of you have folks from whom you solicit advice. Those of you who own a business most likely get counsel from a banker, attorney, or a CPA. Others may seek wise words from priests, clergy or a sage family member. And finally, maybe you get direction from Tik Tok, Facebook or Instagram. Regardless, you rely upon a trusted advisor. I am such a source for many of my clients. Today, I’d like to review some of the advice I’ve given this week and the situation that preceded the request for counsel.
 
Lease renewal on preset terms. We originated a lease in 2017. We are the owner Included in the transaction were five years of term with an option to renew for an additional five. As we’ve discussed here before - options are “personal” to the tenant and must be exercised within a specific time window. Also known as “time is of the essence” - you fail to give your owner the proper notice and you no longer have the option. In this case, the tenant wanted to remain in the building but missed his option window. He also wanted the owner to contribute to some construction expenses and wanted the right to buy the building.
 
So what advice did I give? I recommended the owner renew the tenant at the preset option terms and contribute a small amount of the construction expense. Additionally, I suggested not granting a right to purchase. But why? The family that owns the building relies upon the rent for their livelihood. The tenant wants to remain an keep paying. An interruption of this stream through a costly vacancy plus the expense of originating a new lease would not be offset by a small bump in rent that could be achieved with a new occupant. As to buy rights. These come in several flavors - option to purchase, right of first offer, and right of first refusal - and most favor the occupant. Vs limiting flexibility through a purchase right grant - I offered the owner approach their tenant first if they desire to sell. No commitment to the resident but they’re the most likely buyer anyway.
 
Lease term remaining. I was introduced to a light manufacturing company several years ago. They’ve not had a need for my services but we’ve kept in touch. Recently, the owner made a decision to exit the business she worked hard to build. Trouble was - time remained on her lease and the business buyer only wanted to occupy the premises for a short while - just enough time to relocate the business out of state. This is typical of a strategic buyer who purchases a competitor but has adequate physical plant to consume the operation - thus potentially creating redundancy. Consequently, some time would remain once the new owner of the enterprise vacated.
 
So what advice did I give? Fortunately, the lease rate she pays is dramatically below market - so she has a few paths forward. The easiest is to approach the owner and request a buyout of the remaining obligation. Sometimes a landlord will see a benefit if new tenant will pay more. The buyout is based upon the cost once downtime, broker fees, free rent and improvements are calculated. If that approach isn’t palpable, the tenant can sublease - in this case at more money than currently being paid. Some leases will ding you with a sharing if this profit - so beware.
  
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.
 

Will commercial real estate cause bank failures

In March of 2008 Bear Stearns failed and was purchased by JP Morgan Chase for $10 per share. The stock had hit a 52 week high of $133 a share. According to Wilipedia - “By November 2006, the company had total capital of approximately $66.7 billion and total assets of $350.4 billion and according to the April 2005 issue of Institutional Investor magazine, Bear Stearns was the seventh-largest securities firm in terms of total capital.” Among other ventures such as wealth management, capital markets, and equities trading - Bear was in the business of underwriting and issuing mortgage backed securities or MBS. Packaged were a number of risky home loans with their blended interest rates serving as a return for the offerings. When borrowers stopped paying, the securities went bust and the whole house of cards collapsed. What followed six months later was the Great Recession - the largest economic downturn since the Great Depression of the early 1930s. Bear Stearns was the proverbial tip of the iceberg for the titanic sinking of all real estate markets for a good portion of the early 2010s.
 
This March, Silicon Valley Bank failed and was taken over by the Federal Deposit Insurance Corporation. By comparison, SVB is a bank with depositors vs Bear Stearns with brokerage accounts. Depositors place money needed for short term future operations such as payroll, rent, mortgage payments, and salaries. The expectation is the money will be there when needed. If depositors lose faith in their ability to draw down their accounts - a run on deposits occurs. In this case $40 Billion in just over two hours. Unlike the scene in “It’s a wonderful life” where depositors had to line up and wait their turn - a modern run happens across myriad smart phones with the click of a few keys.
 
So, what’s the tie to commercial real estate and how could the collapse of Signature Bank, Silicon Valley Bank, and the sale of Credit Suisse to UBS portend greater peril?
 
Simply. Banks make loans to commercial real estate borrowers. These borrowers run the gambit of those who own and occupy the buildings from which they operate to owners of high rise office buildings loaded with tenants. In the former - a borrower’s ability to make timely payments is conditioned upon the strength of the business and financial wherewithal of the mortgagee. Also, some owner occupied commercial real estate loans are guaranteed by the government through the small business administration. In the continuum of loans - these are relatively safe - which means a bank is not required to add additional dollars to its reserve account for default insurance. But what about the latter example of a high rise office building? Much has been written here about the flux office tenants have experienced with hybrid and virtual workforces. It’s been difficult to predict office occupancy. Versus a single entity - a business occupying a building - you now have multiple tenants - in uncertain times - responsible for paying rent to an owner who’s in turn paying the bank. Should a high rise title holder’s vacancy creep up to levels above 50% - she must resort to extreme measures to rent the vacant space. Such things as free rent, beneficial occupancy, tenant improvements, broker fee bonuses, and moving allowances are employed to attract paying customers. ALL of these things cost money. I recently experienced these items totaling 45% of the consideration of the lease! But the problem is compounded if the physical plant of the structure is aging and needs capital improvements such as a new roof, elevators, lobby improvements or collaborative outdoor space. Once again - very expensive. Now a catch 22 exists. Declining occupancy - high tenant acquisition costs - further vacancy - lack of dollars to renovate an aging structure - solution? Give the building back to the bank. Now a fire sale takes place to find a buyer of a distressed asset for which the lender must boost its reserve accounts.
 
This over simplified example shows how commercial real estate could in fact cause additional banks to fail. 
 
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 does April Fool’s day signal?

Today is April Fool’s day. I wish I had a pithy prank to put forth however the reservoir is dry when it comes to when it that. However, with the dawning of spring, the crack of the opening baseball bat, Easter, the Masters golf tournament, and the NCAA final four - spring has officially sprung and the first quarter of 2023 is officially in the books. As I wrote about last week, there are some things to behold with respect to the economy for the balance of 2023 - however, today I will focus upon what you should have accomplished in the first quarter of this year. Don’t despair. If you didn’t get it done, there’s still time.
 
Review all of your lease agreements. Now would be a great time to put your hands on a fully executed copy of your lease and any extensions. Make sure all are signed by both parties. You don’t want to be scrambling around during a critical date with a half executed document. This is best done at the end of a year with a careful eye toward any upcoming expirations, options to extend, rent increases, options to purchase, etc. But what if you occupy a building you own. Should you have a lease agreement with your operating company? Absolutely! I could write an entire column on the horrors of handshake agreements between related entities.
 
Taxes. Normally, corporate returns should have been filed on March 15 and personal by April 15. But this year, thanks to our deluge, we get to sleep in until October 15th. Check with your tax professional as situations may vary. If your attempting to perfect a tax deferred exchange - according to PR Newswire - “The IRS has extended the 45-day and 180-day 1031 exchange deadlines for eligible taxpayers. Those who qualify will now have an extended General Postponement date of October 16, 2023 to find a replacement property and close on their 1031 exchange transaction.”
 
Reconciliation of your common area maintenance expenses. Your landlord may lump all of your operating expenses into an annual amount and bill you on a monthly basis. Normally, budgeting for this occurs in October so that invoicing may commence in January. Taken into account are things such as property taxes, insurance and maintenance. If you pay too much or too little during a calendar year - the amounts are reconciled in the first quarter. If you’ve not received a reconciliation - I’d suggest phoning your owner.
 
Make sure all of your entities are active. A good time to check this is during tax time. But since the window for taxes has moved - make sure you’ve paid the state for those corporate filings. Check on business licenses as well. We represented a seller a few years ago who hadn’t paid his LLC filing fees for 28 years! You can imagine the drama and expense to reactivate his entity so that we could transact.
 
Take a look at all of the physical elements of your commercial real estate. Now that the rain has - hopefully - subsided until fall - your roof may need more than a seasonal patch. With the crunch of repairs causing roofers sleepless nights - you may actually be able to hire one. Now is a great time to check on your air conditioning as the hot months will be here soon. The sump pump on your truck well got a good workout last quarter. Make sure he’s up for the next soaking.
 
Plans for the balance of the year. Is a move in your future? With industrial vacancies still at historic lows - don’t wait until ninety days prior to expiration to commence the search. Most will agree a year to eighteen months is appropriate for a proper search, negotiation, fit out and relocation. 
 
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 for the balance of the year with commercial real estate.

As I write this column there are approximately nine months remaining in 2023. Yes. The year is slipping by quickly. And now with the tax deadline postponed until October - the landmark signaling “it’s time to get rolling” each year has vanished. The first three months of 2023 have been curious. Overall, the amount of industrial activity has waned. Certainly compared to Q1 of 22 but also compared with the last half of the year as interest rate hikes, inflationary pressures, and global turmoil created uncertainty. So what am I watching and what should we expect for the last gestation period of 2023? 
 
The Federal Reserve. Our central bank is in a real quandary. On the one hand, inflation has proved stubborn - due primarily to consumer spending, the cost of shelter, and services. On the other hand, if the Fed resumes its aggressive rate march up the ladder, it risks causing other bank failures. As well, a pause could be an indication they’re concerned about breaking something else which could further shake confidence. Two weeks ago, I was in the camp expecting a 50 basis point bump. Now, I believe we’ll see a 25 basis points. This will increase the Fed Funds Rate 4.83%. In January of last year it was .58%. Will we reach a 6% target as anticipated this year? Unlikely at the point. But with the fluidity with which we saw events unfold over the past week - it wouldn’t shock me.
 
Class A industrial leasing activity. Our market is delivering more class A industrial inventory than ever since we began tracking such things in 1990. Fueled by a low cost of money, large global manufacturers making a decision to sell their aging campuses, and rabid developer appetites with an institutional credit card and desire for returns - we saw such name brands as Kimberly Clark, Boeing, Beckman, Kraft Heinz, National Oilwell Varco, Schneider Foods, Ricoh, and others hit the exit ramp. Resulting has been an array of beautiful new logistics spaces with all the new amenities of upgraded warehouse fire suppression, super high stacking capabilities, and marvelous truck maneuvering. Just over 2,700,000 square feet of new addresses are open for business and seeking residents. Goodman’s development in Fullerton - on the old Kimberly Clark site and been noteworthy. Delivering first in an otherwise crowded waiting room and with size ranges not normally found in North Orange County - 100% of the 1,600,000 square feet have been leased with recognized names such as Sprouts, Samsung, and Bandai. Very successful! What remains to be born are a number of buildings of essentially the same size range - 120,000-200,000 square feet. I believe we’ll see some lease rate softening in order to get all the buildings absorbed.
 
Office building defaults. A perfect storm is brewing. First, our hybrid working environment has cratered high rise occupancy. Second, office deals are expensive to originate. Once downtime, rent concessions, beneficial occupancy, tenant improvements, and broker commission bonuses are computed - roughly half the income an owner will receive is pre-spent. Next, our stock of office buildings in Orange County is aging and many don’t provide the modern experience many office tenants are seeking. In order to retrofit these vintage spaces is extremely expensive. Plus, the investment doesn’t guarantee a higher level of occupancy or higher rent. Finally, we’re in an unfavorable interest rate environment that is filled with lenders unwilling to loan on office space. My sense is some owners will opt to hand over the keys to the lender vs investing a ton of money to bolster leasing activity.
 
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.