Location Advice for Transitioning Companies

Recently, I described several changes that occur during the life of a family operated business - specifically, manufacturing and logistics interests. These outfits are owned by your neighbors next door and employ millions around the United States. To review - a transition could be; acquiring a competitor, the death of a matriarch, exponential growth, loss of a key customer, sale of the operating unit via stock or asset purchase, or a move out-of-state. Sadly, it could also be the end of the road because of a changing market.

 This week alone - I met with three such companies. Yep! All experiencing a change. Below is the commercial real estate advice I gave them. You see - whenever a transition occurs - a commercial real estate requirement soon follows.

 Better returns out-of-state. In 2014 a family owned aerospace tooling entity was sold and the real estate that housed the company retained. A couple of years later, it was time to sell the buildings. Concern was - the new owner of the business ran the day-to-day differently. Could the rent be replaced if the group bolted? Sale of the real estate and the purchase of three investments through a tax deferred exchange quickly followed. Then, as 2020 dawned, a decision to sell was made on one of three 2016 buys. After all, activity was robust, pricing was at an all time high, and belief was - higher returns and reduced taxes could be garnered out of California. Meanwhile, all of the partners had vacated the Golden State. In addition, there was uncertainty with near term roll over of half the tenancy. And if that wasn’t enough - after launching in February and just in time to receive a great offer - the Novel Coronavirus ravaged the national economy! The buyer paused and then cancelled. After the buyer exited - due to the uncertainty - guidance was sought on which direction was best. We were able to provide clarity, create best in class collateral, and re-launch the offering. Closing happened on time! The net proceeds of the sale allowed a 1031 tax deferred exchange into properties in tax friendly states and with a greater overall return and reduction of risk. The last of the four upleg purchases closed this week.

 Structuring for the future. Maybe one of my favorite stories of owner occupied commercial real estate enjoyed a new chapter this week. Two of my dear manufacturing clients purchased their business home in 1995. In the ensuing twenty-five years exponential appreciation has occurred. By their admission - the address is worth three times the value of the business it houses. Finally, a suitor for the company has gained favor. A sale of the assets may occur soon. The terms and conditions of the leaseback are critical. Potential investors for their real estate holdings will look at the lease rate in comparison to market, the length of the lease, and the maintenance expected of the owner. Even if there is no interest in spinning the parcel today - these issues need discussion.

 Everyone is agreeable - until they aren’t. One of my clients was approached by his neighbor. They struck a handshake deal. Unfortunately - the agreed upon rate, term of lease, and extension rights don’t provide my client with a lot of latitude. He’s bound to dealing with the expanding neighbor if he wants or has to sell - at a pre-determined price and time.

 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.

 

Position YOUR Purchase Offer for Success! FIVE Ways.

As previously mentioned - industrial real estate - those buildings geared for manufacturing and logistics warehouse providers, is on fire in Orange County! These are typically constructed out of concrete, located on little known city streets such as Blue Gum, Coronado, Carnegie, and Capricorn, and house companies that make and ship things. But, as the term on fire means different things to different folks not related to our industry - I believe it’s important to offer some context.

2020 - the year of the pandemic is now over 80% complete. Costco has Christmas decorations - and socially distanced Halloween isn’t yet a memory. What? You’ve not yet strung your lights? But, I digress. Since January, 15 sales have occurred - on industrial buildings greater than 50,000 square feet within the 34 Orange County, California cities. These from approximately 868 existing units in this size. Excluded from these statistics are lease transactions - another conversation. But, in 2020, suffice to say - 15 sales, 868 buildings 50,000 sf and larger - 1.7% of the base inventory sold. Wow! Now. How many 50,000+ sale availabilities are there? Care to hazard a guess? If you guessed 5 - you’d be spot on. Viewed another way - only a bit more than 1/2 of a percent (5 available, 868 exist) is ready to receive your offer to buy. To add some historical perspective, during the last pause in the action - 2008-2009 - there were 22 buildings for sale (50,000+) along La Palma Avenue in East Anaheim ALONE! My, my. Look what 10 years of robust growth has done to our stable of sale availabilities!

You may be thinking, so what? What’s caused this and how does this affect my plans to purchase in 2021? The causes are two fold. Increased demand and the lowest borrowing rates in decades - maybe ever! If your plans include testing the sale market in 2021 - please be prepared for pitiful supply, intense competition, multiple offers, and lenders that scrutinize every debit. Please don’t enter the fray unprepared for the environment that exists in today’s sale market. Sure. You can consult with your banker and get pre-qualified - a MUST. Maybe now is the time to wait - after all, can this overheated frenzy last for years? Leasing for a period of time until the fever ends might work out well. If you’re adamant about buying - have you considered these things?

Your Representative. Recently, we found ourselves in competition for a site. Our buyers were well qualified and motivated. But, akin to straight A+ students competing for limited grad school spots - ALL of the buyers were well qualified and motivated. We won the deal based upon a twenty-five year relationship we had with the seller’s broker. He knew us, trusted our word, and advocated for our buyer with his seller.

Your Story. In today’s sale arena - the back story is critical. We came in second last week. Second is first loser and doesn’t pay very well in commercial real estate brokerage. Why, you may ask? We got “out storied”! Sure, I crafted the reasoning for pursuing the building along with our track record of successful purchases with this buyer. What won the day? The neighbor. It seems he’s been trying to buy the building forever. Tough to compete.

Your Differentiator. We were honored to represent a family last month in their purchase of an income property. They didn’t need financing. Proceeds were in the bank awaiting the right deal. Short due diligence and a quick close could be accomplished. Tack on - we were prepared to offer asking price and no one could touch us.

Intangibles. In the previous examples - intangible factors existed - a twenty five year relationship, the neighbor as the buyer, and tax deferred exchange motivated capital. If you dig deeply into why one buyer was chosen over another - in many cases an intangible is the reason. Sometimes it boils down to a gut feel. Trust those!

Other Directions. What alternatives are available with a lease? Maybe a short term with an option to buy may be structured. How about adjacent states of Nevada, Arizona, or Oregon? We’ve witnessed several occupants exodus California in favor of a tax friendlier area. Buildings are cheaper in some of our inland markets such as Riverside and San Bernardino counties - although the gap is narrowing. Could you shorten a contingency period? How about paying cash today and refinancing later? Factors like these can give you an advantage.

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 commercial real estate lease terms are normally negotiated?

In any given year - as a commercial real estate professional - approximately 50 to 85% of our transnational volume is generated from lease originations and lease renewals. The balance occurs with sales. Certainly this is an industry average and the percentages vary based upon an agent’s specific expertise. Simply, if the niche is tenant representation - the deals completed each year will be all leases. Conversely, selling Single Tenant Net Leased (STNL) investments yields all sales. Today, I’d like to delve into some specific terms typically negotiated during a lease transaction. I’ll break these down into new leases and renewals - similar yet different deals.

New deals. As defined - a transaction which involves a relocation from point A to point B. These deals are about half of the lease transactions that occur in a market during a given year. Covered during most negotiations are the following points:

Term of lease. For leased premises fewer than 5000 square feet, we will see 2-3 year terms. As the square footages increase, so do the number of years. For a 100,000+ square foot building, we generally ask for a much longer term - maybe a five year minimum up to ten. The rationale for this is pretty straightforward. Bigger spaces can lay fallow for longer periods of time which is costly. Therefore, owners of large buildings want a secured term for a longer period of time.

Form of lease. Many are unaware that you can ask an owner for a specific form of lease. Standard forms include those produced by the AIR-CRE or the California Association of Realtors. As deal sizes increase we see a preponderance of owner generated leases.

Commencement of lease. The start date of the lease is an important part of any lease negotiations. We try to marry this with the expiration of the existing location. If successful, any sort of double rent payment is avoided.

Possession of the premises. In some cases tenants are given occupancy prior to the commencement of the lease. This is known as “Early Possession”. It’s not uncommon to see early possessions of 30 to 45 days prior to the commencement of the lease.

Lease rate. A critical component of any lease negotiation is the lease rate and monthly rent that will be paid throughout the term. Rent amounts may include the operating expenses - such as property taxes, property insurance, and common area maintenance - also known as an industrial gross lease or an office full service gross lease. An agreement net of these operating expenses which is known as a triple net lease.

Increases in rent. Standard in any multi year lease would be an increase in rent throughout the term. 2 to 3% annually would be found in today’s market place. Rarely do we see changes in lease rates as they occur in the consumer price index - the reason for this is the increases are too difficult to compute.

Tenant improvements. Any sort of office additions, power distribution, changes in the parking, or general cleanup and painting should be clearly outlined in the tenant improvement ask. Most leases provide a warranty for the systems within the building such as air-conditioning, roof, plumbing and other mechanical systems. However, it’s very important to specifically outline the condition with which the building should be left prior to occupancy.

Free or abated rent. In robust times like we’re seeing industrially - free or abated rent would encompass many fewer months than in more difficult economic times. As a landlord’s motivation increases so does the amount of free or abated rent he is willing to consider. Half to one month per year of the term is pretty standard.

Extension rights. What happens at the end of your lease? That question is answered via extension rights. Whether they are a Right of First Refusal to Extend, a Right of First Refusal to take additional space, a Right of First Offer for additional space or some sort of an Option to Extend or Purchase or an option to purchase arrangement - all can be found in the request for an extension right.

Miscellaneous. Many large corporate leases will have opt-out or termination clause within their leases. Some also might include an allowance for moving expenses, a must take provision whereby a tenant agrees to lease a smaller square footage today in return for an absolute agreement to expand into additional square footage in the future.

Lease renewals. The biggest difference between a lease renewal and the origination of a new lease is the tenant is currently in residence and desires to stay. Therefore many of the terms and conditions above or non-applicable. Things such as the miscellaneous category which includes termination rights are probably not included in a lease renewal. Many times free or abated rent are excluded. But the length of term, the lease rate, and in certain cases clean- up or a small allowance for carpet are included within at lease renewal. One word of caution with respect to your renewal - please don’t try this at home! Even if you have a wonderful relationship with your landlord, it’s always best to have representation by a commercial real estate professional who is familiar with market conditions and can advise you 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.

 

Are 1031 Exchanges at RISK?

As we have now surpassed Labor Day in the election year of the pandemic 2020 - expect political rhetoric to reach a fever pitch. Sorry. Pun intended. As our nation slowly recovers from business lockdowns, distance learning, storms along the gulf coast, wildfires in California, and upheaval in our streets - and governments respond monetarily to stem the bleeding - expect the next question to be - “how on earth can we possibly pay for all of this?”

 California has proposed a 16.8% marginal tax through AB-1253. Targeted are those who earn more than $5,000,000 annually. Who cares, you may ask. They should pay their fair share. What’s another 3.5% of their income to help the greater good? Consider this, please. Many small business owners could tip this scale and face the extra burden. How long will they remain in California when Nevada, Texas, and Washington have ZERO state income tax? If we export a significant amount of our tax base - who’ll be left to foot the tab?

 Proposition 15 - on the California ballot in November - proposes to split the property tax roll and tax commercial properties differently than residential parcels. I’ve written ad nauseam about where the ultimate bill will be paid. Yep! By you as the consumer of goods and services. You see - if the cost of commercial real estate rents rise through an increase in property taxes - businesses who occupy the industrial buildings, office space, and retail storefronts will be forced to pass that expense along to their customers - you.

 A target for a significant tax grab could also be the way in which capital gains taxes are deferred through 1031 exchanges. I’ve not seen any storms massing on the eastern horizon - but it’s always calmest - so the saying goes.

 Congress could propose an elimination of this “loophole” and generate billions in tax revenue. It currently works like thus. If you sell a piece of income property - you are allowed to defer your long term capital gains taxes. Simply, you enter a contract to sell, create a qualified intermediary before you close, close, net sale proceeds go into an accommodator account, you identify upleg purchases within 45 days from close, and buy the upleg(s) at the earlier of 180 days from close or the filing date of next year’s tax returns. Easy! Literally thousands of these are done each year. Deferred are Federal long term capital gains of 15-20%, depreciation recapture of 25%, California state taxes on Capital Gains of $13.3%, and 3.8% for the Affordable Care Act. A whopping amount! Assumed is - if we tax those sales today vs allowing a deferral - think of the revenue we’d generate!

 Good in theory - but here’s the rub.

 When I visit with owners of commercial real estate about the likelihood of selling their property - I’m asked this question. If I sell, what will I do with the proceeds? After all - I don’t want to pay close to half my gain in taxes! We then have an in-depth conversation about tax deferred exchanges. So if Congress were to change the rules or disallow 1031 exchanges altogether - sellers would be left with very little motivation to sell. 

Some might say - this argument is quite self serving. After all, this guy is paid to sell commercial real estate. True enough. However, please don’t forget the multitude of industries who benefit from the sale and purchase of commercial real estate. Title companies, escrow holders, transactional lawyers, CPAs, qualified intermediaries, lenders, property inspectors, environmental engineers, contractors all drink from the trough of a commercial real estate transaction. Behind the scenes are real people - with families - whose livelihoods depend on property sales.

 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.

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.