How will we Know When the Market Changes?

Much has been written lately about economic storm clouds massing on the horizon. If you doubt what I say, pick up any periodical, listen to talk radio or a network news broadcast and mentions of inflation, interest rate hikes, and the Fed’s remedies will abound. Akin to a desert monsoon that starts with a puff of clouds and morphs into something larger - everyone senses the deluge is coming but are uncertain how extreme the soaking will be. Full disclosure. Neither do I. 

 
Certainly, my years of experience and witness of several downturns can add credence. But, the reality is all are different in their causes. Take 1990-1994 as an example. Loose lending by savings and loans and their ultimate demise, over building, and Iraq’s invasion of Kuwait catalyzed the boom years of the late eighties to a screeching halt. 
 
How about 2008-2011? Easy money to unqualified home buyers coupled with another spate of massive construction starts was ill prepared for a pause in the music. Many were left without a chair as the financial markets froze and lending ceased. 
 
Today, the culprits are the pandemic which left us home bound and computer key happy, stimulus checks, and supply chain clogs. The classic case of too many dollars and too few goods took effect causing consumer prices to spike. Not since the Carter years have we seen inflation this high. 
 
Caught in the crossfire is real estate - commercial and housing. Housing has started to slow as buying power is directly impacted by pricier loans. Even though inventory of homes for sale is low - offerings are sitting around longer and the frenzied pace of January 2022 is a distant memory. 
 
So when will we know the commercial market is slowing? The following will provide some guidance. 
 
As I’ve mentioned, commercial real estate trends follow residential by 12 to 18 months. But we’ll sense a slowdown soon - if it’s coming. 
 
First, listings will languish. What flew off the shelves earlier in the year will take longer to lease or sell. Recall, our vacancy is at historic lows. So, this won’t happen next week. But, maybe an offering that generated multiple offers will settle for one or two. 
 
Next, owner motivation will shift. The longer a vacant building lays fallow, the more desire an owner will have to fill it. 
 
Pricing will stabilize and then decline. With occupants on the sideline, owners will be forced to deal. One way to do so is through a reduction in asking prices. 
 
As rents adjust, so will values. Recall, the price an investor will pay is a return on the lease check a tenant writes each month. A decline in this amount coupled with an upward move in capitalization rates causes the price per square foot to decrease.  

Believe me, I’m watching all of the above quite carefully. Just today - while guiding a tour - the conversation centered around “where are we going” as it pertained to our owner’s situation. Yep. An entirely different rhetoric was rampant a mere three months ago. 

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.

Random CRE Thoughts

Occasionally, it’s cathartic to empty the cache of our consciousness. Today is that day. As someone famous once opined - they’re only thoughts but they’re random and all mine. So with no further adieu, here goes!
 
Lee and Associates Summit. Last week we found ourselves at the Encore in Las Vegas for our annual soirée - AKA the Summit. Participants from all over North America and the UK attended. 2020 was scrapped entirely. 2021 was virtual. So this was the first time we’d been together since 2019. MUCH has changed - including a supercharged industrial market, an uncertain office environment, and a morphing retail experience. I should mention, our technology tools have also improved. Months of lockdown will do that to an industry.
 
Highlights from the industrial panel featuring professionals from the Rockefeller Group, Dermody, and Prologis follow. Institutional property owners are wary of inflation, a pending recession, and what impact both will have on cap rates. All agreed - industrial has been the darling and even if all of the new projects under construction laid fallow - our vacancy would still be skimpy - around 5.5%. Fuel conservation, automation, and taller and more efficient inventory is in our future. With the advent of self driving trucks - truck courts may be shorter.
 
Technology use in commercial real estate has lagged our residential counterparts. Since a house purchase is largely a consumer transaction vs a business deal - target rich social media sites are not as plentiful. Plus, we don’t share our available inventory and lease comps through a realty board clearinghouse. Therefore, we’ve been slower to adapt. We’ve witnessed a large consolidation of tech providers as evidenced by Lightboxes acquisition of ClientLook, Real Capital Markets, and Digital Map Products. Also, Buildout recently added Apto, Rethink CRM, and Prospect Now. No one dares to take on the big Gorilla - CoStar however. Some in the audience wondered if the broker would ultimately be ousted? Consensus was more money CSM be made selling to brokers vs replacing their role.
 
Who knows where we’ll be next year. Most agreed Las Vegas is tough to beat for its travel ease, entertainment, and massive convention know how. It is a tough schlep from the East however.
 
My foray into the Orange County office world. As readers know, my expertise centers upon manufacturing and logistics buildings and the family owned and operated companies that occupy them. I don’t seek office assignments, but occasionally they find me. Our current task is an offshoot of an industrial deal. You see, we were engaged to sublease a building’s warehouse. Planned was for the tenant to remain in the office portion. As our campaign unfolded - two groups emerged who wanted both - the warehouse and office portion of our offering. Now the operating group is considering a move into a suite of offices. Therefore, we toured eight suites in five buildings over the past week. The office world is changing to meet an evolving workforce. Open collaborative spaces are vanishing and returning to banks of private areas. After all, virtual meetings require privacy. Outdoor space is sought for respites, meetings, and functions. On-site amenities such as conference areas, fitness centers, and game rooms are cropping up. Corporate America is considering amenities in office buildings as a way to attract new workers and convince existing ones to return. Quite interesting turn of events, indeed.

 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.

Mechanics of a Build-to-Suit

Negotiations are underway - actually we have a signed Letter of Intent - on a large logistics building outside the Southern California basin. Our client plans an expansion of their operation into this location. The lure of less expensive land and fewer city restrictions hooked us. The lack of supply nearly capsized us until we decided to buy land and build - AKA a build-to-suit.
 
Recently, we sold a building located out of the state of California. Our client is an investor who purchased the Texas building to affect a tax deferred exchange.
 
Cash flow, ease of management, and the multi year lease had appeal to the buyer. For the next 10+ years, our client will enjoy clipping the coupons of rent payments. 
 
The building is leased long term to a Fortune 500 company. A build-to-suit was accomplished for the tenant four years ago.
 
So, what is a build-to-suit and when should one be considered? I believe one or more of the following circumstances would dictate building new versus buying or leasing an existing building.
 
Lack of availability. Industrial vacancy in Orange County, California is the lowest in history. 99.5 of every 100 manufacturing and warehouse buildings are occupied. And if your desire is Class A - in many cases there is no supply. If your company needs to grow into a larger building, chances are you'll be hard pressed to find one. The lack of available buildings should suggest a good climate for a build-to-suit. The trouble is - there is very little undeveloped land in the county. Even if you wanted to build a building, no vacant land exists to accommodate the build. In the case of the Texas building above, there were NO vacant buildings within the desired city - but a surplus of affordable, available, buildable land sites. Thus, the choices were - build or consider another city.
 
Special purpose building. This is similar to the circumstance of "lack of availability" yet very different. If you are patient, and occupied buildings are present in your market, eventually one will lay fallow, create a vacancy, and need a new occupant. A special purpose building contains features that don't exist in the market - a warehouse with 40' ceilings, or a building with acres of excess land for outside storage, maybe one constructed to store highly combustible or explosive contents. Our Texas building required two of these - VERY high ceilings and acres of excess land for expansion and trailer storage.
 
A unique deal structure. Recently, a grocery distributor required a class A constructed warehouse building in a size that didn't exist in the city they desired. Additionally, the occupant wanted to own but couldn't afford to purchase land, build the building and carry the debt on a building under construction they couldn't occupy until completion. The solution was to interject a developer who purchased the land, built the building, leased the building to the grocery distributor and granted the occupant an option to buy the building once completed.
 
But, be wary of the following issues.
 
Lotsa lead time. Few if any occupants can predict their space needs two to two and one half years in advance of a move. However, you must allow this much time to complete a build-to-suit.
 
Complete understanding of the mechanics. The basic structure is - land is owned or purchased, new construction is planned and permitted, building is built, new construction is occupied. Easy, right? Yes, if you own the land, already have the plans drawn and permitted, have a bucket of cash to spend on the construction, and don't need the building for several months. Complexity is added with each un-checked box.
 
Financeability. You need to understand how the financing of a build-to-suit works. I could write an entire column on this subject, however, some of the highlights are - vacant land will generally need to be purchased for cash, a construction loan will precede the permanent loan, a couple of appraisals may be needed, land owners won't allow their loan (if seller carried) to be junior to a construction loan - are you yet confused? Exactly - not a simple transaction!
 
Understanding you will pay more. I would encourage you to take a look at the reasons you will pay more to occupy a new build vs. an existing building. In short the reasons are - land prices, soft costs, entitlements, time value of money, financing, economies of scale, and market forces.
 
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 Market a Leased Investment

As commercial real estate practitioners, our assignments vary. But generally they are representing an owner or an occupant. Occupants need a place to conduct business through leasing or purchasing their commercial real estate. Therefore, we conduct searches, tour alternatives, and advocate for our occupant clients. With owner representation, we’re engaged to find a buyer or tenant for an empty or soon to be empty location.
 
But. On occasion an owner assigns us the job of selling an occupied building - also known as a leased investment. You may be wondering why a stakeholder would sell a cash flowing asset. The reasons are myriad. But typically a transition has occurred - a death, divorce, or business succession. Sometimes a change in motivation, the need for cash, or a desire to expand a portfolio through the use of a tax deferred exchange happens. Lately, as values have increased exponentially, we’ve seen a spate of unsolicited offers at eye popping amounts which has caused some owners to transact.
 
So, how do we market a leased investment assignment? First of all we need to understand the differences between an income generating vehicle vs an empty address. You see, a vacant building needs an inhabitant. But an occupied location doesn’t. Therefore, the prospect you’re seeking changes - from a company looking for utility to an investor driving returns. A growing enterprise cares about yard space, warehouse ceiling height and power whereas an investor considers term of lease, rents paid, and the financial strength of the tenant.
 
Marketing collateral for a leased investment will include information on the tenant, demographics, a rent roll - which details the leases, term increases, and expirations - and some color on the local area. Depending upon the dollar amount and nature of the offering - a National appeal may exist. As examples. A $30,000,000 logistics warehouse located in Chino and occupied by Amazon would garner interest from far and wide. But a $2,500,000 price tag with Joe’s Mufflers housed would generate local suiters.
 
We now understand the differences and are ready to launch our effort. Remember, we must get the information in the hands of those most likely to have an interest. Generally, an industrial building will not appeal to a group that acquires shopping centers. High rise office investors normally will not buy big box retail. But other investors will look at any asset class - office, retail or industrial or multi-family. Next, consider the investor’s source of capital. Will they use their own funds or rely upon OPM “other people’s money. And finally, what is their exit strategy. Are they going to raise rents and sell the holding or planning to keep it forever.
 
We’ve identified the most likely buyer pool. Now it’s a matter of choosing the platform to market our assignment. We want to cast our net where the fish are. Real Capital Markets will get your information into many sophisticated investor’s inboxes. A mailer might supplement. Certainly, calling likely candidates is effective. An email campaign to proprietary lists works great. Publishing in a multiple listing service - Costar, LoopNet or CREXI will yield results.
 
Ok, nets cast. Time to harvest the bounty of investor interest.

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.

Inflation Fears

Inflation is a ugly tax that reduces the buying power for all Americans rich or poor.
 
Granted, those at the upper echelon of earnings may not feel the pinch of those making minimum wage but there is an impact nonetheless. Our current inflation rate is running at an annual rate of over 8%. We’ve not seen that since the Carter years in the late 1970’s!
 
Clearly, all that we buy is not considered. Take industrial real estate rents for example. A small percentage of our society leases manufacturing and logistics buildings. But those that do and have the unfortunate timing of a lease expiration are experiencing a doubling or tripling of their rates. You read that correctly. In many cases we’re witnessing a 100% increase in that check you write to your landlord! Wow. We’ve seen rents increase close to 31% annually since the doldrums of 2010.
 
Why you may be wondering? Really it’s a simple case of too few available spaces (supply) to fill expanding business operations (demand). Owners are bullish and press rents. After all, where is the operation going yo move? In order to compete and win a deal, asking rates are often exceeded. We launched a lease listing three weeks ago. Bettered by 30% was our offered monthly amount.
 
Good thing commercial lease rates don’t factor into the metric of annual inflation percentages. Or do they? You see when a business - that leases an industrial address - sees a dramatic pop in one of its costs - that cost must be recouped somewhere.
 
Labor - especially skilled workers - was in short supply before the pandemic. Now that we’re back to work, companies must pay more in salary, benefits, and perks to attract and maintain quality employees. Therefore, another layer of costs is added to the product made or shipped.
 
What about fuel? A manufacturing company must receive raw materials to build its wares. Said components arrive via trucks that burn…yep! Diesel fuel.
 
So rents, labor, and delivery expenses are all spiraling out of control. Consequently, in order for an enterprise to remain profitable it must charge the consumer more. And the beat goes on.
 
Our government - in an effort to quell inflation has adopted a strict policy of increased interest rates. Now, on top of rents, labor, and materials - the cost of money is higher. When the Fed tightens credit by charging banks more - the trickle down to consumer prices eventually crashes home.
 
Buying power is further reduced. Just look what’s happening to housing. When a home buyer must pay more for a thirty year mortgage - the price they can afford goes down. Sure. A share of homes is purchased all cash - no loan. But when does that end?
 
You now start to understand why Amazon is curtailing expansion and why Target and Walmart reported abysmal earnings last quarter. The folks that buy things can’t afford as much.
 
Short term? More pain is on the way as the pendulum swings. But, know. Inflation fears will pass. Our last bout was followed by the greatest economic expansion in our nation’s history.

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.

Memorial Day Memories

Most of you are reading this on the day before Memorial Day. A day set aside to remember those who gave the ultimate sacrifice for our freedom. Freedom to live in a great country with infinite opportunities to worship, work, and live without the threat of an oppressive government. For those - we give thanks. For others who’ve lost loved ones in this struggle, our heartfelt condolences. Today, I’d like to share with you some folks who’ve been instrumental in my commercial real estate career who sadly are no longer with us. To my knowledge, none served our country but are fondly remembered nevertheless.
 
Bill Lee. Bill left this world on April 5, 2021 surrounded by friends and loved ones. I wrote a column in this space about Bill’s life and impact on Commercial Real Estate. If you like, you can read it here - Location Advice - California Businesses: How to Become a Commercial Real Estate Legend? Simple! R.I.P. Bill Lee. Bill’s enthusiasm was contagious. I adored him the moment we met. His wheels were always turning and you’d sense it when you spoke to him. Always open to new ideas and keenly aware of opportunities - times with Bill were memorable. However, Bill was chronically late. I finally learned to tell Bill a meeting was thirty minutes before it’s actual commencement so that he’d show up on time. Fashionably late indeed! Because, I could never count on his punctuality - I was acutely aware of my meeting preparation. Thus, I was less reliant upon his presence. Maybe that was his intention all along - to train me to be prepared. Also gleaned was the importance of cooperation with your competitors. Please don’t misunderstand. Bill wanted to beat them for assignments but once the client decided - cooperation was tantamount.
 
My paternal grandfather, Sam Buchanan Sr. I had the privilege of knowing Samuel Abraham Buchanan, Sr. until his death on March 30, 1975. He was 71. I thought he was an old man. Now that I’m 65, I’ve revised my definition of old. Grandad founded the Buchanan Bottling Company in 1930. Texarkana, Texas was his location of choice. Relocated we’re his wife and two small boys and their new lives began. I marvel at his grit. To take a risk at that time - the Great Depression was in full swing and a World War was a decade away - form a business, move his family on hope and prayer was remarkable. Observing the joys and struggles our family business experienced prepared me well for a career advising family owned and operated manufacturing companies on their real estate decisions.
 
My father Sam Buchanan Jr. As many father son relationships can be - ours was strained at times. I spent far too much time concerned about his opinion of me. Shortly after he died on July 4, 2020 - I penned this final momento. “Dad, as an adult, I’ve been the best I could be. I celebrated forty years of marriage with the love of my life, raised three amazing college grads, have been blessed with five beautiful grands, live debt free, don’t drink, smoke, or do drugs, have achieved success within one of the toughest industries in one of the most competitive markets, have a great relationship with all of our family and enjoy a strong faith in God.” I have Dad to thank for that - pressing me to achieve.
 
Sheldon McKnight. “Shelly” was one of my dearest friends and clients until his death in 2017. My first encounter in 1996 was a sign call. You see, folks - in need of a building - used to drive around and call agents whose names appeared on signs. He described his requirement like this - 4000 square feet of dock high space he’d prefer to lease month-to month. You brokers understand. Best case, this was a $200 pay check. And I should mention, had an availability rarer than a Big Foot siting. Something inside me said I should not shine this gentleman but should try to help him. His requirement morphed into a much larger deal - a 15,000 square foot sale. Many more would follow - 18 in all over the next decade and a half. He shared with me years later his strategy. He wanted to team with someone who was hungry and would work hard on his behalf. By describing an uber small deal - he knew he’d weed out those not interested in rolling up their sleeves.
 
So, there you go. Rest well dear ones. Our memories are still alive.
 
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.

The BIG Deals

I’m penning this column from our oldest son’s breakfast room. You see, his wife, three beautiful children and he live north of Austin, Texas - which is my home for the next few days. Our agenda includes lots of hugs for papa, wary looks and barks from their new puppy, a birthday celebration for #2 of our five grands and caddying for our son as he played in a qualifier for the Texas State Amateur. For those not bitten by the golf bug - it’s sort of a big deal. Stay with me, commercial real estate is coming - I promise. Our son has never - until yesterday - played a competitive round of golf. But, he maintains a 5 index - quite respectable for a recreational golfer. Consequently, yesterday was a huge stage! Akin to singing at Segerstrom when you’d only Kareoked - he was a bit outclassed. His demise was epic, humbling and embarrassing as he carded more shots in four holes than most do in nine. But the learning experience was life altering. I believe the lessons he learned apply to commercial real estate - so fore!
 
Two things were lacking. Quite apparent were the absence of competitive rounds and a fool proof pre-shot routine. In our trade, what he attempted was to sell a 100,000 square foot logistics building when his previous record was a 2000 square foot lease. Doable but highly unlikely. It’s quite necessary to “build your resume” with months or years of sale transactions before you venture off into huge deals. Our pre-shot routine of relationship building, qualifying, controlling and transacting provides a gauge on how things are progressing. Once you’ve taken these steps for awhile - they become rote. Skipping a step will always bite you. Similar to a shank - you just don’t know when.
 
When should you swing for the fences? Sorry to mix metaphors but just when should you try for the big transactions? My rule is not until your expenses for the year have been paid from smaller closings. Those whoppers are elusive, buyers and sellers more sophisticated, and competition fierce. Large real estate contracts have more attorney scrutiny, lender oversight, and can take time. If your staying power is compromised - the waiting is agony.
 
Practice is not the same as playing. You must place yourself in positions that mimic tournament conditions - the nerves, the fear of failure, the penalties for errant shots. In our world, practicing a pitch is great - but drastically different from live. The more opportunities you give yourself to compete for assignments, the better you’ll be. The nerves vanish. Sure, you may get some pre-proposal jitters but once you start they go away.
 
You miss 100% of the shots you don’t take. Made famous by Wayne Gretzky - these words are applicable to life, golf, and commercial real estate. I was very proud of our son for his attempt. It took real moxie to tee it up with the big boys. In brokerage it’s fine to compete for assignments outside your comfort level. It’s how we grow. But, just be prepared to be humbled…often. Just always take away two things you’ll do differently before the next time. Is transactional experience lacking? Are you unfamiliar with the market? Could your team use another member? Are you with the wrong firm? Consider all of these carefully.
 
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.