Occupants of commercial real estate, also referred to as users or occupiers fall into two categories - tenants or owners. To draw a finer distinction - both are tenants - however one genre pays rent to an unrelated third party, a landlord and the other pays rent to a related owner of the building. Most common in the second type, is a real estate ownership structured as a limited liability company, LLC, and the occupier a corporation.
Friday, April 26, 2024
Occupant Mistakes
Occupants of commercial real estate, also referred to as users or occupiers fall into two categories - tenants or owners. To draw a finer distinction - both are tenants - however one genre pays rent to an unrelated third party, a landlord and the other pays rent to a related owner of the building. Most common in the second type, is a real estate ownership structured as a limited liability company, LLC, and the occupier a corporation.
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Friday, April 12, 2024
Random Thoughts
Ahh, springtime. Longer days, warmer temps, flowers abloom, the crack of the bat on opening day of MLB, NCAA final four, and the Masters golf tournament. You may be wondering how I have time to make any deals with all the sports happening this time of year. It’s tough. But in light of the screen time I’m spending, my thoughts these days are random.
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Friday, April 5, 2024
Education of Buyers and Sellers As The Market Adjusts
In order for a real estate transaction to close - whether it is a lease or a sale - a properly motivated buyer and seller must be present. By this I mean you need an owner ready to make the next deal and an occupant who’s kicked the tires and is prepared to sign. Ideally, these motivations mesh into a synchronicity that is melodious.
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Friday, March 29, 2024
What can Little House on the Prairie teach us about Commercial real estate
Fifty years. Wow! Has it really been that long since Half Pint, Ma, Pa and Almanzo graced our tv screens? In a word, yes. Little House on the Prairie, the iconic 1970s series about a pioneer family struggling to make their way on the prairies of Minnesota just celebrated its golden anniversary. Little did I know the series was filmed in our very own Simi Valley, California right down the road from the Ronald Reagan presidential library. Admittedly, my wife is a larger “bonnet head” than I - but I cooperatively loaded the car with water and snacks and left the house at 6:30 in the morning in order to make an 8:45 bus tour of the original filming location. The day unfolded with sights, sounds and scenes from another era - that of our youth and unspoiled innocence shared by many of us in the seventies. I’m officially now a Landon head.
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1004 W Taft Ave #150, Orange, CA 92865, USA
Friday, March 22, 2024
Reflections from Paradise - Commercial Real Estate Insights from My Florida Keys Adventure
I Just got back from an unforgettable getaway in the Florida Keys, and let me tell you, the experience was more than just sun, sand, and sea. It got me thinking about the commercial real estate scene down there, and boy, do I have some stories to share. So grab a mojito and join me as we unravel the lessons I learned from Ernest Hemingway's haunts, Harry Truman's hideaways, and the breathtaking beauty of the Keys.
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Friday, March 8, 2024
Advice I’m Giving These Days
Hello friends! I’m penning this on the balcony of my stateroom on a ship somewhere in the Caribbean. With Nassau in our rear view mirror and steaming toward San Juan - the weather is slightly overcast, mid seventies with a mild breeze blowing. Well not really, but a man can dream. Actually, I’m just pecking away at my dining room table in Orange. But I digress. Today, I go deep on the advice we’re giving to a client of ours who wants to purchase a building. They’re woefully short in space and have placed a bandaid on their growth by adding 3PL pallet positions.
Positives:
+ avoid moving twice
Negatives:
· space is smaller
· already racked
· 3PL is costly
Positives:
+ cheapest space alternative
+ racked
Negatives:
· no equity
· racking RE-config
· uncertainty after 22 months
· two moves
Positives:
+ certainty
+ size
+ divisibility
+ one move
Negatives:
· price impasse
· expensive
+ lowers his basis
+ rent is equity
+ one move
+ time to ramp up operation
+ speed of move.
Negatives:
· absolute non-starter with the ownership
· difficult to peg an option price
Positives:
+ preserves operating capital
+ cheaper
Negatives:
· no generational wealth creation
· expense at the end of the term?
· Over 120 months no equity build-up and loan pay down.
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Friday, March 1, 2024
Can Subleases A Market Make?
By the time you read this, we will have exhausted two months of 2024. Christmas lights will be appearing in home improvement retailers in no time. But I digress.
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Friday, February 23, 2024
What Are Experts Saying?
I am a huge networker and have been since the commercial real estate market tumbled in late 2008. As I scanned the scorched earth of what little remained of a vibrant business - I wondered if our commercial real estate activity would ever return. Buyers weren’t transacting, sellers couldn’t sell and lenders refused to lend. The financial world was in free fall as values lost nearly 40% - seemingly overnight. Brokers, reliant upon deals were forced to wait - something very few us were good at doing.
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Wednesday, February 14, 2024
Valentine’s Day
A day for lovers. Valentine’s Day falls every February 14th and is celebrated by couples worldwide.
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Friday, February 9, 2024
Subleases
Sublease
listings remind me of a half yearly sale at Nordstrom. You better get there early
in the markdowns to get a deal of selection and price. The longer you wait, the
price gets better but the selection wanes until your only choice is an XS
purple long sleeve tee. But. The price is unbeatable. If you’re like I am, an
XS tee only has once use - that of a dish rag. But I digress.
Much
has been ballyhooed about the amount of industrial space coming back to the
market - so I did a little research. My trusty spreadsheet is not quite as
robust as Jonathan Lansners, but I made it work.
As
a quick review, a sublease is a remnant sale of sorts. When an occupant
originates a lease agreement, the contracts vary in length. Depending upon the
size of the premises, lease terms range from 2-10 years. Many times smaller
buildings mean shorter leases. If an occupant can’t - or doesn’t choose to -
fulfill the term obligation, they’re faced with three choices. These are a
buyout from the owner, a default, or a sublease. A buyout is best for the
tenant as they are relieved of the remainder for a fraction of the cost. Since
the owner takes the risk and expense of finding a replacement, the situation
must be quite compelling. A default is least palatable for both parties - owner
and occupant. Subleasing is a nice compromise. The tenant markets the excess
space in hopes of locating a surrogate to live out its lease term.
So,
on to the numbers.
Presently,
in all of Orange County, 92 listings in excess of 50,000 square feet exist. Of
these 92, 12 are subleases or 13%. Los Angeles county came in at 497 listings,
73 subleases for 14.6%. Inland markets, spanning that vast swatch of industrial
space to our east, clocked in at 245 listings of which 34 were subleases or
13.8%. Most of the give backs appear in square footages above 100,000 square
feet. As an example, in the IE the percentage jumps to 16%!
Ok,
you may be wondering, why does this matter. Allow me to expand on a few
reasons.
Market impact. The most
valuable subleases in the industrial market closely mimic that of a direct
lease. By that I mean the term is long enough for an occupant to spread his
moving costs over a period of time. Using our Nordstrom half yearly sale as an
example, a beautiful suit in your exact size at a 30% discount is much more
appealing that one two sizes too big which will then need expensive
alterations. Your savings are eaten up by the expense of making it fit. Plus,
in some cases, all sales are final and you can’t take advantage of Nordstrom’s
generous return policy. Subleases are similar because all sales are final. Your
benefit is in the discounted price - not in other concessions such a tenant
improvements.
Additionally,
subleases have a downward push on market lease rates. Of the 12 buildings
currently available for sublease in Orange County, all will trade at a rate
significantly less than that direct listings. With a few of these, the
discounts can be explained as anomalies. However, if a large percentage of
leasing activity is with these remnants, an adjustment of pricing occurs
because the pricing is driving demand.
Occupant considerations. In a sublease
arrangement, the tenant becomes the sub-landlord, and the surrogate becomes a
sub-tenant. Many occupant/sub landlords price their sublease at a slight
discount versus a direct lease with an owner. In my opinion, this is a mistake,
because a sub lease really needs to pop and provide a shock and awe price to
attract demand.
In
order to affect a sublease, you must seek and gain approval from the owner of
the property. This approval may not be unreasonably withheld, but it’s a step
which must be accomplished. An unauthorized sublease can create a default,
which is never advisable.
With
your surrogate in place, don’t forget you, as the tenant, are still ultimately
responsible for the lease obligation. Yes, you’ve located someone to pay the
rent in your stead. However, if they fail to pay rent or break another lease
covenant, the owner may look to you for a remedy.
Owner considerations. If your
tenant is financially viable, and has simply outgrown your building thus the
need for a sublease, your position is generally pretty solid. If, however, your
occupant is struggling for other reasons, such as a downturn in business, or an
industry collapse, it’s important to pay close attention to their process of
locating a surrogate. Depending upon your tenant’s lease rate compared to the
current market rents, it might make business sense to allow your tenant to buy
out of their obligation. Under this circumstance, you take the risk of finding
a new occupant, but avoid a potential bankruptcy by your tenant which could tie
up your real estate for several months. Ultimately, you have the right to
approve anyone that wants to sublease your building. As mentioned in the
paragraph above, this cannot be unreasonably withheld, but it’s well within
your purview to require a use compatible with your building to be sought along
with a financially viable group.
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.
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Friday, February 2, 2024
Selling Motivation
What’s
selling motivation, you may be wondering. True that! We’ve not experienced much
since the middle of 2022 when the Federal Reserve mounted its stair climber and
hiked interest rates several times over the next eighteen months. Most of the
selling motivation from the start of 2021 was fueled by crazy high prices
investors were willing to pay paired with cheap money. Some never considering a
sale of their property cashed in during this run up. We even saw the occupant
premium disappear for a few months. An occupant premium refers to a higher
price the user of a building is willing to pay versus that of an investor. You
see, occupants consider the utility a piece of real estate has to offer its
operation whereas an investor is interested in the income generated. Generally,
that means they’ll pay more. Once the easy money evaporated and investor buyers
were relegated to the sidelines - selling motivation ebbed. I believe in 2024,
we’ll experience a different kind of selling motivation - more forced selling.
Bear with me as I review five situations that could render me prescient.
Transition
triggered by one of the Ds. Transitions can predict
a sale. Most common among the transitions owners face are divorce, death,
disposition, distress, disputes, and dissolution. When a marriage
ends and
the combatants must reconcile the assets, sometimes a sale occurs. Death creates
an interesting tax treatment known as a “step up in basis” which makes selling
more attractive. Sometimes business owners decide it’s time to sell
their companies. What
follows, occasionally is the sale of the building the operation occupied. A
vacant address with a mortgage means someone must foot the bill. Distress happens
when no one wants to rent the premises. Arguments can lead
to a sale. When partners can’t agree on a direction for the property, selling
could be imminent. Finally, when an ownership entity is dissolved a
property is sold. Effectively ending the involvement of the members.
Lender
pressure. Here’s
my theory. Stress among regional banks has been widely reported - especially,
if the bank has risky loans on the books or faces upward rate pressure in its
bond portfolio. The demise of Silicon Vally Bank and First Republic are
examples. If a bank funded construction loan was originated at the beginning of
2022 - which financed the construction of a new building - certain assumptions
were made. These included the costs, the time to complete the build, the lease
rate that would be achieved, and the amount of carrying time before an occupant
moved in. The expectation was a permanent loan would replace the short term
construction loan. But now the new structure is delivered into a very different
world - lease rates have softened and vacancy times have expanded. Plus
interest rates have risen substantially. Lenders fear their construction loans
may not be timely repaid and could force a sale.
Owner
capitulation. Refinancing into a higher interest rate market
could bring some owners to the table with selling motivation. This will
especially be true with the owners of office properties. If the owner of an
office building faces substantial vacancy, and must resort to lowering its
lease rates to attract a tenant, the income generated by the office building is
less than anticipated and may not service the debt. Additionally, if
substantial capital expenditures are necessary in order to attract occupants,
the money may not be in the budget. As you can see, a tsunami of issues could
cause a seller to hand the keys to their lender. The lender, not wanting to own
commercial real estate, then disposes of the property at a discounted amount.
Short
term rollover. We currently represent an occupant looking to
acquire a building in the Inland Empire. During 2021, this business owner was
effectively blocked from purchasing because he could not compete with the
investor activity. Investors were willing to pay astronomical prices with very
few contingencies, and close quickly. Therefore, we sold and leased back for
two years. Our theory was we could re-buy before lease expiration and we
believed the market was headed for a correction. We are now noticing some
building owners, faced with a pending vacancy, looking to sell rather than
experience the lengthy and costly process of originating a new tenancy.
Investors
awakening from their slumber. Who knows when we’ll see an
uptick in investor activity. My prediction is this genre of buyers - faced with
allocation requirements, a declining interest-rate market, and a realization of
where lease rates have settled, will cause some buying activity this year. The
interesting part of the equation will be how owners - not faced with any of the
pressures above - will react to unsolicited investor offers. We shall
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.
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Friday, January 26, 2024
Trends
Over
the past three years we experienced changing markets. By that I mean the
dynamic between buyers and sellers that sets stage for negotiation and results
in transactions.
At
the beginning of 2021 - as we slowly awakened from the ether of pandemic
lockdowns, two trends emerged - rampant on-line shopping and hybrid work
forces. Both of these affected commercial real estate and the three asset
classes - office, industrial and retail - in different ways. Owners of
industrial spaces - especially those equipped to welcome logistics providers -
saw a rabid increase in demand. Fulfilling on-line orders quickly and
efficiently required more on hand inventory - read. A place to receive, stage,
store, and distribute said goods.
Conversely,
as our shopping experiences turned from visiting our local retailer in person
to surfing the web - foot traffic to brick and mortar stores lessened and
spaces became ghost towns. On the office front, tenants choreographed a
thoughtful dance of safety of work forces vs in-office appearances. We realized
we could ply our trades from most anywhere - our home, from the front seat of
our cars, or abroad - and many did. Therefore, office and retail tilted toward
tenants and industrial spaces were heavily slanted in owner’s directions.
As
we dawn 2024, the aggressive pursuit of available inventory by industrial
tenants has ebbed, investor activity has been reduced to a trickle, and we’re
seeing signs of lease rate softening.
In
light of changing markets, how should you - as an occupant of industrial space
- tender your offers? That, dear readers, is the focus of the balance of this
column.
Know
the trends. At
the beginning of 2023 we counseled our industrial
occupants to watch lease rates. Our prediction was significant softening would
occur by the end of the year - and therefore, to transact at the beginning of
the year might result in a rate higher than anticipated. Our gamble proved
prescient as we experienced a declination of rates - in some cases by
25%.
Know
the metrics. A
simple review of how many available properties within a certain size range
exist versus how many similar properties have leased or sold, is a good way to
measure the velocity of a market. As an example, if during the past year three
buildings between 25 and 35,000 ft.² have leased or sold, and presently there
are 15 available, one could surmise that five years of supply exist. This, of
course, assumes everything stays the same, pricing is not reduced in order to
spur demand, or something outside our economy causes the need for space to
increase - i.e. a pandemic.
Understand
the owner’s situation. If an owner is currently carrying a vacant
building, it’s important to gauge how willing she will be to accept a deal. For
someone who purchased the building at the peak of the market with the
appurtenant increase in operating expenses, and potentially debt service, her
willingness to strike at a number less than her carrying costs might be
difficult. By the same token, if an ownership has existed for many years with
low operating expenses, and little to no debt - any deal might look
appealing.
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.
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Friday, January 19, 2024
Institutional vs Private
One
of my predictions headed into 2024 is that we’ll see an uptick of buying
activity - especially from institutional purchasers. Why you may be wondering?
For three reasons. Number one. Most haven’t transacted since the middle of 2022
and must to balance allocations. Number two. We should get clarity this year
about one of the metrics that determine commercial real estate value - rental
rates. Number three. A declining interest rate environment which will make
Treasuries less compelling and real estate more so.
Allow
me to add color to these three reflections. But first a quick review of my
definition of an institutional investor. If you’re a teacher, firefighter,
police officer, or work at city hall you can relate to a potion of your
paycheck that’s deducted to fund your retirement. Prior to the predominance of
401ks, Private employers also provided pensions and took a slice of your salary
to do so. If you pay into a whole or universal life insurance policy - those
premiums must be invested as well. All of the above form pools of capital that
need returns and are used to buy stocks, bonds, money market funds and
commercial real estate. Each asset class has its own percentage the fund
managers dictate. Advisors - at the direction of fund managers - use these funds
to make buys. Thus an institutional investor.
Now
to that promised detail.
Pencils down. When we began
2022, institutional interest in commercial real estate was rabid - especially
if you owned and operated a company from your building - you had many buyers
knocking on your door. The play two years ago was to purchase the real estate
and provide the occupying company a lease-back of preferably two years in
duration. Demand during this period of time drove values to unseen levels. In
some cases doubling the amount buyers were willing to pay by double. The theory
was by 2024, rental rates would far eclipse the lease back amount -therefore,
providing a greater return on the investment. However, when the Federal Reserve
started to hike interest rates in the middle of 2022 - coupled with global
uncertainty - we saw a shift in Investor attitudes. The term, “pencils down“
permeated the industry. For the entirety of 2023 this outlook continued and
institutional investor activity was reduced to a trickle.
Where are rents. One of
the fundamental metrics in the world of commercial real estate is rental rates.
Think of it as the heartbeat of the industry. The coming year holds the promise
of clarity in this crucial metric. As I’ve written in the space, rents in
class-A industrial in North Orange County seem to have found a level that has
spurred demand. So why is this so important? Imagine you're considering
buying a commercial property. You need to know how much rent you can expect to
charge tenants. If this number is vague or uncertain, it's akin to navigating
in the dark. But when you have a clear picture of expected rental rates, it's
like having a bright guiding light. Clear rental rate data allows investors to
make informed decisions. They can assess whether a property is undervalued or
overpriced, which ultimately impacts the return on investment. It's the
linchpin that can make or break a deal.
Rates. Now,
let's talk about something that affects every investor's decision-making
process - interest rates. In 2024, we're looking at a landscape of declining
interest rates. But why should that matter for real estate? Picture this. You
have some money to invest, and you're considering your options. On one side,
you have Treasury bonds, historically considered a safe bet. On the other side,
you have commercial real estate. Traditionally, when interest rates on
Treasuries are high, they're a compelling choice because they offer a
relatively safe and stable return. However, when interest rates start to drop,
as they're doing now, the risk ratio changes. Suddenly, the returns on Treasury
bonds become less appealing, while the potential returns from real estate start
to become more compelling. Investors look for opportunities that offer higher
returns, and that often leads them to the commercial real estate market. In a world where real estate
can provide solid returns in a low-interest environment, the appeal of this
asset class becomes evident. It's a shift that institutional investors can't
afford to ignore.
So
to sum it up. 2024 holds the promise of an exciting year for commercial real
estate. Institutional investors, with their careful balancing of allocations,
eagerly await clarity on rental rates as they navigate the changing interest
rate landscape. These factors, when combined, create a compelling case for
increased buying 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.
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