I’ve SOLD My Commercial Real Estate - Now What?

Motivation to sell can vary from desperation to windfall. Some sellers don’t have a choice - they must sell. While others take advantage of a large run up in pricing to reap some profit. In the former - a loan that must be repaid, a business failure, or a pending foreclose are all catalysts. The latter? Taking advantage of market swings, an offer “too good to reject”, or an uptick in business. Ideally, sale proceeds are rolled into another buy - which defers capital gains taxes. Such a mechanism is referred to as a tax deferred exchange under chapter 1031 of the Internal Revenue tax code. Allow me to spend a moment and discuss some nuances of the 1031 Exchange.

 The way an exchange works. Simply. A 1031 Exchange defers capital gains taxes - both state and federal. Any income property generally qualifies - including an owner occupied building if properly structured. Relinquished or downleg is the term typically used for the property sold. Replacement or upleg describes the property(s) purchased. 45 days is allowed - from the close date of your relinquished property - to identify a replacement property(s). You must complete the upleg purchase(s) the earlier of 180 days or April 15 of the following year from the sale date. “Like kind” must be bought. A fancy way of saying - another income property. Finally, if your relinquished price was $1,000,000 - you must spend $1,000,000 or more to qualify. Don’t forget any loans as those must be replaced also - either with new borrowing or additional cash. Whew! Complex? Yes! Please don’t attempt this at home. Consult tax, legal, and commercial real estate professionals.

 May I do it myself? No. Prior to the close of your downleg, you’ll need to designate a qualified intermediary to affect the exchange for you. IPX1031 Exchange is a good one.

 Can I change my mind? Yes. If you decide to forego an exchange prior to the sale of your downleg - you receive the sale proceeds - albeit now with potentially a large tax bill looming. If you designate a qualified intermediary, close, and then pivot - you, once again, receive the boot - but it’s most likely taxable.

 May I take some of the sale proceeds? Simple answer, yes. In reality, the answer is more complicated. This is where legal and tax counsel can help.

 When must the upleg purchase be completed? Some sellers overlook this nuance and have their exchange disallowed. The rule is the earlier of 180 days from your sale’s close date or the filing date of your taxes the following year - presumably April 15th. Let’s say you close your relinquished property on July 17th. 180 days later - your replacement(s) must be completed. However, if your close date falls after October 15th of this year and you file your returns April 15th of next year - your 180 days decreases.

 Can I buy more than one property? Yes you may. Within your 45 day identification period you’re allowed to designate as follows:

1.        Up to three with unlimited value - you can then buy one, two, or three

2.        An unlimited number at 200% of the relinquished value - you’re allowed to buy several , or

3.        An unlimited number with an unlimited value - but you must buy 95% of the ones identified.

 Multiple exchanges? If you sold and did a tax deferred exchange and subsequently sold again - you’re allowed to affect another exchange. Currently, there is no limit on the number of these you may complete. Just remember - at some future sale point the taxes will be due. So plan accordingly.

 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.

What Can Loss Teach us about Commercial Real Estate?

Loss. Simply, “the state or feeling of grief when deprived of someone or something of value.” 2020 so far has been a year of loss. Businesses bankrupted, careers cratered, freedoms foregone, routines re-routed, celebrations cancelled - all losses - in some cases forever. Required are we to change - like it or not.

 Last week, our family experienced loss in its most poignant form. Our father, Samuel A. Buchanan Jr. left us to be with the Lord. I’m certain this is true. Dad was a faithful follower of Jesus and loved his church. Suffering from a terrible bout with cancer - fortunately, Dad’s final days were peaceful. He left a legacy of five children, ten grandchildren, nine great grands, and countless friends. I’m sad that Dad is gone but relieved he is no longer in pain. Thank you for allowing me to share that!

 So, what - you may be wondering - does loss have to do with commercial real estate? Only this. From loss comes gain. Here are a few examples.

 2008 ended with many commercial real estate professionals scrambling. Our world abruptly halted. Buyers weren’t buying, sellers refused to sell at such depressed values, and lenders were more frozen than Queen Elsa. Tenants suddenly were seeking great deals. Landlords were stubborn. A mist of uncertainty shrouded our industry akin to that over the Enchanted Forest in Frozen II. Yeah. Recently, I got my Papa cred by watching The Disney Channel with our grandkids. But I digress.

 In 2009, we were forced to adapt. With vacancy in commercial properties rapidly rising, I focused on tenants and buyers. “Blends and extends” became a thing - a reduction in a rental rate today in exchange for a longer lease term. ‘Working out loud” - a phrase coined by my wife, Carla - was the start of a blog in 2010. Authored is digital content for owners and occupants of industrial buildings in Southern California. The Location Advice blog is now published by the Southern California News Group on Sundays. Yep. You’re reading a post now. A return to fundamentals caused the decade of the 2010’s to be my best yet.

 Gains from the losses we’ve experienced in 2020 are starting to sprout. E-commerce has exploded. More folks are shopping from their iPad vs visiting a brick and mortar store. Logistics companies that feed the supply chain are hustling to fulfill demand.

 Material handling outfits - forklifts, racking, dock and door equipment - are recording a record year. Owners of warehouses have enjoyed steady rent checks.

Rumored is a re-shoring of manufacturing. Our economy’s dependence on cheap stuff may shift. Less reliance on low cost production will cause prices to rise but quality and reliability will as well.

 Regional malls could spell the end of our housing crises. How, you might ask? Brookfield Properties made an enormous bet on mall ownership in 2018. Currently, Brookfield is the nation’s second largest owner of regional malls. As we see major mall tenants such as Sears, JC Penney, Neiman Marcus, Macy’s, Pier One, J-Crew, Forever 21, Brooks Brothers and others struggle and fail - watch a gradual re-tooling of these massive spaces into multi-family mixed use re-developments. Closer to home, Integral Communities just bought the land beneath the JC Penney store at the Village in Orange. A similar proposed development is slated for a portion of Main Place Mall. So, it’s happening!

 I’ll always be grateful to my Dad for not hiring me to run the family business. The rejection motivated me to seek an alternate career path - commercial real estate brokerage. What I viewed as an horrendous loss at the time resulted in a huge gain.

 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 AVOID the Re-Trade in Deals

Last week week we covered four things that can occur once a commercial real estate deal reaches the end of its contingency period - that time frame whereby a buyer can determine - in its sole discretion - whether the proceed to close. As you recall - the four outcomes are - move forward, cancel, seek additional contingency time or ask for a price reduction - AKA re-trade.

 Promised last week was a discussion of how to avoid a re-trade. But first, let’s spend a moment and dissect this request a bit more. Once a buyer spends time and money understanding a commercial real estate purchase - in many cases they know the building better than the owner. After all, they’ve poked, prodded, reviewed, surveyed, and analyzed every aspect of the structure, title, roof, HVAC, mechanical systems, zoning, tenancy if any, and operating history. Therefore, it should come as no surprise if something untoward is discovered. Hopefully, what’s uncovered is a minor fix and the deal can proceed smoothly. However, if the issue requires a price reduction, your options as a seller are:

 Agreement. If the request is well reasoned and thoughtful you might simply agree.

 Cancellation. I’ve seen sellers get very defensive and cancel. Certainly, this is your right. You entered a contract to sell for a certain price. Your buyer agreed to buy the property in its “as-is” condition. Now they’ll proceed - but at a lesser amount. Sure. Something is cheesy about a buyer that operates this way. A deal’s a deal. But, if you walk away, the next buyer may ask for more. You’ll certainly have to disclose what you encountered. Plus, you’ll now start over with another buyer and reset the shot clock with another contingency period.

 Compromise. We just completed a lengthy due diligence. The buyer discovered three things that gave them heartburn. We successfully whittled the three down to one and the seller agreed to a slight price reduction to remedy the remaining problem. Had the buyer sought recompense for all three - the conversation would have been short. Fortunately, the seller was prepared and the buyer’s ask was reasonable. Game on!

 But, in my experience the best way to avoid a re-trade is to anticipate them and prepare. You know your buyer will require a water-tight roof. How about conducting a preemptive inspection? You’ll then know if there is a problem. Take it a step further and get bids from contractors to repair the leaks. I’ve found some buyers will inflate the cost to remedy what they find. Imagine that! It’s your option whether you bear the expense pre-marketing or wait. You’ll then be armed to address any request for a price reduction - because you know the extent of the issue and what it costs to fix it. I also enjoy putting a seller into a great offensive position - with back-up buyers who’ll step in and perform in case buyer number one hiccups.

 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 DREADED Re-Trade in Commercial Real Estate Deals!

Ahhh, the dreaded re-trade! Simply. A buyer asking for a price reduction well into the purchase process, prior to close, but before they are contingency free. 

Buying a parcel of commercial real estate is really three negotiations. I even wrote about it here. http://allencbuchanan.blogspot.com/search?q=Three+negotiations. A quick review of the three is in order. First - price and terms. This conversation could take place through a binding Purchase and Sale Agreement but typically is negotiated via a non-binding Letter of Intent. Next - Purchase and Sale Agreement talks - if not handled in the first dialogue. And the final discussion - which occurs once a buyer has completed their due diligence - and where the re-trade can happen. 

Generally, commercial real estate transactions allow the buyer a certain amount of time to inspect what he’s purchasing. Reviewing a title report, conducting environmental surveys, insuring the AC blows cold air, and confirming the roof doesn’t leak usually are done. Also in this no obligation contingency period - the buyer arranges financing, interviews the tenants if any, and pours over leases, utility bills, aged receivables, operating statements, and anything else they can dredge up. A quick trip to the city may be important to work out any zoning concerns. We see 30-45 days as a typical contingency time frame. Once ALL this is completed - the buyer decides to move forward, cancel, request additional time, or ask for a price reduction to offset anything untoward discovered. Since a monetary remedy is sought - in effect the purchase price is re-traded or re-negotiated. Bummer!

Let’s discuss in detail the four ways a deal can proceed once due diligence is completed - shall we?

Move forward. The BEST result for buyer and seller! Everything came out great. Lender approved the loan, city welcomed the new business with flowers, all systems are AOK and pilot you are cleared for landing! I can tell you from experience, this happens about 10% of the time. As a seller - if you get this outcome - awesome! Count yourself among the very fortunate. 

Cancel. Extreme! But it happens. Generally cancellation is trumpeted far before the end of a buyer’s contingency. Sure. We’ve all had deals stall in the “red zone”. However, in my dealings, you know when a transaction is doomed. Entrenched within all real estate professionals is a sixth sense of sorts that shouts “danger Will Rogers!” Cancellation occurs in around 5% of all deals. What causes a buyer to walk away will be discussed another day. 

Request additional time. Executing deals during our shelter-in-home period found many buyers asking for additional days to complete their study. Inspectors - hampered by rules and regs, lenders swamped by PPP loan processing, sellers squeamish about tours - all contributed to slow the process. Typical 30-45 day contingency periods became 45-60 days. Frankly, the delays were out of the buyer’s control. 50% of deals reach this crossroad. 

Re-trade. Maybe my least favorite outcome! Why? Because you are so close - yet so far away. Sellers have agreed to the purchase price. Buyers now want some blood. If not properly managed - this can quickly spiral out of control. Plus, as the intermediary, you’re often sought to “bridge the gap”. Candidly, sometimes a cancellation is easier. At least contention is avoided and energy can be expended to locate another buyer. However, close to 75% of agreements include some sort of “ask”. Roof and heating, ventilation, and cooling head the buyer’s list. These are major capital expenditures that must be addressed. Buyers gladly ask for a seller to pay. 

Next week I’ll discuss the ways you can minimize or avoid a re-trade. So, stay tuned!

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 Exercise an Option in a Down Market

Business shutdowns in Southern California have wreaked havoc in some sectors of commercial real estate - most notably retail. Others - such as manufacturing and warehouse buildings have barely skipped a beat! Certainly, where our economy is headed with respect to the “new normal” is worth considering. Masks, gloves, sanitizing, distancing, and limited capacity will all have a seat at the company table as we reopen. Add in some down days on Wall Street, civil unrest, and a pending election and the crystal ball is a bit murky. I was encouraged this week to read Disney’s plans for rebirth. Those guys are pros! Watch and learn. Their organization is inspiring.

Occasionally, a long-term decision must be made in the midst of a short term disruption - our present circumstances. If you lease commercial real estate and currently have an option to renew your term or purchase your building - you understand what I mean. You must predict where business will be in the future. An option is a right you have as an occupant. Certain characteristics apply. For one thing - an option is personal. Simply, you cannot transfer it. Dates are critical - also known as “time is of the essence”. A fancy way of saying - if you don’t by then you can’t. Finally, most options contain a mechanism for the exercise of the right plus some means of determining price and terms.

Typical language in an option to extend the term of your lease might be - five years at the prevailing market rents for comparable buildings within your market - but in no event less that your current rent. Ok. Easy enough. Generally, you’ll have to notify your landlord in writing within a window of time prior to the expiration of your lease. Common is, no sooner than nine months or later than six months is common. Got it!

However, here is where things get tricky. What if your window - to extend your term - opened on April 1 of this year and closes June 30? Hmmm. A bit tough to imagine where we are headed - especially if now you must commit for an additional five years.

So what should you do? I’d break it down like this.

Understand your specific option. You could have something of real value here! Or, you might simply have an agreement to agree. In the former, options forged during the last downturn could be at preset rates. Those presets could be substantially below the prevailing lease terms found in today’s environment. Value indeed! You can stay, avoid a costly move, and enjoy a favorable rent. Conversely, your “market rate option” creates a negotiation with the owner. Tenancy continues but at a higher amount. Regardless, spend some time and know how your option reads.

Take a look at the worst-case scenario. What happens if you don’t exercise your option? Will the landlord give you the boot? Certainly, that is a possibility. But how realistic? Here is where you might be vulnerable. Let’s say you moved into your space in 2010. Times were a bit different then. You clipped along for five years and extended for another in 2015. Mid-decade found rents on the rise - but the exponential increase occurred in 2017-2019. So now, a wide gap might exist between the rent you pay and the market. As we explained above - if your extension is tied to current rates vs presets - you’re facing a monthly bump. On your side? The cost to replace you. Don’t forget. Vacancy down time, concessions, abated rent, and brokerage fees - all must be paid by the landlord if you bolt.

Examine where you are - now. Congratulations! We’ve just weathered one of the largest business downturns - if not the largest - EVER! If you’re still standing - albeit a bit wobbly - chances are your operation is built for the long pull. My prediction is we climb from here. Send that letter! Stay and pay. On the flip side - serious concerns about the future don’t bode well for long term commitments.

Talk to the owner of your building. With the understanding of your specific option, a hard look at the worst case, and a view of present and future - schedule some time to talk to your owner. It should be in person. This can be challenging but manageable with ZOOM or other video conferencing tools. Covered during your chat will be your view of the world, your desire to renew or move, and an exchange regarding his situation. We just attended such a meeting. It was enlightening! Resulting was a comfort level. Both sides aired their positions. We will now move forward. However, some tenants use the following strategy. The building works for our business. We’re girded and armed for what’s next. Rent as outlined in the option is too high. What can we do? Your landlord’s answer might surprise you.

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.

Options in a Commercial Real Estate Lease

By definition - an option is a right contained within a commercial lease which allows you to do something as the occupant. Generally, an option enables you to extend the term of your lease, cancel your lease, or purchase the building. Simple! Oh, I wish that were the case. In practice - option language and exercise can be much more complex. Let’s explore a few of the tastier ones - shall we?

Options are personal. If your company has successfully negotiated an option with the owner of your business address - the option is “personal” to only you as the occupant. It cannot be assigned. Consequently, if you’ve a right to buy the building at a number dramatically below market today - prohibited is passing this along to someone else. We’ve seen cases whereby an occupant exercises their purchase right only to quickly flip the property to another. However, there are tax consequences and logistical challenges to this approach. I should also mention - options completely benefit an occupant. An owner derives little if any benefit from their grant.

Strike prices. On the scale of most valuable to least valuable - an option right with a set price is the most attractive. Conversely, an extension with a price at “market” would be a bit better than worthless. A “market” option - an extension which computes the lease rate or sales price at the time of option exercise - is fraught with peril. Unless a specific mechanism is outlined to calculate market rates - left to opinion is the price. Here’s the rub. Let’s say you have a right to to extend your lease for five years at the prevailing market rates. Cool. You signed your lease in 2015. It’s time. But there is a problem. You and your landlord have a different view of the market and reach an impasse. Now what?

Time frames. Typically - an option - whether to extend, purchase or cancel will have clearly defined time frames from which your right may be exercised. IE: no sooner than twelve months or longer than six months before the expiration of your lease term. These periods are sacrosanct! Strict adherence must be observed or your right may be extinguished. So, what happens if you blink and miss the window? Should you start looking for a place to move? Not necessarily. You’ve simply limited your leverage as now you have no “right” to extend. Your owner still may want to keep you in residence - but at terms more favorable to him.

Method of exercise. Options must be exercised in writing by you. Remember that “options are personal” description? Yes. YOU must send a letter to your owner - unless another method - electronic exercise - is specified in your lease agreement. I discussed this issue with a prospect the other day who shared with me a horror story. Let’s call him Al. At Al’s prior location - Al wanted to renew his lease, avoid a costly move, and had an option to do so. Al’s owner paid Al a visit to discuss Al’s intentions. Clearly stated was Al’s desire to stay. Al assumed all was groovy. After all, Al made his pitch directly to the owner. In person! Imagine Al’s surprise when his notice to vacate arrived in the mail a few weeks later. You see, the option was not exercised in writing. Extreme? Maybe. But don’t fall victim.

  

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 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.