6 Non-Starters for Commercial Real Estate Deals

Commercial real estate transactions, akin to a dance, take two to tango. In the case of a lease - opposite are the tenant and landlord sometimes called Lessee and Lessor. When a building purchase is considered, a buyer and seller square off. Customary in both is a negotiation which precedes the agreement - a lease document or purchase and sale contract. Outlined in most negotiations is a set of deal points - price, term, concessions and the like. Generally, both sides of the aisle have representation - a commercial real estate professional or a real estate attorney. Depending upon the dollar consideration, both vocations may be employed. Frequently, a general outline is submitted by brokers and agreed to to by both parties and then attorneys fine tune the language. When a deal takes flight - it’s a beautiful thing. But, there are some requests which prevent lift-off. A few of these “Houston, we have a problem” are listed below. 

Termination clauses. Occasionally in a lease arrangement - especially with major corporations - an “opt-out” provision is requested. Simply, these give a tenant the right to terminate their lease prior to the expiration. Flexibility - in case the space is outgrown or exceeds capacity - generally is the reason. But these wreak havoc on the back and forth. You see, an owner expects a flow of income for several years. Rate, concessions, and motivation are reflected. If this stream can be interrupted - landlords view the worst case and react accordingly. A five year lease with a termination after three really is a three year commitment. 

Options to buy. Options benefit the occupant. Period. Terribly one sided and limiting - many owners simply refuse to consider them. You see, if the title holder grants an option to buy, he’s locked in. Sure. He can sell to someone else, but the new buyer must honor the option. It’s murky. Softer solutions exist. Rights of First Refusal or Rights of First Offer are examples. 
 
Special purpose tenant improvements. If you’re looking to a landlord to fund your freezer cooler space, add a clean room, or double the amount of private offices - expect some reluctance. Typically, dollars invested to modify a building are viewed for their reuse. An owner considers how valuable the adds will be to future residents and responds accordingly. 

No financing contingency. We sold a property earlier this year for the income it produced. Our buyer was a well-heeled investor with ready cash to deploy. He will not occupy the building but will own it and reap the returns. His offer did not require a loan - therefore his performance was not conditioned on a lender nod. However, most buyers who plan to house their business within the premises need some time to get funding. A seller unwilling to allow this contingency may force a buyer to look elsewhere. 
 
Closing extensions. A seller planning to re-invest the proceeds through a tax deferred exchange has strict timeframes to follow once the sale consummates - 45 days to identify within a 180 day completion. Therefore, we occasionally see extension requests. If closing is delayed, the clock remains at zero until the deal is done - thus giving the seller “free time” to find a replacement property. Buyers are in peril, however, as loan commitments or operational needs dictate their timing.  

Lengthy contingency periods. Sellers seek certainty of close. Extended uncertainty will kill most transactions. A great example occurs when a buyer contemplates a use change - like converting industrial to residential. Municipalities have something to say and they say things quite deliberately. It’s not uncommon for the rezoning - if needed - to eclipse 18 months. An awful lot can change in that period. Consequently, few sellers are willing to “tie up” their property on a maybe. 
 
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.

Subleases - What Causes Them?

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

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

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

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

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

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

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.