You've opted to lease your business location - which means every month you pay rent to a landlord. Several considerations led you to the decision to lease versus own your building. We will leave the lease versus own conversation for another day.
Today, my goal is to discuss the dynamics that will cause your rent to increase - sometimes dramatically! Hopefully, the topics discussed here will prepare you for the call that your rent will soon balloon.
When a commercial real estate lease originates, the number of years - term, rent amount, rent increases, concessions - such as abated rent, building improvements and the like are spelled out in the document you and the landlord sign.
As the term of your commercial real estate lease can dictate increases in your rent, a brief explanation about length of leases is important to review.
Depending on the size of your space, lease terms range from month-to-month to ten+ years. A smaller space - fewer than 5000 square feet - normally means a shorter term - fewer than two years. Why, you may ask? Tenants that occupy small blocks of space are frequently start-up companies without the benefit of years of financial history. In some cases, these businesses are a payment risk. Landlords counter this risk by limiting the lease term - the overall amount of rent to which a tenant is obligated. Additionally, growth trajectory is tough to quantify with a new enterprise. Therefore, these operators are reluctant to commit long term lest they outgrow their digs.
With term explanation as a back drop, there are several other factors can cause rents to rise. I've ordered these from least to greatest:
Increases in operating expenses. Operating expenses include charges for property taxes, insurance on the building, common area maintenance - landscape, trash, utilities, parking lot sweeping, a share of capital expenses - a new roof or air conditioner, and in some cases property management. All of these charges are either baked into your base rent - a gross lease, or are paid for in addition to your base rent - a NNN lease. Unless your agreement specifies otherwise, as these expenses increase over the term of your lease - yep - your rent increases.
Pre-set increases throughout the term. Leases today typically carry annual increases in the base rent of 3%-4%. Gone are the days where the amount of rent paid each year increased by the change that occurs in the Consumer Price Index. Even though three to four percent annually seems steep compared with inflation - please understand, commercial lease rates have increased approximately 70% since 2009 - a staggering 8% a year! So, if you signed a ten year lease in 2009 with annual escalators of 2.5%, prepare for a bit of a jolt next year.
The sale of your building. The largest operating expense is property taxes. Recall, these are paid as a part of your base rent or in addition to your base rent. Annually billed at one percent of the assessed value of the real estate, property taxes can increase a maximum of two percent per year - unless - the building is sold for more than the assessed value. And then, WHAM! You are stuck with a huge bill.
The expiration and renewal of an existing lease. The coup de grace these days. Many leases expire and are slated for renewal - as our volume of leasing hit a peak in 2010-2013. A seven year lease originated in 2010 expired last year as did a five year lease commenced in 2012. Shock and awe are mild adjectives to describe tenant reactions to their landlord renewal proposals. Met with a limited amount of available buildings, many tenants have been forced to swallow hard and accept that their rent might increase 30-40%! Ouch!
Next week, I will discuss some strategies for limiting your rent increases - so stay tuned, faithful readers!
Friday, April 20, 2018
Friday, April 13, 2018
Would you Own your Commercial Real Estate - If Vacant?
Frequently, if you operate a small business, owning your location can make a great deal of sense.
Generally, it works like this - you form a Limited Liability Company personally. The LLC then buys the commercial real estate. Your business signs a lease with the LLC. Therefore, you pay rent to yourself. Brilliant!
Ownership allows you to fix your location costs - the purchase is financed with fixed rate debt for a period of time. The occupant is under your control - after all it is your company. Personally benefited are you from the location's appreciation - if any. Finally, there are some potential tax benefits individually. Awesome!
Now, let's add a dimension which many small business owners are facing these days - someone approaches you and offers to buy your business.
When you consider selling the business that occupies your real estate - even if the purchaser of your business signs a lease with your LLC - the question you should ask is: would I want to own this location if it were vacant? Business changes, motivation varies, locations depreciate. At the end of your tenant's lease you may be faced with a costly vacancy.
Remember, when you are the occupant and the owner, the dynamic is different than being the owner but not the occupant. You are now an investor who must compete with many other investors for your tenant's occupancy. The cost of originating a new lease is staggering - in some cases 20-25% of your lease income. Are you prepared for that potential risk? If the answer is no, then there are steps you can take to minimize the risk of owning a vacant building.
First, analyze your location's monthly carrying costs - debt service, taxes, insurance, common area maintenance, miscellaneous maintenance, etc. You should maintain a 9-12 month cash reserve of this total amount.
Secondly, determine how marketable the vacant building is. A commercial real estate professional familiar with the current market can provide this for you. How many vacant buildings similar to yours exist? What is the current appetite - including market time - for such a location? What is the current vacancy rate for facilities such as yours? - like yours specifically - not a market wide vacancy of all locations. How special purpose is your space?
Third, determine what the lease income is worth to an arm's length investor. This amount less any debt owed against the location and less any closing costs of sale and net of any taxes determines the proceeds that can be deployed into an alternate non-real estate investment. If you choose to invest in another income property, the gain may be tax deferred if the new purchase meets certain criteria. You may be wondering why you would sell one piece of real estate only to buy another? The simple answer is to lessen the risk. By selling a special purpose single tenant location and investing in a general purpose multi tenant location, the management is greater but the downside is more manageable - akin to selling stock in a single company and buying a mutual fund of many companies.
Generally, it works like this - you form a Limited Liability Company personally. The LLC then buys the commercial real estate. Your business signs a lease with the LLC. Therefore, you pay rent to yourself. Brilliant!
Ownership allows you to fix your location costs - the purchase is financed with fixed rate debt for a period of time. The occupant is under your control - after all it is your company. Personally benefited are you from the location's appreciation - if any. Finally, there are some potential tax benefits individually. Awesome!
Now, let's add a dimension which many small business owners are facing these days - someone approaches you and offers to buy your business.
When you consider selling the business that occupies your real estate - even if the purchaser of your business signs a lease with your LLC - the question you should ask is: would I want to own this location if it were vacant? Business changes, motivation varies, locations depreciate. At the end of your tenant's lease you may be faced with a costly vacancy.
Remember, when you are the occupant and the owner, the dynamic is different than being the owner but not the occupant. You are now an investor who must compete with many other investors for your tenant's occupancy. The cost of originating a new lease is staggering - in some cases 20-25% of your lease income. Are you prepared for that potential risk? If the answer is no, then there are steps you can take to minimize the risk of owning a vacant building.
First, analyze your location's monthly carrying costs - debt service, taxes, insurance, common area maintenance, miscellaneous maintenance, etc. You should maintain a 9-12 month cash reserve of this total amount.
Secondly, determine how marketable the vacant building is. A commercial real estate professional familiar with the current market can provide this for you. How many vacant buildings similar to yours exist? What is the current appetite - including market time - for such a location? What is the current vacancy rate for facilities such as yours? - like yours specifically - not a market wide vacancy of all locations. How special purpose is your space?
Third, determine what the lease income is worth to an arm's length investor. This amount less any debt owed against the location and less any closing costs of sale and net of any taxes determines the proceeds that can be deployed into an alternate non-real estate investment. If you choose to invest in another income property, the gain may be tax deferred if the new purchase meets certain criteria. You may be wondering why you would sell one piece of real estate only to buy another? The simple answer is to lessen the risk. By selling a special purpose single tenant location and investing in a general purpose multi tenant location, the management is greater but the downside is more manageable - akin to selling stock in a single company and buying a mutual fund of many companies.
Friday, February 23, 2018
Buyer's WILL Pay for these Commercial Real Estate Features
Last week, in this space, I discussed the amenities contained within your commercial real estate that do not "move the meter" with buyers - AKA, buyers don't care and won't pay a premium for the benefit.
You may wonder - are there, in fact, features that will create a greater worth for the real estate?
Absolutely!
In no particular order they are:
Extra land. Generally, a greater price will be paid if extra land exists. In our congested county, extra land is a rarity. However, I must define "extra". We use the term excess and surplus interchangeably - even though we shouldn't - to describe extra land. You see, if the extra land doesn't serve the use contained, but cannot be separated and sold, the land is actually surplus land. In this instance, an occupant who had a large outside storage need would ante up. If the surplus could house additional building square footage - voila! In the absence of these two circumstances, no increase - because fronting cash for future advantage is costly. Conversely, if the extra land was excess - I can separate it and sell it - eureka!
Warehouse ceiling height. Rents and sales prices are quoted in floor area square footage. Ignored is the cube space that exists in a warehouse. I wrote about that here. In effect, if the warehouse ceilings are higher than what's normally found in the market - an occupant can stack their goods higher and benefit from space for which they aren't being charged.
Loading doors that allow large trucks. Large trucks cannot make deliveries to a warehouse door that is lower than the truck bed - without a lot of excess material handling. Therefore, buildings equipped with "truck high loading doors" are valuable. If the warehouse ceiling also allows high stacking - you've got a duo in higher demand than Batman and Robin!
Fenced outside staging or storage areas. A typical manufacturer can benefit from outside storage of raw materials or finished goods. Logistics companies enjoy fenced and secured parking for their trailers. If your building has either, plan on jacking up that asking price.
Heavy electrical service. Much is involved with upgrading an electrical service into an industrial building - permitting, capacity, SCE studies, cost, time delays. If you own a building that has survived the agony of adding power, congratulations! This is a feature that will sell!
Fiber optic feeds. Many of the buildings in Orange County were built before the digital age. Consequently, few of them are wired for today's mass use of on-line commerce. Akin to the description of heavy electrical service additions, adding fiber suffers the same challenges and the same appreciation if the hurdles have been crossed.
You may wonder - are there, in fact, features that will create a greater worth for the real estate?
Absolutely!
In no particular order they are:
Extra land. Generally, a greater price will be paid if extra land exists. In our congested county, extra land is a rarity. However, I must define "extra". We use the term excess and surplus interchangeably - even though we shouldn't - to describe extra land. You see, if the extra land doesn't serve the use contained, but cannot be separated and sold, the land is actually surplus land. In this instance, an occupant who had a large outside storage need would ante up. If the surplus could house additional building square footage - voila! In the absence of these two circumstances, no increase - because fronting cash for future advantage is costly. Conversely, if the extra land was excess - I can separate it and sell it - eureka!
Warehouse ceiling height. Rents and sales prices are quoted in floor area square footage. Ignored is the cube space that exists in a warehouse. I wrote about that here. In effect, if the warehouse ceilings are higher than what's normally found in the market - an occupant can stack their goods higher and benefit from space for which they aren't being charged.
Loading doors that allow large trucks. Large trucks cannot make deliveries to a warehouse door that is lower than the truck bed - without a lot of excess material handling. Therefore, buildings equipped with "truck high loading doors" are valuable. If the warehouse ceiling also allows high stacking - you've got a duo in higher demand than Batman and Robin!
Fenced outside staging or storage areas. A typical manufacturer can benefit from outside storage of raw materials or finished goods. Logistics companies enjoy fenced and secured parking for their trailers. If your building has either, plan on jacking up that asking price.
Heavy electrical service. Much is involved with upgrading an electrical service into an industrial building - permitting, capacity, SCE studies, cost, time delays. If you own a building that has survived the agony of adding power, congratulations! This is a feature that will sell!
Fiber optic feeds. Many of the buildings in Orange County were built before the digital age. Consequently, few of them are wired for today's mass use of on-line commerce. Akin to the description of heavy electrical service additions, adding fiber suffers the same challenges and the same appreciation if the hurdles have been crossed.
Friday, February 16, 2018
Friday, December 29, 2017
A Commercial Real Estate Buyer Doesn't Care!
Akin to an automobile with a DVD player - a commercial building with certain features may NOT appeal to a buyer.
In fact they don't care, won't pay for the renovation - and maybe worse - will exclude your building from consideration if the betterment exists.
Hmmm, weird you say. I spent a lot of money installing those solar panels in my parking lot. Who cares if the equipment consumes ten spaces - my employees carpool or uber to work. Congratulations! You invested in an upgrade that made your building less desirable - even though you believed the value was enhanced.
So, with that preamble - what other improvements do buyers shun and to which sellers cling - with the expectation of a higher price?
Freeway frontage. Not an improvement per se, but an attribute with which many owners ascribe value. Unless your buyer wants looks from 225,000 cars per day, he will be unwilling to pay. In some cases, freeway visibility is a negative because of noise, debris, and transients that loiter. An exception to this rule is the retailer whose business can benefit from the exposure. Most others don't care.
Signalized corner. Similar to freeway visibility, a signalized corner causes traffic to pause in front of your location - which means your building is on a busy street. Great! but if your business isn't dependent upon destination customers, you just as soon they whisk by. An exception - which could bolster worth - is a property with a higher and better use - i.e. a residential conversion in the future. Now, the signalized intersection creates some benefit and can generate more dollars.
Amount of office space within an industrial building. The amount of office space within a building - especially an industrial building where companies make and ship things - is the biggest merit disconnect between a seller and a buyer. Adding office space to an industrial building is a costly adventure - permitting, construction, timing, new office furniture, etc. - in some cases $75-$100 per square foot. When a seller shells out that amount of money, he expects a return. Unfortunately, rarely does the next guy see any benefit. The layout is wrong, the finishes are outdated, too much shop space is consumed, a second story was created with no elevator, and so on. If a buyer doesn't need the excess office space, he must pay to have it removed or move on to the next building without the problem. Certainly the exception is the black swan that can walk in and use everything without any changes - he will see the benefits and gladly pay.
Assumable financing. Money is cheap and plentiful these days. Lenders are begging qualified folks to borrow. In many cases, a buyer can finance 90% of the purchase at interest rates in the fours. Enter assumable debt. Chances are the assumable debt was written at interest rates higher than present and for less than 90% of the sale price. Thus, a buyer is better served getting a new loan. An exception would be an owner carried loan - especially if the buyer can avoid the costs of an appraisal and loan origination.
In fact they don't care, won't pay for the renovation - and maybe worse - will exclude your building from consideration if the betterment exists.
Hmmm, weird you say. I spent a lot of money installing those solar panels in my parking lot. Who cares if the equipment consumes ten spaces - my employees carpool or uber to work. Congratulations! You invested in an upgrade that made your building less desirable - even though you believed the value was enhanced.
So, with that preamble - what other improvements do buyers shun and to which sellers cling - with the expectation of a higher price?
Freeway frontage. Not an improvement per se, but an attribute with which many owners ascribe value. Unless your buyer wants looks from 225,000 cars per day, he will be unwilling to pay. In some cases, freeway visibility is a negative because of noise, debris, and transients that loiter. An exception to this rule is the retailer whose business can benefit from the exposure. Most others don't care.
Signalized corner. Similar to freeway visibility, a signalized corner causes traffic to pause in front of your location - which means your building is on a busy street. Great! but if your business isn't dependent upon destination customers, you just as soon they whisk by. An exception - which could bolster worth - is a property with a higher and better use - i.e. a residential conversion in the future. Now, the signalized intersection creates some benefit and can generate more dollars.
Amount of office space within an industrial building. The amount of office space within a building - especially an industrial building where companies make and ship things - is the biggest merit disconnect between a seller and a buyer. Adding office space to an industrial building is a costly adventure - permitting, construction, timing, new office furniture, etc. - in some cases $75-$100 per square foot. When a seller shells out that amount of money, he expects a return. Unfortunately, rarely does the next guy see any benefit. The layout is wrong, the finishes are outdated, too much shop space is consumed, a second story was created with no elevator, and so on. If a buyer doesn't need the excess office space, he must pay to have it removed or move on to the next building without the problem. Certainly the exception is the black swan that can walk in and use everything without any changes - he will see the benefits and gladly pay.
Assumable financing. Money is cheap and plentiful these days. Lenders are begging qualified folks to borrow. In many cases, a buyer can finance 90% of the purchase at interest rates in the fours. Enter assumable debt. Chances are the assumable debt was written at interest rates higher than present and for less than 90% of the sale price. Thus, a buyer is better served getting a new loan. An exception would be an owner carried loan - especially if the buyer can avoid the costs of an appraisal and loan origination.
Friday, December 15, 2017
5 Considerations When Leasing Commercial Real Estate
I recently authored a post entitled Gotcha Clauses in a Commercial Lease. Wherein, I discussed those nasty sentences in that twelve page tome you were asked to sign - watch out! Today, I'll take a step back and discuss the factors you should consider BEFORE you are ready to ink that commercial real estate lease.
The location. Raise your hand if you have never heard the three most important factors in real estate - location, location, location! Right? But why? Here is why - in no particular order. Your customers may need to find you. May, because some business have zero walk-in or destination customers - others rely upon foot traffic. Access to qualified employees is important for the health of your business. Trucks must deliver your raw materials and transport your finished goods. Employee retention is critical - if you locate out of state, how many will follow? Proximity to your suppliers can save you money. Where do you live? After all, you are the boss. So, location does matter!
The term of the lease. Two common errors I see occupants make are committing to a long term lease when times are frothy or a short term lease when the market is crippled. Business activity fuels a business owner's sense of well being - business is great so I will commit to a ten year lease. Little thought is given to where we are in the cycle, that lease rates are at their all time high, and you would be better served with a five year lease with a five year option. The opposite is true when business bosses are uncertain. Even though landlords are handing out goodies - many opt for a shorter term commitment - three years or fewer.
The leasing entity. Any owner of commercial real estate will require tax returns and financial statements from the corporation, individuals, LLC, or partnership signing the lease. Great! Got those. However, I suggest being preemptive by having your formation documents, information on your previous landlord, bank statements, and history of your company at the ready. Also, give some thought to the reason for the move and why you chose this location. I've witnessed this "story" as the determinant for a tenancy.
The type of owner. A pension fund advisor from New York will view your tenancy differently than a private investor who owns two buildings in Anaheim - and not always more discerning. Speaking "owner" will cause the lease negotiation to proceed swimmingly.
The vibe. How quickly did you receive a response to your lease offer? What additional information were you required to provide from your initial offering package? What do other tenants in the building have to say about the owner - yes! you should talk to a few of them. The answers to these questions will provide a glimpse of your future as a tenant.
The location. Raise your hand if you have never heard the three most important factors in real estate - location, location, location! Right? But why? Here is why - in no particular order. Your customers may need to find you. May, because some business have zero walk-in or destination customers - others rely upon foot traffic. Access to qualified employees is important for the health of your business. Trucks must deliver your raw materials and transport your finished goods. Employee retention is critical - if you locate out of state, how many will follow? Proximity to your suppliers can save you money. Where do you live? After all, you are the boss. So, location does matter!
The term of the lease. Two common errors I see occupants make are committing to a long term lease when times are frothy or a short term lease when the market is crippled. Business activity fuels a business owner's sense of well being - business is great so I will commit to a ten year lease. Little thought is given to where we are in the cycle, that lease rates are at their all time high, and you would be better served with a five year lease with a five year option. The opposite is true when business bosses are uncertain. Even though landlords are handing out goodies - many opt for a shorter term commitment - three years or fewer.
The leasing entity. Any owner of commercial real estate will require tax returns and financial statements from the corporation, individuals, LLC, or partnership signing the lease. Great! Got those. However, I suggest being preemptive by having your formation documents, information on your previous landlord, bank statements, and history of your company at the ready. Also, give some thought to the reason for the move and why you chose this location. I've witnessed this "story" as the determinant for a tenancy.
The type of owner. A pension fund advisor from New York will view your tenancy differently than a private investor who owns two buildings in Anaheim - and not always more discerning. Speaking "owner" will cause the lease negotiation to proceed swimmingly.
The vibe. How quickly did you receive a response to your lease offer? What additional information were you required to provide from your initial offering package? What do other tenants in the building have to say about the owner - yes! you should talk to a few of them. The answers to these questions will provide a glimpse of your future as a tenant.
Friday, October 27, 2017
4 Random Commercial Real Estate Leasing Thoughts
Today, I decided it would be fun to regurgitate a few random thoughts as they pertain to LEASING commercial real estate.
As we have discussed before, leasing is a big part of our daily activity - unlike our residential counterparts. We, as commercial real estate professionals help occupants find space to lease or buy.
Typically, leases account for 70-75% of our deal volume - sales the balance.
We differ from our residential counterparts. Our fees are based on a percentage of the deal's total consideration - purchase price or the amount of rent paid over the term of the lease. Generally, commercial leases run 3-10 years - so the amount of rent payments negotiated is a significant sum. Whereas, residential leases are month-to-month or a year maximum. Consequently, the potential fees on a residential lease - because the term is much shorter - make it unprofitable for residential agents to pursue.
Subleases are a pain. A sublease is necessary when an occupant no longer needs the building - for myriad reasons - yet has a term of lease remaining. The owner of the building still wants his rent. So, the occupant resorts to finding a substitute - a subtenant - to move in and assume the rent payments. Differences in uses, credit, number of players, and changing market conditions all create the pain in a sublease transaction.
Credit requirements of a property owner. At a minimum, the owner will look at the total amount of the lease - let's assume $10,000 per month for sixty months or $600,000. The owner is leasing an occupant the building in return for $600,000 in rent payments. Therefore, the owner is extending the occupant $600,000 of credit - so to speak. Carefully scrutinized is the occupant's ability to repay the $600,000 - through an analysis of the business's sales and credit history.
Process. Searching for a space to lease is similar to searching for a building to buy. The similarities: Facility requirements are discussed - loading, power, amount of office space, warehouse ceiling height, etc., geographical areas are considered, a list of alternatives is toured and a candidate is chosen. Now, the differences occur. A sale deal will proceed to a negotiation, an agreement, an escrow, due diligence and closing - approximately 60-90 days. But, a lease will involve a negotiation and a lease - much quicker - fewer than 30 days, in most cases.
If ever we can assist you in leasing or buying a building, please call us at 714.564.7104 or email us at abuchanan@lee-associates.com.
As we have discussed before, leasing is a big part of our daily activity - unlike our residential counterparts. We, as commercial real estate professionals help occupants find space to lease or buy.
Typically, leases account for 70-75% of our deal volume - sales the balance.
We differ from our residential counterparts. Our fees are based on a percentage of the deal's total consideration - purchase price or the amount of rent paid over the term of the lease. Generally, commercial leases run 3-10 years - so the amount of rent payments negotiated is a significant sum. Whereas, residential leases are month-to-month or a year maximum. Consequently, the potential fees on a residential lease - because the term is much shorter - make it unprofitable for residential agents to pursue.
Subleases are a pain. A sublease is necessary when an occupant no longer needs the building - for myriad reasons - yet has a term of lease remaining. The owner of the building still wants his rent. So, the occupant resorts to finding a substitute - a subtenant - to move in and assume the rent payments. Differences in uses, credit, number of players, and changing market conditions all create the pain in a sublease transaction.
Credit requirements of a property owner. At a minimum, the owner will look at the total amount of the lease - let's assume $10,000 per month for sixty months or $600,000. The owner is leasing an occupant the building in return for $600,000 in rent payments. Therefore, the owner is extending the occupant $600,000 of credit - so to speak. Carefully scrutinized is the occupant's ability to repay the $600,000 - through an analysis of the business's sales and credit history.
Process. Searching for a space to lease is similar to searching for a building to buy. The similarities: Facility requirements are discussed - loading, power, amount of office space, warehouse ceiling height, etc., geographical areas are considered, a list of alternatives is toured and a candidate is chosen. Now, the differences occur. A sale deal will proceed to a negotiation, an agreement, an escrow, due diligence and closing - approximately 60-90 days. But, a lease will involve a negotiation and a lease - much quicker - fewer than 30 days, in most cases.
If ever we can assist you in leasing or buying a building, please call us at 714.564.7104 or email us at abuchanan@lee-associates.com.
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