Shortage of Inventory? No Problem

There is an acute lack of available buildings for lease and sale in Orange County and the Inland Empire. In most cities and size ranges, 98 to 99 of every 100 spaces is occupied. The culprits? Lack of new construction, exponential growth of industrial operations, and increased competition from well funded investors. In short, demand outstrips supply and has for several years. This time last year - when a pandemic fueled pause persisted - we believed the end to shortages was finally near. But alas, in June of 2020, the turbo charged appetite for manufacturing and logistics locations voraciously returned.
 
But, there are ways to creatively solve the dilemma. Below, are just a few.
 
If you’re looking to buy, consider leasing. Currently, we represent a well qualified buyer looking to purchase 200,000 square feet in the IE. Alternatives to buy are rarer than Elvis sightings. A quick scan of the multiples yields fewer availabilities than digits on your left hand. However, a similar survey of lease options is brighter with several more choices. Sure. With a lease you pay rent to another when you could be funding your retirement - but at least your revenue will grow in the larger building. Once your lease terms out - consider re-entering the buying fray.
 
If you’re looking to lease, consider buying. Our food processing client is having a bear of a time locating a facility to lease. Ideally, the spot will have some of the special purpose goodies he needs - floor drains, washable walls, and substantial power. Slim pickings! However, we did source a prime deal for him to buy. We can couple our tenant with an investor who can buy the building, construct a long term lease and voila - everyone wins!
 
Make unsolicited proposals. Occasionally, we will find a gem by panning for gold. Be aware - offering on a property not on the market is inefficient. Generally, there is little room for negotiation. Sellers have not fully considered the tax impact. Third party reports such as inspections, surveys, environmental, and appraisal must be generated. Finally, motivation to sell is strictly based upon the price you offer. Any variance from your offered price - if you discover something wrong - will be met with a resounding no. We have found a few sale opportunities by scanning buildings for lease. The math of selling a vacancy vs waiting for a tenant can sometimes make sense.
 
Wiggle, wiggle, make it work. My wife is a seamstress. In the past, she taught countless young folks to sew. One of her sayings was “wiggle, wiggle make it work” when shoring up a pattern. If you look at your current setting, additional square footage may be found. How wide are the aisles in your warehouse? If you slim them down to “very narrow” - you multiply the capacity. Are you maximizing the cube of your space? By stacking higher - this is accomplished. I’ve seen some very cool production mezzanines which double your floor space. If you have no place to put that new injection molding machine - consider a mezzanine.
 
Find the soft spot. Recently, we completed a deal with a logistics company. When all of their musts were identified - nothing was available to tour. The reason? Required was more office space than the typical warehouse building sported. Our solution was to separate the office need from the operation. We found a plethora of available suites close to the mother ship.
 
Outsource! People, inventory, machinery. Generally, these three drive increased revenue - and require more space - albeit different types. Folks require an air conditioned, carpeted office. Inventory? Racking and stacking. That new CNC machine that cranks out parts needs floor space. A careful dissection of the increased enterprise is in order. Will the business be generated by a larger sales force? Maybe a virtual group could be considered. Factory reps do this sort of work. For finished goods that need a place to rest - many of our clients use a third party logistics provider for the ebb and flow of warehousing. Avoided is a long term commitment to square footage. Have you considered using another producer to manufacture for you? Until you scale and the cost benefits level - you can produce more without the investment in machinery and the need for a place in your plant.
 
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.

Reconciling Operating Expenses

Today, we venture into the weeds to discuss an event that occurs this time of year. Nope. Not Chinese New Year - which is cool, by the way. But, that of reconciling operating expenses including common area maintenance charges. Fun stuff - huh? Generally, this proceeds with occupants of commercial real estate who do not own their building. In other words, tenants. You see lessees have contracts with landlords - also known as leases, rental agreements, or the like. Contained within each understanding is an outline of such things as base rent, commencement, expiration, rental increases, and responsibility for mowing the grass and fixing a leaky roof. It’s VERY important you - or someone within your group - understand how each of these cost categories is handled.
 
Typically, leases call for you - as the resident - to pay for expenses related to the operation of your address. If your company occupies a suite of offices - most likely you executed a Full Service Gross lease. Similar to other Gross Leases, a FSG lease lays out a rate inclusive of rent, property taxes, insurance for the premises, and general exterior maintenance. Unique to this arrangement is a charge for utilities and janitorial services which are baked into the monthly check you write. If you consider a high rise building with many enterprises - there is a prorata sharing of electricity, water, trash, and the crew that vacuums your conference room in your absence. It would be impractical to contract separately for these services - so owners don’t. Most, however, include an Expense Stop. Simply, anything above is billed to you. Below, base tent takes care of it. More on this in a moment.
 
Industrial landlords take a slightly different approach to re-capture costs. As an occupant of a manufacturing, warehouse, or service building - your lease probably is a TRIPLE Net Lease or an INDUSTRIAL Gross Lease. The main difference here? Rent with a NNN Lease excludes operating expenses with your monthly payment whereas an Industrial Gross Lease lumps them together. Am I saying no expenses are passed along in a NNN arrangement? Quite the contrary. They are invoiced as they occur or annualized and collected monthly.
 
So with that preamble - let’s get to the meat, shall we?
 
Each year between October and December, owners of commercial real estate budget for the following year. Taken into account are such line items as rent, property taxes, insurance, and yes - common area expenses like parking lot sweeping, trash collection, landscape maintenance, and system repairs. Considered? Is a vacancy anticipated? Are lease term extensions expected? Reviewed is how the current year fared. Were expenses properly predicted or dramatically overstated? Next, will the gardener charge us more next year? Have insurance coverages been impacted by a hurricane in South Texas? We know property taxes will increase by 2% unless a change of ownership occurred. Once calculated - a projection of next year’s - starting in January - plus budgeted expenses is forwarded.
 
You may be wondering - what happens if the principal collected too much money this year? Ahhh. That is where the February reconciliation begins. Akin to sending Uncle Sam too many tax dollars in anticipation of a refund - an accounting of charges collected vs realized is accomplished. If you paid too much - expect a bonus from your landlord. Conversely, an underpayment will foster a note that you owe more. Please understand. You have full rights to request backup information on anything for which your owner seeks payment. Typical would be a request for documentation outlining why a winds in Texas would affect a California insurance premium. Or why did trimming the trees cost so much.
 
Finally, the “more on this in a moment” promise. Delve into the terms - Base Year and Expense Stops which Full Service Gross and Industrial Gross leases highlight. Simply, these clauses limit the amount of common area expenses an owner can recover.
 
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

SOLUTIONS for Your Commercial Real Estate Requirement

A couple of weeks ago, we discussed a system for analyzing an investment property, commercial lease, or potential building purchase,. Known as the acronym - FOCUS - I deferred our conversation on the S - Solution step - as the final letter of itself was column worthy. As you may recall, the F stands for Facts, O for Opportunity, C - Consequence, and U - Understanding. If you missed the missive and would like to check it out - you may do so here. 
 
Solutions may splinter into several directions. However, they generally fall into one of three categories - do nothing, do something, or defer a decision. Simply, if you’ve sold an income property, have used the FOCUS approach to determine your next move, and are to the Solution step - you may choose to pay the gains (do nothing), purchase another asset (do something), or wait (defer).
 
As you approach an expiring lease - the process could suggest you renew your lease (do nothing), relocate into a new address (do something), or allow the contract to expire and hope your owner doesn’t force you to vacate. By the way - with today’s obscenely low vacancies - I’d not suggest doing this. 
 
A lessee considering a purchase could opt to renew the leased premises (do nothing), pull the trigger on the buy (do something), or wait until the nutty prices level (defer).
 
Unfortunately, Solutions are rarely as straight forward as outlined above. 
 
Using our income property sale situation - hours of analysis precede the Solution. Doing nothing and paying the taxes owed appears simple. But, when you consider Uncle Sam and Cousin Gavin will clip an enormous chunk of your profit - this may pale in comparison to another route. Doing something - by affecting a tax deferred purchase and buying another parcel comes with myriad complexities. First, you must decide to do this before your sale closes. Next there are finite time frames guiding your acquisition. And don’t forget. You MUST find something! Sellers are bullish. The pool of suitable offerings is limited. As Tom Petty crooned - “the waiting is the hardest part”. Deferring a decision - if you sell an income property - forces you into the “Do Nothing” mode. If you close without designating your desire to exchange - you lose the option. A fat tax bill awaits.
 
Now, let’s take the example of an expiring lease. Sure. You could elect to find a new spot. In effect “do something”. But the thinking behind the decision warrants some dissection. Frequently we meet with a tenant and hear - “once our lease expires, we will DEFINITELY RELOCATE!” But, these days the majority of occupants don’t. After careful consideration, most realize renewing an existing lease has many benefits - an expensive move is avoided, disruption is nullified, and downtime is erased. The industrial real estate market suffers from an acute lack of available spaces. In some size ranges, our vacancy is zero! Your fine intention to upgrade into a newer facility might be met with very limited choices - and costly at that. Finally, some just cannot pivot into a new address. Generally, we see as motivators such things as - custom improvements, special permitting, or an irreplaceable area.
 
A direction to purchase your business home and pay rent to yourself is a sound plan - sometimes. Doing nothing means you’ll stay, continue to rent, and run your business with little change. Hopping into a purchase - doing something - would require you to survey the market, get yourself approved for financing or tap your piggy bank, and execute a transaction. Don’t forget to look into the “true cost of ownership” by adding - mortgage payments, property taxes, insurance, and some little things like maintenance. It’s generally much cheaper to lease. Oh yeah. Your down payment isn’t free - even if it’s in a liquid account. You could choose to hire, invest in machinery, or open a new market with the cash. In some cases, these alternate investments yield bigger returns than buying a building. Deferring until our pricing settles could make sense. My opinion is we’re long overdue for a correction. But, so far, even a Pandemic hasn’t stalled the upward march.
 
Sometimes FOCUSing on the Solution is tough! 
 
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.

Making a Commercial Real Estate Decision Requires FOCUS!

As a frequent reader of this column, you know how much I like acronyms! You may have seen my missives on NUCLEAR, ask MR BOB, and even one from my friend and neighbor, Rudy - CLIP. Acronyms and their sister, nemonic devices, got me through school - somewhat unscathed - as they train your mind to remember lists and/or a process. Today. Yep! Another one. Proper attribution must be given to my business coach, Rod Santomassimo of the Massimo Group for this sequence. If you’d like to learn more - he’s written a great book entitled Knowing Isn’t Doing - Don’t Kid Yourself. If you’re facing a commercial real estate decision - specifically a relocation - I’d suggest you run down the list and ask yourself a few questions. In other words FOCUS!

F. Facts. Your current location as an owner or an occupant of commercial real estate contains a set of knowns - facts. You been at your location for a period of time. You lease. You own, etc. Layer in such things as the expiration of your rental agreement or a loan maturity. Consider the drivers of your business and how those may have changed. Was a competitor acquired? Did you add employees or machinery since you moved in? By the way. At this point - you may already have a direction. Humor me. Work yourself through the balance of the exercise. Sometimes - results may vary. 

O. Opportunity. Let’s now carefully delve into what’s working with the building and importantly, what’s not. Examples of what’s working could be - your customers know where you are, freeway frontage provides free advertising, or the lease rate you negotiated is 20% below the market rates. However, if the spot causes your employees to park down the street or if your warehouse must be completely unloaded and reloaded so folks can work - those are problems. You may also want to give some reflection to the motivators when you leased or bought the real estate. Was the market on fire and you took what you could get with the promise of re-evaluation? 

C. Consequence. Simply. You’ll need to do some math here. Consider what happens if you do nothing vs something - in dollars and cents. We recently counseled a logistics company. Considered was converting a leased premise to an owned one with a lot more space. Clearly, the new digs were going to cost a great deal more. However, the downside of staying put and continuing to lease would cripple their ability to grow their business. The loss of revenue - by standing pat - was enormous. 

U. Understanding. Now you know your situation, have dived into what’s working or not, and have calculated the monetary impact of your options. All that remains is a road map. Proceed to the next step. 

S. Solution. As the solution is column worthy itself - you’ll have to tune in next week for some suggestions. 

So, please don’t lose FOCUS this week until we meet again. 

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.

Look Beneath the Surface for the TRUE Story

We’ve been blessed with five grandchildren - two of whom live within walking distance. We see them often. It’s AWESOME! Our oldest is obsessed with the history of the Titanic. Go figure. Suffice to say we’ve become quite expert on the pitfalls of icebergs. As yet another documentary was consumed last night - my thoughts veered - sorry - to commercial real estate. Not the disaster part but the iceberg part. You see, what’s happening currently with industrial real estate is akin to those floating behemoths of frozen H2O - if you can’t see below the surface - you’ll miss 80% of the market’s activity.

 
If we take a look at north Orange County, California which includes the cities of Anaheim, Placentia, Yorba Linda, Brea, Fullerton, Orange - and throw in East Yorba Linda, AKA Corona - for good measure - you will find a startling lack of available Class A buildings. And by Class A, I’m referring to those constructed since 2010. Many of these cities have ZERO availabilities above 100,000 square feet. What’s special about Class A you may be wondering? Well, new inventory comes equipped with several goodies - such as taller ceilings, more powerful fire suppression, and greater truck access. Might I mention ALL of these goodies are needed for the eCommerce occupants that stack and ship things. One of the advantages enjoyed by the Inland Empire? There are still large swaths of land to be developed into concrete monsters and the existing buildings are newer. So what? Inland Empire lease rates are quickly surpassing those of North Orange County - especially if it’s a Class A building in Ontario vs a Class C in Anaheim. Occupants are paying for image and quality. So what if they drive a hit farther. Their business run so much more efficiently.

So how about what’s happening beneath the waves, so to speak? Developers are voraciously gobbling campuses of industrial buildings formerly housing manufacturing entities. We saw this begin around 2003 and continue with a vengeance through 2008. Oops. Minor reset! Then commence again around 2014. Panattoni Development’s re-tool of the Boeing campus in East Anaheim was spectacular! A wonderful mix of quality manufacturing and logistics buildings was delivered over several phases. Even Disney re-located their costume operation to the project. 

Beckman in Fullerton must also be mentioned. If you’re ever in the neighborhood of Harbor and Lambert - take a look. You’ll be impressed! Western Realco created a masterful layout of logistics spaces which engendered great appeal and demand. 

But over the last six months - acquisition activity has been turbo-charged! A former National Oilwell Varco site in Brea will soon house a gorgeous 108,000 square foot development. Part of the former Mitsubishi holdings in Cypress will be re-developed by scraping some existing buildings and leaving some more on the 22 acre parcel. Kimberly Clark’s operation - formerly located on Orangethorpe in Fullerton could very soon be the home of your favorite warehouse operation. Planned are several large boxes for that site. Finally, that location you pass on the 91 Freeway - Universal Alloys? Yep. Slated for a new development. 

The landscape of available Class A inventory should change dramatically over the next twelve months. It will be curious to see if any of the buildings actually hit the market - or if they are simply pre-leased. I’m betting on the latter. 

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.

6 Credit Enhancements

Merry Christmas and Happy Holidays to you and yours, dear readers! With 2020 rounding third and heading for home - left in my stocking were some transactions that require a nudge in security. We generally see such enhancement requests in lease transactions although one of our lumps of coal is a sale. A review of our solutions is the subject of today’s missive - so buckle up.

As previously discussed, a lease deal is an extension of credit from the owner of the real estate to the occupant. Simply, a landlord will calculate the total consideration of the agreement by multiplying the monthly rent plus annual increases for the term of the lease. If our monthly rent is $30,000 with 3% yearly escalators over a five year span - promised is approximately $2,000,000. Don’t forget to layer in the cost of rent concessions, tenant improvements, brokerage fees, and the like. For our example, we’ll assume these add-ons escalate our amount by 10% - another $200,000. So, our title holder wants to be assured the new tenant can fulfill a $2,200,000 obligation. If after reviewing the financial information provided, a doubt exists - expect the lessor to push for an enhancement. The form and format can morph. Below are some ideas. 

Personal guarantee. Frequently the tenant is a corporation. The C or S version has is a legal unit with underlying owners. Depending upon the complexity of the corporation, the ownership may be an individual or a number of shareholders. In the case of the former, a simple understanding the individuals are responsible if the corporation defaults can shore up performance. Sans a tangible individual - like in the case of a publicly traded group - personal guarantees aren’t feasible. 

Additional security deposits. Quite easily. Typical upon lease execution - rent for the first month and a sum equal to the last is deposited with the owner of the building. Sure. Some lease language allows the security deposit to cover abnormal premise wear and tear - but the primary purpose is to insure timely rent payments. Increasing this amount two or three fold can give some parcel owners a reason to say yes. 

Letters of credit. Good in theory - tough in practice. In essence, requested is an amount of future borrowing sufficient to stem the bleeding. But, if the tenant is sketchy - encumbering their ability to seek financing is difficult. I’ve seen this requirement spook occupants. 

Entity guarantee. Multi-layered corporations create operating companies akin to the layers of an orange. Once you peel back the skin - where’s the fruit. Sought by a holder of commercial real estate? The company signing the lease needs to own the assets - cash - capable of paying the rent. If not, a hollow barrel exists. Try drinking from said barrel. Yep. Nothing there. We’ve solved this in the past by requiring a parent corporation to sign. Just make sure the parent has chops. If not you’ll have an empty guaranteeing an empty. 
 
Reduction in concessions. Generally, we see two types of tenant requests. One of those is free or abated rent and the other is above standard office improvements. In the first case, lessening the amount of free rent requested can solve the problem. Maybe - vs a free month - two half months can be substituted. Or, placing the abatement in the later years. With tenant improvements -  two issues exist. There is a cost associated with producing the over standard build out. Plus, if the tenant doesn’t live out the lease term, the owner is faced with above standard goodies which may not have appeal.
 
Other solutions. Maybe pre-pay some months of rent. A well funded startup with adequate capital reserves but a short time in business will find this palatable. Consider a 
shorter term. In our illustration above - going from five years to a three year term and a two year option to extend may be all you need to do. 
 
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.

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.