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. 

 
Based upon our direction in early 2024
 
We’re early. Which is good if we can get seller capitulation. Which we have. We’ve actually found someone willing to sell to us. Problem is, our idea of value differs. But, remember 2021? We couldn’t compete with the number of buyers in the market with deep pockets and a rabid desire to own. In my opinion, those times return this year as rents stabilize and interest rates decline.   
 
The real soft spot in the market is the rental market. I believe a financially qualified tenant could make an an unbelievable deal today. Not quite to 2019 pricing - but close. Waiting to purchase costs money. Let’s say today’s value is $358 per square foot and we can strike at $350 per square foot and every month you rent costs $1.00 per square foot. If you wait twelve months, you must buy the same building at $338 per square foot.  
 
So based upon this - their alternatives appear to be. 
 
Stay put. By striking a short term deal with his current landlord, we can watch the market and react when pricing becomes more favorable. 
Positives: 
+ avoid moving twice 

Negatives:
·        space is smaller
·        already racked
·        3PL is costly 
 
Strike a short term Sublease. Similar to staying put but different in that the space need is solved. All of this money is sunk. The client builds no equity and potentially misses out on market opportunity as the two year sublease term is a long time.
Positives: 
+ cheapest space alternative
+ racked 

Negatives:
·        no equity
·        racking RE-config
·        uncertainty after 22 months 
·        two moves
 
Buy the deal we found
Positives: 
+ certainty
+ size
+ divisibility
+ one move 
Negatives:
·        price impasse
·        expensive
 
Lease with an option to buy. 
 
Positives: 
+ 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
 
Strike new lease.
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. 
 
What will the client do? You’ll have to stay tuned as this saga is just now unfolding. 
 
Bon Voyage!
  
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.

Status Update on 2022 Predictions

I normally wouldn’t do this in May. Typically, I’d wait until next year to do a look back on my 2022 predictions. However, things are moving so fast these days - a year is eclipsed in 90 days. And by that I mean the stodgy, slow moving old business of commercial real estate is progressing at warp speed and is vastly different than it was in January 2022. With inflation at a forty year high, a Russian invasion of Ukraine, wild stock market gyrations, political unrest, and folks back to work - we are witnessing life altering changes in our world. So, I believed this check was important.
 
2022 Prediction - Industrial rents. They’ll increase. Next bullet point. However, I’ve a few more words, so stay with me. We track Class A inventory for an upcoming assignment. What’s that, you may ask? We describe Class A inventory as buildings constructed since 2000. In this way we are able to weed out functionally obsolete structures that may exist in the market. In Orange County, there are eight new developments proposed or under construction totaling over 2,700,000. A staggering number until you factor in what’s available today. Ummm. That would be one. That’s correct! One available. Demand is still strong so nowhere for rents to go but up. Update - I’m shocked to see industrial rents surpass two dollars per square foot triple net. Just to put this in context, industrial rents in 2010 were approximately 25% of this. Yes! That’s correct 25% of what they are today.
 
2022 Prediction - Developer appetite. With industrial rents increasing, interest rates still low - that will change this year - plentiful capital seeking a place to reside, and an acute shortage of land from which to produce concrete caverns - a conundrum continues. An industrial development at your neighborhood Sear’s store? A campus built for industries who’ve left the area? All will be targets this year. Update - Developers still have ovation appetite for sites with which to add value. There are rumored to be several in play presently at absolutely eye-popping land values. More on this to come.
 
2022 Prediction - The office. No, not the series - the market. Recently, I read this with interest in these pages - “A new report from Ladders, a career site for high-paying jobs, says things will likely stay that way. In fact, Ladders predicts that 25% of all professional jobs that pay $80,000 or more will be remote by the end of 2022.” Wow! My suspicion is it will be greater than that. Anecdotally, take our office as an example. We own a 21,700 square foot, two story location. We occupy the upstairs and a portion of the down for about 13,000 square feet. When locked and loaded - 49-52 folks commuted in each day. Now? Probably half regularly attend. My team works remotely as do others. Adjusting to this change will be smaller footprints and more multi-use spaces. Update - there is some talk among the big players that a return to the office is eminent. Mention frequently is the difficulty in maintaining a culture with a remote workforce. We haven’t experienced this so much in orange county. I believe we are headed for a hybrid between remote and in person office occupancy.
 
2022 Prediction - Retail slowdown? We all know that, big fella. How’s that prescient? Actually, what slowed during our two year pandemic fueled sabbatical were trips to the store. Retail sales actually increased as we bought tons of stuff from our home keyboards. But, one of our clients, corporately based in NYC, is a tremendous gauge on the brick and mortar retail business. By that I mean, destinations such as Wal-Mart, Costco, Burlington, and the like. He’s sensed a REAL dip and predicts more to come. So we’ll see. Update - as you may have read, the largest e-commerce retailer – Amazon - recently put the kibosh on 200 projects in process. Their earnings are predicted to decline by 3% and they admitted they have over built their storage capacity. Consequently, any Amazon deal on the margin was postponed. What this foretells about brick and mortar retail will be interesting to observe.
 
2022 Prediction - Stagflation. What on Earth is that? According to Wikipedia -“In economics, stagflation or recession-inflation is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.” Hmmm. Inflation rates, high - check. Economic growth slowing - check. Unemployment high - check. By the way, you may be thinking - I thought unemployment was low, currently. Actually, the percent of the workforce NOT working is high. The statistics reported are only those who’ve filed claims - quite misleading. Update - Wow! That didn’t take long. With inflation running 8% annually and a decline in gross domestic product for the first quarter we already are in a stagflationary period. Not since the Jimmy Carter administration has this been a thing.
 
Things I didn’t foresee: The invasion of Ukraine, the dramatic Amazon slow down, two dollar industrial rents - were all not on my radar in January 2022. Now you understand why a first quarter update was important.
  
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.

Reasons to Sell - The Sale Market

Image Attribution: www.dreamstime.com

Since June of 2020, the industrial real estate market - manufacturing and logistics buildings - has been on turbo-charge! Anything for sale - regardless how ludicrous the asking price might appear - is met with multiple offers, bidding wars, and one group of winners - sellers! 
 
As buyers go - we’ve witnessed an owner occupant’s ability to compete with investors wane and a flip in the “occupant premium” once experienced. If you don’t recall the meaning of occupant premium - here is a brief refresher. Occupants - companies that own the locations from which they operate - once could pay about 20% more than investors - those reliant upon rental income produced by the location. Utility, financeability, and rent savings were the main three reasons occupants could pay more. The downside of the higher prices paid, however, was the uncertainty of financing contingencies. If the occupant couldn’t get a loan - the deal could crater. But, now that rents have increased exponentially, investor capital is abundant - downright voracious - and most investors buy without needing bank involvement - the tables have turned. Our paradigm has shifted! Now, investors typically pay way more than occupants. 
 
Rarely, would an investor buy a vacant building and rely upon their ability to rent it in a timely manner. Not that long ago, a steep discount would be negotiated for buying an empty site. After all, such things as downtime, free rent, improvements to the real estate, and brokerage fees had to be estimated and deducted. A long term lease found favor with investors. If this lease had to be originated, an investor would pay less. Now? Shorter termed leases or empty buildings are preferred. Because the market rate can be captured. If an under market agreement is in place - it could take years to ramp up the rate to prevailing levels. In fact, product is in such short supply and capital is searching for a home - we’ve encountered a new deal structure - “the forward”. Simply, investors are lapping up “planned” projects prior to them breaking ground! Amazing. 
 
With that update as a preamble, let’s discuss some reasons why sale opportunities pop-up these days. 
 
Business operation is sold which yields the location an excess. One of the most common circumstances today, which creates a need to sell, is the sale of the business occupying the premises. Some owners opt to retain and lease to the new entity but many cash in the chips. 
 
Fund matures. Many instructional investors set up pools of money with sunset clauses. Simply, at the end of x years - the fund is set to liquidate and return the capital investment. You may be wondering what happens if the fund matures in a down market. Is the sale forced? Generally, the administrator has some latitude to move the sale date up or back to account for market fluctuations. 
 
Merchant builders. Some developers like to acquire land, build, and sell. These function much like new home builders. They like to keep the money turning. 
 
Liquidity event. Death of a principal, a bankruptcy, imminent domain, or partnership squabbles - all can force the sale of a piece of commercial real estate. 
 
At these prices - why not? Finally. Much of our sale activity in 2022 is on an unsolicited basis. See a property you like - that’s not for sale - and submit an offer to buy it. Easy. After all, everything is for sale at some price, right? Akin to casting off the Balboa pier in the hopes of a catch - this manner of scarring up deals is terribly time consuming and inefficient. For myriad reasons, these Hail Marys rarely land. But, it only takes one or two.  
 
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.