The MOST important thing in a #CRE purchase

We are immersed in a seller's market in Southern California...AKA, we are close to the end...because buyers are committing to CRAZY numbers for industrial buildings.

An imbalance between available inventory and buyer demand has sent the prices of well appointed (and even misfit toys) buildings past the pre-recession highs. Rents have not quite followed suit, but soon will, as buyers cannot find anything to buy...need to grow...and will lease instead of losing business.

So what do market conditions in my patch of the world have to do with the MOST important thing in a commercial real estate deal? Allow me to digress and meet you on the other side...

I provide Location Advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I have witnessed three price peaks in that period of time...and the resultant price busts...which qualifies me as an expert to discuss the market today...I believe.

So, back to the MOST important thing in a commercial real estate purchase:

Location: We have all heard that the three most important aspects of real estate are location, location, location. Although this has merit, I don't believe that location is the most important thing in a commercial real estate purchase. As an example, if the prime area for appreciation is an hour's drive from your home, what do you gain?...other than a commute in and out of the office of two hours per day. What if the location places your business farther from your customer base or your key employees, thus increasing the cost of your operation? As you can see, location is not the most important thing.

Function: Certainly if you are occupying the building that you buy, the function must conform to your use and the size must mirror your growth projections. The real estate must have ample power for your operation, generous loading and freeway proximity for your logistics, and sufficient sprinkler capacity and clear height for your warehousing. The office space within the building must be adequate to comfortably house your staff. The function must work...but at what expense?

Investment Metrics: If you are buying a piece of commercial real estate strictly for investment purposes, several factors should be considered...capitalization rate, current rental rate that the tenant pays, stability of the income stream, price of the building, general lease-ability, etc. In a moment you will discover the MOST important.

Financing: The interest rate and terms at which a commercial real estate purchase is made can cure a lot of ills, but is it the MOST important item in a purchase? Imagine if you achieved a 2% interest rate but the rate could increase at will. We saw an awful lot of prime rate adjustables in the early nineties that when adjusted crippled the borrowers. What if the loan comes with an enormous pre-payment penalty that will hamstring your ability to sell the building?

Pricing: Some would offer that if commercial real estate is purchased at the right basis (price), then any deficiency with the real estate can be overcome. Really? What if the reason for the pricing is functional obsolescence? A building fifty miles from civilization is going to trade for a much cheaper price than one in the heart of the central business district. There is generally a reason why something is cheap. The best alternative for your business may be a building right next door...but you will probably pay a premium.

Ok, so what is MOST important?

The answer is they ALL are the MOST important! In my experience the stars must align...AKA, all of the reasons must point to go in order for a purchase transaction to occur. Just like the pre-launch scene in the movie Apollo 13, you MUST be go for launch.

Should your company consider a #CRE sale/leaseback?

In 2003, when California was in a world of hurt with worker's comp rates, employers leaving the state, driver's licenses for illegals (which all lead to Governor Gray Davis being terminated by the Terminator), we saw a huge amount of sale/leaseback activity from national corporate occupants.

Aquatics-Lasco Bathware, Akzo Nobel, Johnson Controls, Smurfit Stone, Parker Hannifin, Illinois Tool Works, Limbach...and many others sold manufacturing locations in Southern California and leased them back from the owners. Why, you may be wondering? Provide me your forbearance, while we hear from our sponsor, and I will explain my views...

I provide Location Advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I have been involved with many of the deals listed above which should qualify me as an expert of sorts...if I can only remember...

The two main reasons in 2003-2005 that many national (multi location) companies sold their locations and leased back, were real estate values and the business climate in Southern California. By selling the locations when the market was at its value peak and leasing back for a three to five year time frame, the companies maxed the real estate equity and could decide at the lease expiration whether to stay in California or consolidate into another location. Some stayed, but many left.

In my opinion, another perfect storm is approaching that could portend another round of sale/leasebacks...this time from closely held owners of real estate.

So, what are the reasons that a company should consider a sale/leaseback?

Values: Commercial real estate values have eclipsed all time highs in Southern California and there is a real imbalance between available properties and demand for available properties...AKA an owner's market.

Equity is needed for business expansion: When a bank won't loan money to an expanding business and there is equity in the company's real estate, a sale and lease back can provide much needed expansion capital...at today's capitalization rate...and avoid moving the company out of the location.

An acquisition: I was just asked to prepare a broker opinion of value for a company that acquired another. Along with the business purchase was the real estate that housed the operation. The company is not in the real estate business and leases their other locations. A sale/leaseback would allow the company to sell the real estate, take the proceeds and defray the acquisition cost and leave the operating unit in tact in the real estate with a lease.

A business transition within five years: If a business and location owner foresees a sale of the business within the next five years, now could be a great time to dispose of the real estate (while values are high) and lease back. The business sale (in five years) then would not be encumbered by the location. Certainly, if the new owner of the business wants to remain in the location, a lease with the new building owner can be affected.

A flight to quality: I worked with a national company a few years ago that sold and leased back for five years. Their belief was that values had peaked and their desire was for a more upscale location within five years. The structure allowed the company to achieve its goals. By the way, the company couldn't have planned the timing ANY better...a sale in 2005 (high for sales) and a new lease in 2010 (low for leases)...BINGO!

The good ole days in #CRE...circa 1985...AKA where is my Delorean?

I am pleased to say that I just closed the sale of an industrial building in 30 days! My guy waived contingencies in two weeks...including city approval of his use and operation, secured financing from his savings and loan at 9.5%, and will move in next week!...this post from 1985!

Man, those were the days...am I sounding old?

I have to admit I got a bit jaded this week as I attended yet another seminar on AB 1103...California's weak attempt to benchmark energy uses across commercial real estate sectors. I pondered how the "deal process" has morphed in the last thirty years. More on that in a moment.

As a disclaimer, I provide Location Advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. As I have sold or leased hundreds of industrial buildings over four decades...and can compare the differences...I am qualified as an expert...if I can only remember why...

So back to the deal environment and how the process has changed in the past thirty years...

Thanks to the regulatory environment that ALL California real estate brokers must adhere to these days, the number of newly minted legal professionals, the Savings and Loan industry imploding, three ugly recessions...1991-93, 2000-2001, and 2008-2009 , changes in the property tax laws (prop 13), gross imbalances of revenue intake and outflow in our cities, etc., our sprint to closing a commercial real estate deal has many new "hurdles" to hump...and many new costs to bear. By the way, ALL of these have surfaced in the last three decades.

Non binding Letters of Intent: A binding offer has evolved into a "we will consider if we want to but only if the consideration will not adversely affect anyone or if it does we can change our mind...and only a lease or a PSA will bind us unless we have a great lawyer and we didn't really mean it and can get a judge to see it our way..."

Phase I, II, and III environmental reports: These broke on the scene in the mid 1980s and add $2500-??? depending upon the phase and extent of enviro contamination (including regional issues). Like leaving home without an American Express card...lenders won't lend without them.

AQMD credits: Frankly, I still don't understand these. If I ever do business with a company needing a spray booth of any sort, I immediately refer them to my expert.

Title 24: HVAC calcs that affect any new office space construction...just wait...this is about to ramp  up to a whole new level thanks to AB 1103.

Seismic upgrades: I get this. We don't want a building falling into a heap when the Earth moves.

Appraisal review boards: Banks and/or brokers used to have a say in the appraiser they chose...that was abused, values sky rocketed...unjustifiably...we now cannot provide any input and neither can the lender as they must follow the recommendations of the appraisal review board. If you get a bad appraisal (less than value)...prepare for a war.

Natural Hazard Disclosures: We need to protect California's business operators from the threat of a flood...mind you Southern California gets approximately 9 inches of rain a year...Texas can get that in two hours...

Americans with Disabilities Act: Once again, I get this one. The problem is no one seems to understand what is required, who is responsible, and what it costs...and oh yeah, no one polices this at the city level...hmmm.

Conditional Use Permits: Visit the counter at a city, check the zoning, is the use permitted?...cool!...ummm, not so fast I recently visited my fair city of Orange, California, checked the zoning, the use was permitted in the zone..and was told I needed a CUP...which costs $3-$5000 and 120 days. Why? because the city was considering changing the zoning in the future and the use wouldn't comply with the new zoning.

High pile storage permits: You can't just rent a building, stack your stuff and do business. You must now comply with the type of stuff you store, in what quantity, at what height, etc. Have your fire consultant's number on speed dial!

Racking permits: About a $10,000 price tag and a 30 day lead time...

Occupancy permits: You can't just move in and operate your business...even if you're an approved use in the zone...and doing everything to code.

UL machinery ratings: Gotta have the tag OR you gotta get one...to the tune of $2500 per machine

AB 1103: The new law enacted in in the mid 2000s...but yet to be fully implemented (because no one understands how to implement it) seemingly has a good purpose...to reduce energy consumption...until you read the fine print. Energy companies are under a mandate to produce 33% of their consumables by the year 2016...now one understands that the energy lobbies are pushing the regs down to the end user.

A buyer of an industrial building is now forced to engage a specialized consultant to advise them on all of the above...some are lender requirements...ala, enviro reports...at a significant cost, BTW!

So what are the takeaways assuming you don't have a Delorean and a wild haired professor with a time machine?

• Understand what is required...and the timing of each requirement
• Properly prepare owners and occupants so that expectations are managed
• Have several consultants in your database that you can refer to your owners and occupants.

Five #CRE secrets...your broker won't tell you

I want to broach a subject today which is painful for me...the five things most commercial real estate brokers won't tell you. 

The reason this subject is painful is because I LOVE our industry...most everything about it...the people, the pace, the financial rewards, the freedom and flexibility...and most of all...helping business owners achieve their dreams with commercial real estate.

However, I have witnessed...as we all have... some practices that are scary and self serving which I will discuss below.

As a disclaimer, I provide location advice to owners and occupants of industrial buildings in Southern California...AKA, I sell and lease commercial real estate for a living and have since 1984. I have dealt with hundreds of CRE practioners, trained new associates, and operated within the industry for thirty years...there is some expertise bubbling below the surface that I want to un-cork.

In a Letterman-tonian format...here goes!

I believe you could avoid a move if you did a few things differently: We are paid to move companies and fill spaces or through companies relocating into those spaces. I wrote about this last week...moving sucks...it is expensive, disruptive and rarely achieves the efficiency that is sought. Do you and your client a favor...discuss ways that a move can be AVOIDED...first...before striking out to find a new location.

 I don't believe that buying a building is in your company's best interest: $$$ Dollar signs cloud our judgement here! We make so much more selling vs leasing. If someone tells us that they want to buy...very few of us will challenge that desire...even if we know that buying might be counter productive.

 I have not fully researched a building before we tour: This drives me CRAZY! So many in our industry will not preview a location before touring...maybe because of the above?...you got me, they will not discuss the owner's motivation with the listing broker, will not check on zoning, etc. An inordinate amount of time is wasted! Hint: Don't take a client through a building that you have not previewed...you will save yourself a lot of agony and improve your professionalism.

I have made touring your property as difficult as possible: Vacant buildings used to be sooo easy to tour...we all had a lock box key that fit the standard lock box and our industry used the lox boxes universally. If you could not reach the listing broker, you could simply drive by the building...if it was vacant, the likelihood was high that a lock box was on the front door...bitchin! You could preview, take your client through...all very painlessly. The world has changed! We now must call for touring instructions...which vary by broker. Many listing brokers insist upon meeting us at the building to preview and to tour...a royal pain in the ass! NET, NET cooperation is discouraged. Hint: Candidly, the opposite approach should be taken...MAKE IT EASY!...your owners will benefit!

Your property is dramatically over priced: Some CRE brokers will inflate the asking price of a listing! Shock..the horror, the humanities! This practice probably bugs me the most...I get that we want to achieve the most $$$ for our owners...but please...is that 1960s vintage, low clear, under powered piece of junk worth more than a class A, beautifully appointed, well located alternative...c'mon.
Hint: Level with your owner. Explain that his expectations are out of line with the market and that a higher than reasonable asking price will actually deter any interest and cause the property to sit...maybe for months.

OK...rant rage over. You get the idea. Please do us all a favor... don't be that guy...

Ways to navigate an owner's market

I provide Location Advice to owners and occupants of industrial buildings in Southern California. Occupants in Southern California have enjoyed a five year occupant market...multiple buildings available to fit the search criteria, "once in a lifetime" owner motivation, no competition, myriad concessions (free rent, moving allowances, broker bonuses, etc.). Well as the old Bob Dylan tune lyrically opines "the times they are a changing'".  We are firmly entrenched in an owner's market! Today, I will discuss ways that you, as an occupant, can navigate an owner's market.

Start early: As discussed in an earlier post, there are five very distinct reasons that companies relocate. I would encourage you to read the post that discusses these reasons. For this post, we will assume that your company has made the decision to relocate. How early should you start considering your alternatives? I believe the correct answer is 12-18 months prior to the projected move date. This is typically tied to a lease expiration. You may be thinking, "so many factors will change in that time frame"...you are correct. One thing that won't change (in your favor), however, is the CRE market.
 

Know where you stand: You should have a very good idea of the market forces...available properties, recent sale or lease comparables, leasing concessions (if any), financing rates and terms (which lenders are the most aggressive), tax law changes on the horizon that could affect buying, selling and leasing motivation (this was huge at the end of 2012), how your current lease terms relate to the market, what extension rights does your lease document contain...options, first rights, etc. Think "fall back" here. You may be wondering..."wow! that's a lot of stuff!" You are correct, but knowing where you stand and what options are available to you will save you a huge amount of aggravation when it's time to negotiate.

Engage good help: So how do you determine exactly "where you stand?" Some of the information is available to you by reviewing your lease, meeting with your banker, or accumulating those annoying broker mailers that you receive daily. I would suggest that you engage a competent location advisor to help you analyze where you stand and what options are available to you. The right CRE practitioner can educate you on the current market conditions.
 

Be prepared: Assemble all of your financial data for easy access. If you are leasing a new location, the landlord will want to review at least two years of financial data both personally and corporately...that's right, personally. Most owners today are seeking lease security...and they can get it... which means personal guarantees of lease obligations. If your desire is to purchase a  location, I would suggest getting your company pre-qualified for financing. A previous post discussed how to accomplish this. When the right alternative presents itself, you will be ready to react to the owners request for financial information (or submit this with the offer to lease) or present your "pre-qual" letter with your offer to purchase.

 

Examine ALL of your options: Do you really need to move? I know that the premise of this post is that a decision has been made to move...but have you truly exhausted all of the ways to utilize your location more efficiently? Please carefully consider all of the ways to avoid moving as contained in this previous post. Believe me, it's brutal out there. If you can avoid the agony of an owner's market...DO IT!
 

Be realistic: OK, so you you've started early, you know where you stand, you have engaged a great advisor, you are prepared...AND you understand ALL of your options...now what? Please be realistic OR you stand to be bitterly disappointed. The smorgasbord of available properties has closed, the waterfall spigot of lease concessions has run dry, and the desperation asking prices are now closer to 2007 pricing. Remember, this location provides a functional hub for your operation...period! Find the most suitable, functional location that is available today and make it work. You may have to add offices, upgrade the sprinkler system, add a loading door, upgrade the power service, survive without a storage yard, expand your geographical search area, etc. Compromise will expand your available alternatives.
 

Shorten the downside: If you are buying and the mortgage, property taxes, insurance, and maintenance on the purchase exceed 115% of the market lease rates...consider leasing. The exception to this rule is if you plan to own the real estate forever and the real estate will meet your company's needs forever...see where I'm going here? The last thing you want on your books is an overpriced, illiquid asset that doesn't function for your business. You will have to sell the location for a loss or rent the location and provide a subsidy. Don't lock yourself into a long term lease if you believe the rate you are paying is above market. Remember that most leases have escalation clauses. This rent will increase over the term. Shortening the term can shorten the downside.

Good luck out there! Owners are "licking their collective chops". Don't be "raw meat".

 



Must dos when purchasing a commercial building

I provide Location Advice to owners and occupants of manufacturing and warehouse buildings in Southern California. Today's post will deal with that "all important" must do list when purchasing a parcel of commercial real estate.

We will assume that you have made a decision to buy and have followed the  suggestions of a previous post on buying an industrial building. We will also assume that you have considered your financing source and have consumed the post on financing a commercial building.

You have agreed upon business points and have signed a letter of intent...now what? Hopefully, your location advisor will assist you though the process and will not just wait for escrow to close and the commission fee to arrive!

Generally and simplistically, here are the things you "must do".

Sign the Purchase and Sale Agreement: Also known as the PSA, deposit receipt, contract for purchase, escrow instructions, etc. I prefer the AIR Standard Offer, Agreement and Escrow Instructions for the Purchase of Real Estate. This document  is widely used in the state of California and contains succinct points on due diligence, financing, representations, warranties, remedies, deposits, liquidated damages, etc. Your contract should contain adequate time frames for you to secure financing and check out the building...structural (roof), environmental, title, operating systems (HVAC, plumbing, electrical, loading doors, fire sprinkler system), underlying liens, underlying financing, leases, etc. I generally ask for 30-45 days for "non-loan" approvals and 45-60 days for loan approval. The times are run concurrently from the opening of escrow (when both parties sign the PSA). Two items of note in the AIR PSA: Paragraph 7.1 obligates you as the buyer to use the services of the buyer's broker for a period of one year from the reference date...not big deal if you close...maybe a big deal if you don't. Paragraph 18.1 obligates the seller to pay a commission if contingencies are waived and you don't buy the building. I would suggest modifying or eliminating both of these paragraphs.

Open Escrow: You or your location advisor should deliver a signed copy of the PSA and any deposits to the escrow company listed in the PSA. As a buyer, you have some say in the title and escrow officer choice. I enjoy using a private escrow company because I get personalized service. My escrow company of choice is Heritage Escrow in Irvine, California. Janet Tilbury is extraordinary and my choice if you want to get the transaction closed with no brain damage.  Janet's phone number is 949.930.8501.

Order the Title Report (prelim) and the NHD: Your escrow officer accomplishes this for you. Once again, you get some say in the title company selected even though the seller pays for a standard owner policy. It is generally a good idea to have a real estate attorney review your prelim especially if the building you are buying is a condo, a PUD, or has an association. Any financing against the property will be removed at the close unless you are assuming the loan.

Review the NHD: The seller will provide you with a Natural Disclosure Statement which will tell you if the building is in a flood plain, seismic area, etc.

Conduct the necessary inspections, receive the reports and review and approve them: I would suggest engaging a company such as All West, Marc Cunningham to conduct a Property Condition Assessment (PCA). the PCA will review all of the building systems...HVAC, electrical, roof, foundation, plumbing, seismic, plumbing, elevators, sprinkler system, etc. and generate a report with any needed repairs and a capital expense schedule for the first five to ten years of ownership. Additionally, you or your lender will order a Phase I Environmental report which reviews the enviro history of the site and the previous uses. All West can also do the enviro but I would suggest routing this through the lender as some companies are not on the lender's accepted list and any loan made on the property will be subject to the environmental health of the building. The lender will also order an appraisal and any loan will be subject to a satisfactory appraisal at the agreed value.

Achieve a financing commitment: Make sure to build the appraisal and enviro approvals into the loan approval so that the time frame negotiated for loan approval includes receipt, review and approval, of the necessary enviro and appraisal reports. If you are seeking an SBA loan, there are actually three approvals...the bank, the CDC, and the SBA. I would suggest not waiving any loan contingency until ALL of these approvals are received.

Waive contingencies: You will receive a PCA with recommended repairs, you will receive a loan commitment. I would suggest approaching the seller on accomplishing some major repairs depending upon the other points of the transaction. Once all are received and approved and you are satisfied with the seller participation (if any), you can waive contingencies. Understand that once you waive, your contingencies you will have liquidated damages if you fail to close because you default. Generally, your liquidated damages amount will be equal to your deposit.

Close the escrow: The fun part! Now you own a building, congratulations!

The Yin and Yang of Moving

I provide Location Advice to owners and occupants of industrial buildings in Southern California. Generally this location advice involves a move of some sort. Today, I want to discuss the relocation of an occupant from an owner's point of view AND from an occupant's point of view. Recently, I wrote about the cost to originate a lease from an owner's perspective. You can read that post by clicking here. The net result, using the assumptions contained in that post, was that a new lease will cost the owner 20-25% of his future cash flow.

As the market in SoCal has tightened, and occupants have fewer alternatives, I believe the origination cost will trend toward the lower end of this range...primarily because buildings are selling and leasing quicker AND concessions are less plentiful...but re-tenanting a building is expensive. From an owner's perspective, it is far easier (and cheaper) to retain a tenant than find a new one...The Yin.

So what about an occupant relocating to a new industrial building or office suite? How much does a move cost? Simply stated, it depends...an artful dodge but there are sooo many factors involved, that the cost is tough to quantify. I will, however, endeavor to identify some of the major areas involved in the move...stay tuned.

A recent move into a 28,000 square foot building by a light manufacturing company cost approximately $100,000. Approximately 10 medium sized machines were relocated along with inventory, racking, and approximately 3000 square feet of office space and 20 employees.

Machinery-number of machines, size, weight, calibration (or recalibration), electrical hook-ups, UL rating, etc. One of my clients received a surprise when relocating machinery that was not UL rated...even though the machinery was new and had the European equivalence of a UL rating. The city my client moved to required my client to UL rate the machinery at a cost of $7500.

Special Purpose Improvements- Office space, paint booths, electrical distribution, freezer/cooler space, food processing space, racking, conveyor lines, clarifiers, etc. In Southern California, relocating a paint spray booth requires several approvals...Air Quality Management District and city. If you plan to stack over 12 feet...check the sprinkler calc...you may be in for a surprise!

Licensing-business licenses,  ISO certifications, spray booth emissions credits, racking permits, building permits, certificates of occupancy...all may be required.

Office-Any new office space will require building permits...which take time...which is money.

Infrastructure-Plumbing, sewer, water, electricity, Internet, cabling. One of my clients re-located into an office space that had inadequate Internet connectivity. We fortunately did our diligence, were aware of the issue, and were able to negotiate an allowance from the owner to cover an upgrade.

Physical move-According to Ron Larrieu of Penn Corporate Relocation Services, moving the contents of an office space can cost approximately $50 per employee or $1-$2 psf. This cost can be added to the cost of moving the "shop space" which includes the above items.

Miscellaneous-business cards, stationary, note pads, promo items, social media, websites, employee disruption, business interruption...all costs that need to be considered.

From an occupant's perspective, it is is far easier and cheaper to renegotiate an existing lease or remodel an owned location than to relocate...The Yang

My advice to you if you are considering a move:

Read my recent post entitled we have outgrown our location but don't want to move.

Analyze your re-location alternatives carefully...number of buildings on the market, pricing, concessions, etc.

Engage a professional relocation specialist such as Penn Corporate Relocation Services to analyze your location and provide a moving budget