Should you "Stage" your Commercial Real Estate?

One of my favorite television channels is HGTV. I love the Property Brothers, Love it or List it, Design on a Dime, and Flip or Flop.

Given my vocation, this is predictable as I do a similar thing for a living - although not residentially.

One thing universal in all of the HGTV offerings - the condition of a house during showing is critical. If the house shows poorly with outdated colors, visible repair needs, over sized furniture or evidence of residents - your purchase price will suffer as potential buyers will discount their offers to deal with the shortcomings.

OK, I get it! But, is there a parallel in commercial real estate?

My answer is a resounding YES! Staging your commercial real estate is not as easy as a few v-dinted pillows and strategically placed sofas, however. Staging commercial real estate involves the condition of the building and how it shows to prospective tenants and buyers.

If the condition of your commercial real estate is tantamount to achieving maximum value, what improvements should you consider before selling or leasing?

Leasing improvements: If your goal is to lease your commercial real estate quickly and for an above market lease rate, you must invest some dollars placing the property in "rent ready" condition. The carpeting in the office should be replaced or at a minimum removed so that a prospective tenant knows that new flooring is in the plans. A fresh coat of paint throughout the office and warehouse brightens things and adds an air of new. All of the systems - plumbing, heating, ventilating, air conditioning, roof, sprinkler system, loading doors, electrical panels, fire alarm system should be checked and certified. The outside of the building is important as well. Remember, if your commercial real estate lacks curb appeal, the tour might hop-scotch your building for one that looks good. Paving, landscaping, and truck loading areas should be shored up and maintained during the vacancy. Most potential tenants have a limited imagination or patience for the way "things could be". Therefore, delaying the above could cause an occupant to bypass your building for another that is move-in ready.

Sale improvements: If your goal is to sell your commercial real estate for top dollar, you want to plan your refurbishment wisely. If you cannot justify a 100% return or greater - question the investment. Said simply, if you repaint the building at a cost of $20,000, that investment should translate into a $20,000 increase in value. In my experience, the items in a building purchase that give buyers the greatest heartburn are the condition of the roof and air conditioning. I generally advise my clients to perform an inspection of these systems. We then know if any issues exist and can plan accordingly.

Biggest mistake: Some owners will adopt the attitude of "waiting until the occupant appears before investing in any building refurbishment." Certainly, there are reasons for this position - no available funds for investment is the most common - but the downside is steep. If a prospective occupant perceives the owner is not "open for business", he will scatter like ashes in a Santa Ana wind.

Showing condition: If the property is vacant during showings - and your broker is not present during showings - complete literature should be available to prospective occupants.

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My Commercial Real Estate Didn't Appraise...Now What?

Appraisals of commercial real estate are required if you are financing your purchase through a lender - conventional or otherwise.

The possible exception might be an owner financed purchase. In that case, the owner becomes the bank and may not require an appraisal.

An appraisal is a lender's way of "hedging their bet" to insure the agreed upon value - the negotiated purchase price -  is consistent with the market.

An appraiser is generally engaged by your lender and looks at three measures of value: market approach - recent sales of comparable buildings, the income approach - capitalized market rents, and cost replacement approach - the price of land plus depreciated construction costs . These three value measures are compiled, reviewed by the lender and a value is determined. The appraised value is then compared to the negotiated purchase price. If the appraisal supports the negotiated purchase price, great! If the appraisal is less than the negotiated purchase price, there is an issue.

So what can be done if the appraised value is less than the price that you and the seller have negotiated? In my experience, one of several solutions exist.

The seller can reduce the purchase price. The solution is simple but not easy to accomplish - especially in a robust market where buyers are plentiful. The seller chose you as the buyer because you had the best offer, the greatest motivation, or for another reason. Remind the seller of this fact. Also, if the building didn't appraise with your lender, there is a high likelihood that the building will not appraise with another lender. The low appraisal is now a material fact that will need to be disclosed to the next buyer - hmmm. Maybe a price reduction isn't so bad after all.

You can invest a larger down payment. If the seller is adamantly against reducing the purchase price, you can bridge the gap by making a larger down payment. Just understand your lender believes you are paying too much for the building so examine your reasons for buying the building.

A combination of the two solutions above can be used. Frequently, the seller and buyer will compromise and the seller will reduce the price slightly and the buyer will invest additional dollars to close the transaction. I would say this is the most common way in which a low appraisal is remedied -  both parties participate to solve the issue.

An appeal can be made to the appraiser. Prior to the economic collapse of 2008, this was a viable option. We could "massage" the appraised value by talking to the appraiser, looking at the value measures and suggesting other comps, capitalization rates, or construction costs. These days, we have very little latitude because brokers are divorced from the appraisal review and the final determination of value. If all else fails, however, this is worth a shot.

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