Unsolicited Offers Abound

With the unprecedented shortage of industrial buildings to buy, cheap abundant capital available, and a steady drumbeat of increased demand from investors and occupants - we find ourselves in an acute seller’s market. 

Many of our clients have received unsolicited offers at eye popping figures! By unsolicited, I mean this - no listing, no marketing, no real thought about selling but the offer arrives in your inbox. Frankly, these numbers are so appealing - it’s caused many to pause and consider accepting the windfall. 

But, there are challenges that must be overcome. What are those, you may be wondering? Allow me to expand your understanding, may I?
 
You still need the building to operate your business. A wise decision was made some time ago to house your business in owned commercial real estate. Through the years, the operation has paid you rent, mortgage balances have been retired, tax benefits achieved, and appreciation has occurred. But the fact remains, so long as your enterprise requires an address - continuing to own and occupy the building is generally the best alternative. Sure, you could structure a leaseback, stay put and take advantage of the lofty offer. Just make sure your operation can withstand the likely bump to market rent your buyer requires. Or, you could relocate the business to a cheaper market. Problem is, this “cheaper market” would likely be in a different state. And the same imbalance of supply and demand likely exists. Finally, many approaching retirement years believe this is a great time to sell the company and the real estate and retire.
 
What will you do with the money? In most ownership structures, the sale of a capital asset triggers a significant tax obligation. Yep. Uncle Sam wants a taste of your proceeds. First off, the gain - difference between your net purchase price and basis will be federally taxed at 20%. Next, any depreciation taken through the years will be recaptured at 25%. California will tack on 13.3% and finally a cut by the Affordable Care Act of 3.8%. All in - your looking at close to 40% of your gain paid in taxes. Some simply believe the best way to go is to pay the levy and be done. With the crazy numbers being offered today - there is still a lot remaining. If the thought of a 40% hit is too much, you can certainly defer the tax through several means - a tax deferred exchange, a partial exchange, a Delaware Statutory Trust, or an allocated LLC. All of these deferral strategies require specialized advice through your CPA and real estate counsel.
 
Certainly, none of us can predict how long these unprecedented prices will continue. Will world events such as the war in Ukraine, rising interest rates, another pandemic, or something unforeseen crater our market with uncertainty? Normally, a vacancy factor of around 5-6% provides a good platform for buyers and sellers to transact. By that I mean 94-95% of our industrial stock is occupied. Leaving the balance in play. Today, depending upon the location in SoCal - we’re talking 1% or less. Skewed is the market. A catastrophe indeed would precede any return to normalcy. 
 
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

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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.
 
 

Finding Additional Plant and Warehouse Space is Easy!

Recently, we explored ways to find additional office space within your building. If you missed the column - you can quickly catch up by clicking the link below.
 
Follow the link below to view the article.
 
We’re lacking space, so now what?
https://ocregister-ca-app.newsmemory.com/?publink=0444e7ae6_1348352
 
In today’s super competitive, hyper tight industrial market - moving an operation is problematic as a relocation target may not be available. Not to mention - moving is expensive, inefficient, and the pay back to your company may be many years. Alternatively, many groups simply cannot move. Reasons given? Owned are the premises, special permitting may be in place, proximity to employees, a lease which doesn’t expire for several years and so on.
 
But if your operation needs more room the regardless of the reasons above, space must be found. Today I’ll share a few ideas as to how.
 
In our experience, many operations believe they’re out of space when in reality a bit more can be found in an existing location.
 
Add a production mezzanine: A production mezz can be a great way to increase production square footage without consuming floor space. If you own your location, add machinery or processes, look into this solution.
 
Store some finished product or raw materials outside: Subject to city ordinances (if outside storage is allowed), a yard or a secured area outside multiplies your usable square footage.
 
Lease additional space close by: Whether you own or lease your location, a temporary fix to your space needs may be accomplished by leasing space down the street. But be forewarned - you may create inefficiency. Certainly the upside to this strategy is that the excess space (if the lease is flexible) can be discarded at the lease expiration (if the space is no longer needed) or renewed until a more permanent solution can be achieved.
 
Outsource a function to another producer: This solution is potentially costly and should be compared to moving and keeping the function in house. Some economies can be achieved however if the function is new (and the upside unknown) or the barriers to entry are formidable.
 
Separate a portion of the operation and relocate that portion: Once again with full acknowledgement that the main reason I see for companies "relocating" is the inefficiency created by operating from multiple locations - in some cases it works and can solve a space issue. The best example that comes to mind is a client of ours. Needed was an upscale office image combined with a plain vanilla warehousing function. The two were diametrically opposed and unattainable in one building. We discovered a solution! Relocate the office into an owned location and leave the warehouse at the existing location - space issue solved.
 
Use a third party logistics company: Also known as a 3PL, these independent warehousing providers serve as an outsource for all of your warehousing needs. A third party logistics company provides a "soup to nuts" solution for additional warehousing. Included in the per pallet charge is warehousing, access, shipping and receiving, insurance, etc.
 
Add building square footage to your location: This solution would only apply if all of the following criteria exist - you own your location, the site is large enough to accommodate additional square footage, and the city will allow additional square footage to be constructed. If all of these apply, congratulations! You managed to foresee your growth and planned accordingly.
 
Utilize cube by reworking your racking plan and purchasing a swing reach forklift: Every time you modify your aisles in to a narrower configuration, you gain approximately 33% increase in pallet storage density. Therefore moving your wide aisles to narrow aisles, increases storage density by 33% and moving from narrow aisles to very narrow aisles, you save another 33%. Of course this increased storage capacity comes at the price of increased capital investment in lift trucks  and pallet rack. A quick and easy tip to help evaluate if you can increase your storage space in your current building is to stand at one corner of the warehouse and look out at the opposite corner. If you can see the opposite corner without obstructions, you likely have an opportunity to increase storage cube using increased investment in materials handling products. Commodity class, stacking height and sprinkler calculation must be considered before you go vertical.
 
Add another shift or two: We have clients who have prolonged moving for several years by adding a second and then a third shift. Generally, the advantage of the second shift is that most overhead (rent, exec salaries, benefits, etc.) are covered in the  business generated by the first shift. The second and third shift become very profitable as a result.
 
So, there you go. More space than you knew existed.
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.
 

How to Unwind a Commercial Real Estate Deal

Today, I will delve into the topic of cancel culture. No, not stifling free speech, but the cancellation of a commercial real estate deal - AKA, how to unwind a transaction.
 
As mentioned in this space over the years - commercial real estate agreements come in two forms - leases and sales. Unlike our residential colleagues, commercial leases can make up a substantial portion of our practices - in some cases 100%. Because many businesses opt to lease the premises from which they ply their professions and the sale market these days has an acute shortage - more and more leases are originated. Clearly, cancelling either - sale or lease - have their nuances - so I’ll spend time on both.
 
What precedes each direction is an identification of needs, a survey of the market, tours of potentials, negotiation and contracts. Departure occurs at the documentation stage. When a lease is signed, the deal is done - notwithstanding fit out and move-in. When a Purchase and Sale Agreement is executed - the deal begins. As you can gather, unwinding depends upon where you are in the process. Allow me to dissect.
 
Leases. Until you scratch your John Hancock on that 17 page tome - you can walk away - even if you’ve signed a Letter of Intent. In some cases, after you’ve signed a lease and you don’t timely deliver the deposits called for - the owner can hit eject. But generally, once you and the owner sign, deposits and insurance are swapped, a lease agreement is affected. Now. Should circumstances cause a “delay in possession” - meaning you can’t move in - beyond what’s outlined - a cancellation may occur.
 
Ok. You’re in and things change. Now what? Typically, you’ve three alternatives - buy-out, sublease, or default.
 
A buy-out works like this. With the lease, you have committed to a certain dollar obligation which is calculated by multiplying your monthly rent by the years remaining on your term. Let’s say this figure is a million dollars. In order to achieve a buyout, you would approach the owner of the building and offer her a fraction of the remaining obligation. She then will analyze whether taking a buyout is in her best interest. Specifically - with the money offered - can the costs of sourcing an new occupant be absorbed.
 
Next, a sublease. You attract a surrogate to live out your lease and do all of the things you committed to do - like pay the rent, reimburse the property taxes, mow the lawn, etc. Beware. Subleases must be ok’d by the landlord - but she can’t be unreasonable.
 
Finally, you walk away and stiff the owner. Never recommended as all manner of legal recourse will be unleashed. But. It’s an option.
 
Sales. Recall. When a Purchase and Sale Agreement is signed, the stopwatch begins ticking. Until a deed is recorded - signaling the race is over - there are escapes.
 
The easiest occurs during a due diligence period. Accomplished within 15-60 days from execution of a contract is a commitment for financing; a review of title; inspection; forensics of the leases(if any), expenses and income; and an investigation of environmental conditions. If any don’t pass muster and a solution compromise can’t be reached - over and out.
 
Once all of the conditions outlined in a contingency period are waived - some money is at risk. Meaning, the buyer may bolt - but the deposit is forfeited.
 
Some may wonder - hmmm. It appears the buyer holds the key. When can a seller cancel? Simply, if the buyer performs - the seller can’t. My lawyer buddies are collective saying - uh huh! True. Suffice to say, however, a costly “specific performance” battle may ensue. Probably, the wackiest example of this occurred a couple of years ago with a seller we represented. It seemed the seller - after committing to sell his property - and the buyer waiving contingencies, discovered a costly pre-payment penalty. I received a call one day from the seller asking me to cancel the deal. Astonished, I asked - “on what basis”? ‘Because I can’t afford the pre-pay, he replied”. Hmmm. Fortunately, we persuaded the buyer to walk away. But not without a reimbursement of their costs and paying their agent.
 
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.
 

Business Values - Part Deaux

You’re reading this on Super Bowl Sunday. A celebration of a very long National Football League season that climaxes with the clash of the remaining titans - in this case our hometown Rams and rival Bengals. Enjoy the guac!
 
Two weeks ago, we discussed the circumstances under which a piece of commercial real estate housing a business becomes significantly more valuable than it’s resident. If you missed the column - you can quickly catch up here.
 
Follow the link below to view the article.
When Property Eclipses Business Inside
https://ocregister-ca-app.newsmemory.com/?publink=0e1e11bb0_1348306
 
Mentioned was - so what? It’s all paper until I’m a seller. Today, it’s time to continue the conversation.
 
Becoming a seller creates two tough challenges for owner-occupied commercial real estate - increased expense to the operation and “what do we do with the money”?
 
Increased expense. Occupants of commercial real estate generally purchase their business homes for very different reasons than investors who strictly look at the cash production. By this I mean, the business is the focus - and all efforts are made to enhance the enterprise’s value. Appreciation that occurs with the address is strictly a circumstantial benefit. Emphasis is placed upon machinery, equipment, and employees which drive revenue and in many cases provide a greater return on the company owner’s investment. Ask most proprietors and they’ll tell you - we purchased our building for our operation. Sure, collected is rent from the occupying company - an investment - but in many cases this payment is subsidized by the building owner.
 
What we’ve experienced locally is the operation clips along and produces its product or service - machine tooled parts, injection molded widgets, or storage and logistics for customers. Hopefully, sales increase and the enterprise’s worth is enhanced. Recall, this worth is a math problem that deducts expenses from revenue to form a net figure. A multiple applied and voila! Enterprise value.
 
Meanwhile, our real estate becomes more valuable simultaneously. Market conditions change, rent increases, capital becomes cheaper, investor appetites are voracious, supply contracts, demand for space increases and boom. So, if we look at the way commercial real estate appreciates (increase in comparable market value, replacement cost, or through a bump in rent and compressed cap rates) - by allowing the occupant to pay less than market rent actually devalues the premises.
 
Let’s take a look at a quick example. Assume rent paid by the enterprise is $8.40 per year. Market rent is $12.00 per year. If our return is 4%, the resulting values are $210 per square foot with the subsidy and $300 if the lease rate reflected market. On a 100,000 square foot box - that’s $9,000,000! But to reap the $9,000,000 and sell the building with our company inside suggests our resident must bear the added rent expense of $3.60 per year or $360,000. Reduced is the bottom line of our company. Unless an owner is exiting, reluctance in hopping an enterprise expense is assuaged.
 
What do we do with the money? If - and it’s a big if, an owner’s operation can swallow a big jump in rent, the next issue arises. Ok. I saddle my group with the $12.00 lease and take that unsolicited investor offer at $30,000,000 (from above, 100,000 square feet at $300 per square foot). After all, the interested party will allow the company to stay put, we avoid a costly move - and I pocket $30,000,000. Easy! Hmmm. Don’t forget. You’ll pay a bit of dowry for that gain. In some cases, up to 45%! Certainly, we can employ some tax deferral through a 1031 exchange, a Delaware Statutory Trust, or a partial exchange. But in the end - you’re trading the devil you know - your company is housed, they pay you each month, and you control the operation for the devil you don’t - another leased parcel of commercial real estate.
 
Many business owner opt to say “thanks for the free appraisal - but we’re not sellers.
 
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.
 

Shortage of Space - Now What?

Image Attribution: www.gograph.com 

Two weeks ago, I got my Star Trek on and discussed space - the final frontier. If you missed the blast off, no problem. You can quickly catch up by clicking here. Follow the link below to view the article.
 
Rent, sell or buy: How real estate values are factored
https://ocregister-ca-app.newsmemory.com/?publink=13f98ef4d_13482ff
 
Ok, now that we’re back up to warp speed, allow me to continue our exploration by discovering ways to overcome the acute shortage of manufacturing and logistics buildings in our market.
 
As previously mentioned, a high demand for industrial space - fueled by the e-commerce boom - coupled with a lack of supply has fostered a game of availability musical chairs. There is simply not enough space for the need. Therefore, we must be terribly creative to fill the void.
 
Many times, the solution is found in the problem. By that, I mean a dissection of the “why” reveals a new direction. Did your company secure a piece of business that cannot be fulfilled in your current location? Has the growth come organically through an increase in the industry? Did you add employees? Has the way in which you conduct your business changed? Have you acquired a competitor or another product line that must be folded into your operation? Have you purchased new machinery or processes that require additional space? Has one of your suppliers asked that you warehouse some of their product where before the product was dropped shipped directly to your customers? Have you brought a formerly outsourced function back into the operation?
 
Specific answers to these questions may determine how we solve your space issue (and what type of space you need - production, warehouse, or office). Let’s spend the rest of our voyage assuming you’ve added a sales staff and the shortfall is caused by a need for additional office employees.
 
Generally, industrial space has a portion of its area devoted to a traditional office environment complete with reception, privates, and possibly a shared cube domain. This “office” is bolted on to the plant or warehouse and may be single or multiple stories. Typically 5-25% of the square footage houses office staff. Therefore, adding additional office space to your location could do it! On the surface this appears to be an easy fix. However, please consider the cost of construction ($100-$125 per square foot depending upon walls, plumbing, upgraded finishes, etc.). If you own, you may be over improving your building for the market and this could affect future resale timing and pricing. If you lease, you will need the owner's approval AND you will be leaving the improvements in the building if you move at the end of your lease. Some occupants have found great utility in modular furniture - flexible layouts and you take the furniture with you if you move. Other considerations are the city in which you operate (the improvements will have to be permitted) and the parking ratio. Generally, office space will require 4 parking spaces for every 1000 square feet of space. Most industrial buildings are parked 2 spaces per 1000 square feet (including office, production and warehouse). You may be limited as to the amount of office space you can add to an existing configuration.
 
Add an office mezzanine:  All of the considerations outlined in the previous paragraph apply here as well. The differentiation is that in addition to adding office space you are also adding square footage to the overall structure by creating a second story. Parking, city permitting, clearance in the warehouse (because you don't want the second floor to be sufficient for Klingons only), cost (structural footings are required to brace and support the mezz and are consequently 40% more expensive than first floor office space). If you create an office mezzanine, are leasing the location, and renew your lease - be prepared for the landlord to base your new lease rate on the "increased square footage" including the new mezz space you added.
 
Lease additional space close by: Whether you own or lease your location, a temporary fix to your space needs may be accomplished by leasing space close by. Please realize you’ll be less efficient with a function close by vs within your confines. The upside to this strategy is that the excess space (if the lease is flexible) can be discarded at the lease expiration (if the space is no longer needed) or renewed until a more permanent solution can be achieved.
 
Allow the function to operate virtually. Not an option a mere two years ago - now quite prevalent in industries across the US. Certainly cultural, management, productivity will be considered but it’s a great alternative for some.
 
You may be wondering how we discover plant and warehouse boons. That, dear readers is a planet for another trek.
 
Columnist note: Today marks my seventh year anniversary as a SCNG columnist! Thank you to all who’ve made the sojourn so enjoyable. Here’s to seven more!
 
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.
 

When Commercial Real Estate Values Eclipse the Business Value

As mentioned previously in this space - many business owners in SoCal have opted to own the premises from which they ply their trade. We refer to this as owner-occupied. Benefits of this structure are plentiful - tax advantages, appreciation, and facility cost stability - to name a few. The other alternative for an operation is to lease their business home. They become a tenant and the monthly rent they pay is sent to an unrelated landlord. Today, I’ll focus on owner occupied real estate.
 
In both circumstances, if properly nurtured and managed, the enterprise value grows. It’s quite common for that plastic injection molding operation or your neighbor who’s company tools aerospace parts to be worth several million dollars. I should mention here - the business valuation appreciates independently of the real estate’s worth. Sales generated by the company - top line revenue - is apportioned to account for expenses such as employees, raw materials, plant and equipment, etc. Resulting is a measurement called EBITDA - earnings before interest, taxes, depreciation, and amortization. Multiplied by the industry norm is this net figure. Generated is an estimate of valuation. There you go. I’ve just simplified the role of an investment banker into one paragraph. In practice, the process is much more complicated - but you get the idea.
 
Now, let’s dissect the ways in which commercial real estate becomes pricier. When considering a parcel of commercial real estate, we look at three metrics - income approach, comparable sales, and replacement cost.
 
Let’s start with the easy one first - replacement cost. You’ll need some land. Curbs, gutters, storm drains, maybe some demolition, and loss due to street widening are called off-sites. An architect will charge you to design, engineer, and process your new build through the city. A contractor will quote construction. Money may be borrowed which adds a layer of expense. Finally, to compare with an existing structure - depreciation is deducted. Now you properly have estimated replacement cost.
 
Comparable sales are a great gauge of commercial real estate value - normally. These simply view the market in the rear view mirror. In our over-heated industrial playground - if only the reverse is considered and not where the puck is going - you’ll miss a big chunk of equity. Therefore, in addition to COMPS, please contemplate what’s available and what those alternatives portend.
 
Finally, the most complex - Income approach. Regardless of the commercial real estate genre - apartments, industrial, office, retail, raw agricultural land - ALL can generate a dollar amount per month - rent. The amount and associated risk of said rent form a valuation labyrinth. Let’s say that manufacturing facility which bears your company’s name pays your LLC $12.00 per year in rent. Coupled with a risk defined return of 4.5% would suggest a value of $266 per square foot. Easy.
 
As you’ve gathered, two buckets of wealth are created - company plus brick and mortar. What’s uncanny today? How far the values of business homes have exceeded the company’s worth. This week I witnessed an example - six fold! Both figures were accurate as the owner recently paid a consultant to value the operation and we received an unsolicited offer to purchase his real estate.
 
Ok, so what? You may be wondering. It’s all paper until I’m a seller. That, dear readers is the topic for next week. So, stay tuned.
 
So, there they are - my 2022 predictions. Stay tuned this time next year to see how I did.
 
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.