How to Approach a Lease Renewal - 6 Suggestions

One thing that differentiates commercial real estate professionsls from our residential counterparts is leasing. Sure, residential agents can lease houses but most focus upon the higher fees associated with home sales. After all, we are paid a fee on the consideration of a deal - a fancy description of the total dollar amount of the transaction. Lease fees are a percentage of the amount of rent an occupant will pay over the term of their lease. Simply, the variables are rate and number of years. Commercial leases tend to be three to ten years in length whereas a lease for house will be month-to-month or a year. Thus, the short term creates a small amount from which a fee can be earned. Now you understand why home sales are more profitable and residential agents shun leases.

In a given year - a portion of a commercial agent’s income will be derived from completing lease deals. These come in two flavors - new leases and renewals. Yes! In many cases our clients engage us to assist with renewals. Today, I’ll focus on some suggestions as you approach your decision to relocate or renew - akin to “Love it or List it” on HGTV.

Understand your owner’s position. Is the rent that you pay sufficient to cover the owners’s mortgage? Is the building owned free and clear? Is this the only building owned? Can the owner afford a vacancy? What is the nature of the ownership - sophisticated or mom and pop? What are the owner’s plans for the building - hold or sell? All of these variables will play into your ability to craft an acceptable lease renewal. As an example - if your rent barely eclipses the owner’s costs - he may be unwilling to negotiate. Conversely, a building owner with no debt can be more flexible.

Understand your position. In many cases, you know the building better than its owner. After all, your business has lived there for a period of time and weathered roof leaks, air conditioner outages, a shortage of parking, break-ins, and truck access. You reside despite the “warts”. However, if you vacate and another occupant must be found - will the new tenant discount for these deficiencies? What sort of renewal rights - if any - are contained in your lease? Do you have an option to extend? How is the option rent calculated? Finally, has your operation outstripped the capacity of the real estate or are you swimming in excess space?

Know where you are relative to market. Lease rates have increased exponentially over the past five years. If you crafted your agreement prior to 2015 - chances are your rate is dramatically below current levels. Plus, inventory percentages - number of available buildings on the market - are at historic lows. Therefore, if you’re not prepared with this knowledge - you’re in store for a shock!

Calculate your moving costs. Moving companies will gladly visit your site and give you a complimentary estimate of the cost to move your operation. However, don’t forget other relocation variables such as electrical feeds, special permits, downtime, and key employee drive-time. An owner will bank on the disruption and cost of moving your operation in his negotiations - so know your stuff.

Do some math. On your side of the aisle - you have relocation expenses, rent in the new facility, and the goodies that accompany a new lease - free rent, fresh paint, new flooring. But, you’ll pay a market rate for these amenities. On the owner’s ledger will be the expense to replace you - building refurbishment, lost rent from the vacancy, free rent for a new tenant, possibly some special stuff like a new office or two, and transaction fees. Most of these allotments will be “lost forever” - IE: an owner will never recoup them. Many times, the cost of replacing you can amount to 15-25% of the lease consideration - the total amount of rent you’ll pay for the term.

Start early. I cannot stress this enough! Your negotiating strength depends upon it. 12-18 months in advance of your expiration is advisable.

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.

Your Business is in Transition - Now What?

Some commercial real estate transactions - especially involving an occupant buying, selling or leasing - stem from a trigger event. In other words, a change. Simply, the ebbs and flows of economic activity cause a company to re-evaluate its business address.

As I reflect upon the deals I have transacted and what caused them to occur - several situations come to mind:

Last year, three of our import/export clients decided to scrap their expensive warehouse in favor of a third party logistics provider. By doing so, brick and mortar expense and labor costs were saved. Gained was flexibility to meet changing inventory requirements in a “pay as you go” arrangement. However, two of the companies leased their previous spots and one owned. We dealt with the excess with two subleases of the remaining obligations and one move-out and vacant building lease.

Recently, we were engaged for just the opposite. Before, our client shipped his customer’s products directly to the job site - thus eliminating the necessity of storage. Now his customer demanded he stock the items locally for will call. His current operation was maxed. Gotta put ‘em someplace! So, we are in the market for an auxiliary location.

Buying a competitor or selling a business always morphs into space adjustments. Locally, we’ve seen merger and acquisition activity akin to the days of Gordon Gecko. “Greed is good indeed”! 100% of the time - when businesses marry or divorce - redundant real estate results. Now, the Brady Bunch of facilities must be absorbed into one hybrid family. One extreme example - with which we are navigating - involves a manufacturing interest which finds itself with four different parcels - but only needs one.

Occasionally, there is a change in the business owner’s motivation. Retirement, the death of a key employee, a move out of state, or just calling it quits - voluntarily or involuntarily - can portend a different use of commercial real estate or a re-deployment of the building’s equity. Upon the decision to shutter a fifty year old construction company we assisted the owner in selling the old site and re-investing the proceeds into a shiny, fully leased asset that will provide cash flow for years to come.

Let’s not forget a dramatic increase or decrease in sales volume. All manner of accommodation must follow if the current physical plant can’t handle the bump. If on the rise - new equipment and machinery, additional employees, and raw materials must have a place to reside. The counter causes a look at ways to jettison expenses. Yep. One of the biggest liabilities can be rent on a commercial location. A distribution client of ours chose to deal with his increase in business by buying a facility twice the size of his current endeavor. He accomplished two things - space issue solved and no longer does he fund his landlord’s retirement.

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.com.

Merry Christmas! Here are your CAM Charges

This time of year, landlords all over Southern California, present their tenants with a Christmas gift - a bill for operating expenses. Merry Christmas indeed! Also referred to as Common Area Maintenance Charges - CAMs - these lumps of coal disguised as presents - anticipate the cost to operate your location.

So what’s included? Contained within the invoice is an estimate of property taxes, insurance for the structure, and various maintenance line items - such as roof, landscape, air conditioning and so on. Typically, these estimates take into account what’s known and what’s anticipated for next year.

Property taxes. Specifically, property taxes will be known - sort of. Owners receive their property tax bill in October for the last six months of the current year plus the first six months of next year. Yep. You got it. If you receive a bill now for expected charges next year - the last six months of next year are unknown. Confusing? Yes. Since County fiscal years run differently than calendar years - most landlords simply figure a small pop will occur and invoice accordingly. However, if your building sells or if The California Schools and Local Community Funding Act should pass - prepare for a large increase!

Property insurance. Insurance on the structure tends to be fairly easy. Policies are written annually. If the owner of your building and his insurance broker are in synch - not the Boy Band, BTW - these renewals can occur in December - allowing for the owner to allocate accurately.

Maintenance. Other expenses - such as mowing the grass and clearing leaves from your roof - can be predicted through yearly renewable maintenance contracts.

But what’s not included? If your owner hires someone to collect the rents and pay the mortgage - AKA a property manager - most likely this isn’t included in your CAM. Bank charges, depreciation, legal and accounting bills, and debt service are not generally your responsibility.

Major improvements - such as resurfacing the parking lot, changing the storefronts, installing drought tolerant landscape, employing solar panels, or replacing the roof - are afforded special treatment in your lease. Known as capital expenses - significant dollar expenditures - they are normally billed back over a number of years vs a lump sum transfer to a tenant.

Do I pay these? Yes! Companies who rent their business home are bound by lease agreements - unless your landlord has allowed the contract to lapse - at which point a month-to-month relationship exists. Regardless of the term remaining - lease contracts are generally one of two persuasions - a Net or Gross lease. And you pay operating expenses with BOTH.

With a Net - or sometimes called a NNN or Triple Net lease - you commonly pay as you go. Base rent is paid monthly and operating expenses are paid separately as they occur. In other words - property taxes twice a year, insurance once a year, and other maintenance as it happens. Remember - roof, HVAC, and trimming the bushes are all your responsibility - in addition to your rent. Some owners figure it’s easier to simply calculate what their occupants will pay and divide the number by twelve vs relying upon the tenant to pay when due.

With a Gross - or sometimes called a Modified or Full Service Gross lease - your expenses are baked into your base rent. A word of caution here. Some believe a Gross lease limits increases in monthly payments. After all - a base rent bump is specified. But, most Gross leases allow an owner to recapture an increase over your first year’s expense - known as a base year. A double whammy!

Can I dispute the charges? Of course! Typically you have a right to audit the invoice - even requesting specific calculations and back up documentation. Plus, if an owner over or under estimates - there is a reconciliation the following year.

It’s been my honor, dear readers, to converse with you weekly - not weakly hopefully - this year! My best wishes to you and yours for a magical holiday season! Merry Christmas, Happy Hanukkah, and Joyous Kwanzaa to you all and to all a good night!

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.com.

Pitfalls of an Limited Liability Company - AKA 3 Horror Stories of LLC Ownership

In California - the Limited Liability Company or LLC is the most common entity with which commercial real estate is owned. Individuals within an LLC are known as members. Members are governed by an operating agreement which outlines whom within the LLC are authorized to sell, buy, and borrow. Also, percentages of ownership are specified in the case of multiple members. Why an LLC? Because of a multitude tax advantages and liability protection - which are beyond the scope of this column. However, as commercial real estate practitioners we encounter some pretty hairy issues involving LLC ownership.

Waking a Grizzly. Annual fees must be paid to the Franchise Tax Board and tax returns must be filed each year with the state of California. If not, the LLC may be declared inactive. To re-activate an LLC is akin to awakening a hibernating Grizzly. We once experienced an LLC that was formed, owned a parcel of commercial real estate, and was allowed to lapse - for thirty three years! Now the owner wanted to sell but couldn’t. You see the individual - with whom we were dealing - was not the owner because title was vested as the LLC. Therefore - with an inactive LLC - the individual member couldn’t sign a listing engagement, execute a Purchase and Sale Agreement, or transact any business until the past returns were completed and overdue due fees paid. Fortunately, no income had been reported through the LLC - thus no taxes were owed. Therefore, it was a matter of preparing tax returns dating back to 1986 and forking over thirty-three years of filing fees - which now - with interest and penalties - were in the tens of thousands of dollars. Oy vey!

Who’s in the mirror. Frequently, we experience this challenge. An LLC owns a building which is occupied by a business. Even though the entities of ownership may vary - building LLC and business a corporation - the individuals of each entity are synonymous. In a recent case - over time this changed - two of the three members of the building ownership LLC died and the business corporation was sold to the employees. Created was a difference of objectives - the occupying company needed less space or a correspondingly cheap rent. Desired by the LLC - now comprised of four heirs and an original member - was maximum return from the investment. So now what? The LLC sold and the business relocated to a building half the size.

But we are divorced. Sure. But your real estate ownership may not be. In a particularly nasty situation - we were thrust between LLC members - an ex husband and wife. The only remaining joint asset was a piece of commercial real estate once occupied by a business they operated. While still married - the business was sold but the real estate retained - providing a nice cash flow for the couple. When the two divorced - now desired was a sale of the building. Problem was - the divorcees also wanted to defer the taxes which would inure from the sale. The solution was a risky tactic known as a “drop and swap”. Title was changed to tenants-in-common from the LLC. This change in ownership vesting allowed the individual members - divorced husband and wife - to go their own ways. Please seek legal counsel and tax advice before attempting this.

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.com.

Hunters vs Farmers - a Parody

Commercial real estate professionals must be transactional - they must close deals - to survive. However, the pathway toward those deals can be through the transaction treadmill or through fostering long term relationships with owners and occupants of commercial real estate. Today, I vary a bit through a parody that describes the difference between transactional and relational brokers. I hope you enjoy the comparison.

Once upon a time, in a land far away - before the Internet - there lived a buffalo hunter and a seed farmer. Buffalos were plentiful and slow, and would graze for hours on the grassy plains. Because the flat lands were populated by bountiful bison, the seed farmer found very little land on which to plant, cultivate and harvest his crops. Farming subsisted on small hilly plots here and there - unsuitable for grazing. 

Buffalo hunting was easy. These herbivores were huge and habitual. The hunter - without much skill or effort - in a couple of hours - could "harvest" all of the meat, hide, and hooves he and his family could handle. Others were attracted to the bounty. Times were good to be a buffalo hunter! Eventually, the hunting became more difficult, the hunters outnumbered the hunted and buffalo became extinct. Now what?

As the hairy hunted's haunts - the grassy plains - became less populated by the buffalos, the seed farmer found acres of fertile soil from which to extract the Earth's green goodness - crops. Although the growing cycle was long, the work tedious, the benefits and payback uncertain, the seed farmer continued to plant. When the Earth's bonanza was broadcast - the seed farmer was overwhelmed. Seeds beget seeds, the output grew (sorry) and the farmer was able to feed his family forever. 

Searching for new prey, the buffalo hunter happened upon acres of cultivation and decided to become a seed farmer - how tough could it be, right? After all, he was a mighty buffalo hunter. Unfortunately, the buffalo hunter failed at farming. The hunting chops he possessed - sitting around and shooting a large animal - didn't translate well to the skills required for seed farming - patience, perseverance, nurturing, tilling and harvesting.

The buffalo hunter eventually was forced to sell fax machines. Hmmm, how many of those are around today.

So, can you guess which one has a transactional focus vs building relationships?

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.com.

Cut Out the Broker - Save 6%! Maybe Not

I told the owner of my building, hey if you decide to sell, call me first. I'll buy it and we can avoid paying the 6%". REALLY? This was a conversation I recently heard. I was not eavesdropping, mind you. I was the guest of a network buddy of mine at the monthly meeting of trade organization. The conversation was between my friend and one of his clients - that I had met previously. As I stood there with them - I recalled trying to help him last year with some space issues he was facing - for FREE!

The comment really irked me and I flippantly responded, "yeah, by all means, cut out those greedy brokers!" The client quickly excused himself and walked away. He realized the comment struck a nerve.

I've thought about that encounter a lot over the past week and have tried to imagine myself in his position. If I leased a building and had an opportunity to buy it, would I "cut out the middle man?"

Indulge me and I will attempt to explain why I wouldn't - with full disclosure that I have seen the "end of the movie." By the way, I believe this buyer's sentiment is rooted in the premise that "we didn't find the building or negotiate" the deal - so where is the value? I also believe his position is on widely held by most occupants of commercial real estate.

Here is the value - a commercial real estate professional can anticipate the issues and structure the deal around them or formulate a suitable alternative. This is BEST done before final terms are negotiated, but sometimes, we are shackled.

So let's assume we are talking about a 20,000 sf building, a $4,000,000 purchase - or a $240,000 ($4,000,000 x 6%) dollar savings (potentially). $240,000 represents $12 psf on the square footage of the building. A lot of money for sure! However, if the buyer overpays (based upon market data that brokers track) this "savings" can be consumed quickly.

What if the property doesn't appraise? How does the buyer bridge the gap? Brokers are skilled at solutions due to the market comps, current avails, etc.

What if something "untoward" is discovered - historic hazardous materials, seismic zone, non ADA compliance, unpermitted office or other improvements, a sprinkler system that is inadequate, a lien against title? OK you get the idea. A seasoned professional - has overcome these challenges many times before.

Who will handle the management of the deal's execution - escrow, title, inspections, loan qualification, review of leases, estoppels, etc? A real estate attorney trained at identifying issues - but equipped to resolve them?

What if specialized consultants are needed in the execution process? Buyers can utilize our networks.

So how do you "hear the buyer's concerns?” Remember, the buyer is convinced you are excess baggage.

From experience, I reduce the fee and offer to manage the transaction. Specifically, in return for my involvement, the fee is 1-2%. I justify this because I didn't find the building or negotiate the terms - just like the client believes. But, I can add significant value from the agreement forward to close.

As we know, negotiating the terms is generally the EASY part. The execution is the difficult step. Win win, done!

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.com.

Leases, Subleases, and the Like

Your business expansion will enjoy more space very soon. Now your employees can park at their place of employment vs down the street. Crisp new offices or tons of manufacturing space await you in the new location. You cant’t wait!

You’ve opted to lease the new spot and postpone ownership. You’ll encounter two leasing scenarios once you scour the market for suitable addresses - leases and subleases. So what are the differences? Indulge me while I describe them.

Leases are negotiated directly with the owner of a parcel of commercial real estate. Therefore - they are referred to as direct leases. Normally - your initial conversations will be through your commercial real estate professional. The deal you get depends upon the landlord’s motivation, competition in the market and the skill with which your broker volleys. She will work with the owner’s rep to craft your agreement. Outlined will be a monthly payment amount - rent, number of years - term, increases in rent throughout the term - bumps, and concessions - free or abated rent, refurbishment, and extra stuff - tenant improvements. An early termination right, extension rights through an option to renew, right of first refusal, or right of first offer to purchase may also be included. Once you reach a pact - you and the owner will sign a lease, you’ll deposit the requested amounts and secure insurance. Now your company can live in the new location for the agreed upon period - let’s assume five years.

But during the lease term - something untoward occurs - a decline in sales, someone acquires your company, you decide to move your manufacturing function to China, or California imposes a huge levy on your product - which dictates a move out-of-state. You find yourself with a glut of space - for which you’ve committed! Now what? Well, those circumstances, dear readers create subleases.

A sublease is akin to a remnant sale at your favorite carpet retailer. A full roll of flooring is not available - so you get to pick from what’s left. Because a finite amount remains - little flexibility exists. If the scrap fits your area - great! You benefit. But if you’ve a larger area to cover - you’re hosed. Also, the smaller the amount of over run- the fewer takers. Now a price discount must be employed to liquidate. Ouch.

With a sublease - the primary motivation is to stem the bleeding. Excess space wastes rent payments. The thought of providing any concessions runs contrary to a desire to move-on. Consequently - a different dynamic unfolds compared to a direct lease. Plus - another layer of decision makers will be involved. Remember. A lease is in place - with a landlord and a tenant. Now the tenant becomes a de facto sub-landlord and you are the sub-tenant. All parties - master landlord, sub-landlord, and you - sub-tenant must agree and all must approve.

So with the descriptions of leases and subleases as a backdrop - how should you proceed?

Consider all your alternatives. If you need a ton of abated rent, extensive tenant improvements, or a 10 year term, a direct lease might be your best bet. Conversely - absent these requirements - a sublease can provide you with an adequate solution.

Seek counsel. Leases are complex. Subleases are uber complex. They are not for the squeamish. If your “landlord” stiffs the owner - your sublease is in jeopardy. You’ll need two sets of approvals. Plan on extended time frames to get all resolved. We recently encountered a sublease that took ninety days to get the nod!

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.com.